Dear Clients and Friends:

Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees through the proper use of the annual gift exclusion.

The amount of the exclusion for 1999 is $10,000. The statutory exclusion amount of $10,000 is adjusted annually for inflation beginning with the year 1999. However, because the inflation adjustment requires that the exclusion amount always be rounded to the next lowest multiple of $1,000, the $10,000 amount won't increase to $11,000 until the inflation adjustment is at least 10%. The exclusion amount didn't increase for 1999 and, at current levels of inflation, it may be several years before the exclusion will rise to $11,000. Therefore, the illustrations I use in this letter assumes that the amount of the gift tax annual exclusion is $10,000.

The exclusion covers gifts an individual makes to each donee each year. Thus, a taxpayer with three children can transfer a total of $30,000 to them every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $10,000, the exclusion covers the first $10,000 and only the excess is "taxable". Further, even "taxable" gifts may result in no gift tax liability thanks to the unified credit. (Note, this discussion is not relevant to gifts made by a donor to his spouse because these are tax-free gifts under separate marital deduction rules.)

If the donor of the gift is married, gifts to donees made during a year can be treated as "split" between the husband and wife, even if the cash or gift property is actually given to a donee by only one of them. By gift splitting up to $20,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $120,000 each year to their children and the children's spouses ($20,000 for each of six donees).

Where gift splitting is involved, both spouses must "consent". Consent must be indicated on the gift tax return (or returns) the spouses file. The IRS prefers that both spouses indicate their consent on each return filed. (Because more than $10,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $20,000 exclusion covers total gifts.

For a gift to qualify for the annual exclusion, it must be a gift of a "present interest" meaning the donee's enjoyment of the gift can't be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while he's alive and donee B is to receive the principal at A's death, B's interest is a "future" interest. Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $10,000 of its total value will not be taxed. However, the gift of the other interest (called a "remainder" interest) is a "taxable" gift in its entirety.

Exception to present interest rule: If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he reaches age 21 and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

"Unified" credit for taxable gifts: Even gifts that are not covered by the exclusion and that are thus "taxable" may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first $650,000 of taxable gifts you make in your lifetime. (The $650,000 amount, which applies in 1999, will gradually rise to $1 million by 2006.) This credit, however, applies both for gift and estate tax purposes (that's why it's called "unified"). Thus, to the extent you use it against a gift tax liability, it is reduced (or eliminated) for use against the federal estate tax at your death.

Please call (315) 363-3338 if you wish to discuss this area further or have questions about related topics.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner