Magazine article The CPA Journal

Gift Taxes: Beyond the $325,000 Exemption Increase

Magazine article The CPA Journal

Gift Taxes: Beyond the $325,000 Exemption Increase

Article excerpt

ESTATES AND TRUSTS

MAXIMIZING LIFETIME GIFTS IS ONE HALLMARK of a good estate plan. A common strategy is to make annual exclusion gifts; another is to use up the gift tax exemption during the taxpayer's lifetime.

The Economic Growth and Tax Relief Reconciliation Act of 2001 increased the gift and estate tax applicable exclusion amount to $1 million, effective January 1, 2002. The gift and estate tax continue to have the same graduated rate structure, but the maximum rate, currently 50%, will decrease to 45% by 2007. The gift tax exemption will remain at $1 million, however, while the estate and generation-skipping transfer (GST) tax exemptions will increase to $1.5 million in 2004 and reach $3.5 million in 2009.

Under prior law, the gift and estate tax exemptions were the same and the GST exemption (originally $1 million) was indexed for inflation. For 2001, the gift and estate tax exemption was $675,000 and the indexed GST exemption was $1,060,000. Under current law, the 2002 gift and estate tax exemption is $1 million and the indexed GST exemption is $1,100,000.

Maximizing lifetime gifts is one hall>mark of a good estate plan. A common strategy is to make annual exclusion gifts (currently $11,000 per donee; $22,000 if gift-- splitting); another is to use up the gift tax exemption during the taxpayer's lifetime.

Taxpayers that have already made $675,000 of taxable gifts should consider taking advantage of the increase in the exemption by making additional gifts of as much as $325,000. No additional gift tax will be incurred on this amount by taxpayers whose cumulative lifetime taxable gifts do not exceed $1 million in 2002 or 2003. Some such taxpayers, however, may owe some gift tax on an this additional gift because of the cumulative nature of the gift tax as well as its graduated rate structure. Taxable gifts from $675,000 to $750,000 are subject to the 37% rate. Gifts from $750,000 to $1 million are taxed at the 39% rate. This graduated rate structure means that the $325,000 exemption increase is equivalent to a $125,250 applicable credit increase, computed on the first $1 million of cumulative lifetime taxable gifts. But if a taxpayer's taxable gifts are taxed at a higher effective rate, such that the tax before the credit is more than $125,250, there will be a gift tax liability.

Example 1

John has made $750,000 of cumulative lifetime taxable gifts, using his $675,000 exemption equivalent and paying gift tax of $27,750 (37% of $75,000). He is thinking of making an additional nontaxable gift of $325,000 in 2002. Because he has already exhausted the 37% bracket, the precredit tax on this gift is would be $128,250. Since the additional credit is only $125,250, John would owe $3,000 of gift tax. To avoid paying any gift tax, John should limit his taxable gift to $317,683 (on which his precredit tax would be $125,250).

The maximum amount of tax-free gift that can be made in 2002 also depends on when prior taxable gifts were made. Unused prior year exemption increases can protect a larger amount from gift tax this year.

Example 2

Mary made all $750,000 of her cumulative lifetime taxable gifts in 1999, when the exemption was $650,000. She thought that the maximum tax-free gift she could make this year would be $325,000, but actually she can give as much as $340,244 in 2002 without paying any gift tax. …

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