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A gift is the voluntary transfer of property or funds to another without receiving anything of value in return and without conditions attached while both the giver and the recipient are still alive. The gift giver (donor) must understand the nature of the act and have a voluntary intent to make a gift, called a donative intent. There must be either physical or symbolic delivery of the gift and actual or imputed acceptance by the donee. Large gifts are subject to the federal gift tax, and in some states, to a state gift tax. However, a person or entity can give any amount – no matter how large – to a qualified charity completely tax-free. A gift in contemplation of death is a gift of personal property (not real estate) by a person expecting to die soon for natural reasons. Federal tax law will treat this gift as part of the estate if the giver dies within three years of the gift. Treating the gift as made in contemplation of death has the effect of including the gift in the value of the estate, rather than making the gift subject to a separate federal gift tax charged the giver. If the giver recovers from an apparently fatal illness, the gift is treated like any other gift for tax purposes. A gift deed is a deed in which the consideration is not monetary, but is made in return for love and affection. It is a document which transfers property to another as a gift. Such a deed is often used to present someone with a gift. Transfer of a gift deed can be reported as a gift for federal tax purposes.
A person's taxable estate is defined as the gross estate less allowable deductions. Gross estate means the value of all property in which the decedent had an interest at the time of death. The gross estate includes life insurance proceeds payable to the estate or the heirs, the value of certain annuities payable to the estate or heirs, and the value of certain property transferred three years or less prior to death. The taxable estate includes the value of all property and assets owned at the time of death plus any gifts made in the three years prior to death.
Estate tax is imposed on the transfer of property based upon the net value of a decedent's estate. Congress has approved a schedule that increases the amount an individual can leave to heirs tax-free to $1.5 million in 2004 and eventually to $3.5 million in 2009. In some states, the tax is imposed on the receipt of the property by the heirs, rather than the decedent's transfer, and is called an inheritance tax. Estate taxes are a form of transfer tax because it is based on the transfer of title to property, rather than the property itself.
Gift taxes are taxes that supplement the estate tax. Gift taxes are placed on gifts given away to any person while the giver is still living, so that the giver may not avoid estate taxes by making gifts of his or her estate. The annual exclusion applies to gifts to each donee. In other words, a person may may give up to $11,000 in 2002-2005, $12,000 in 2006-2008, and $13,000 on or after January 1, 2009. Married couples can give, as a couple, $22,000 to each donee (2002-2005) or $24,000 (2006-2008), $26,000 (effective on or after January 1, 2009). Under federal tax law, gifts totaling more than these amounts to one person in one year are considered a taxable gift and generate a potential gift tax. Gifts of a "future interest", no matter what their value, also are considered a taxable gift. Gifts beyond the exclusion limit (there is an exception for gifts that are directly paid by the gift giver for tuition and medical expenses) are considered "taxable gifts." Taxable gifts create liability for a gift tax.
Most gifts above the annual exemption are still not subject to tax because each taxpayer is allowed a lifetime credit against taxable gifts and estate. This credit reduces or eliminates the amount of taxes owed. A unified credit applies to both the gift tax and the estate tax. The unified credit is subtracted from any gift tax owed by the taxpayer. Unified credit used against a gift tax in one year reduces the amount of credit that can be applied against a gift tax in later years. The total amount used against a gift tax reduces the credit available to use against estate tax. In other words, any unified credit not used against gift tax during the taxpayer's lifetime is available to reduce or eliminate an estate tax. This credit has the effect of exempting $1 million from tax.
The recipient of a gift or an estate is not liable for the gift or estate tax. An estate's executor is responsible for payment of any estate tax that is due; the donor is responsible for payment of a gift tax, if one is due. Moreover, gifts and inheritances are not subject to income tax.