The gift tax is unique in the federal tax structure. On the one hand, it is imposed annually. On the other, it is a cumulative lifetime tax. Because it is closely linked with the estate tax, and many of the concepts are shared, an understanding of the gift tax is helpful in understanding estate tax issues.
I. Determine Your Total Taxable Gifts for the Year

A. Determine your total gifts

Add up all gifts made to all parties during the year In general rules of property, a "gift" is a transfer without *any* consideration (exchange or payment). If there is any consideration, the transaction is governed by the laws of sale, rather than gift. For tax purposes, a gift is a transfer for insufficient consideration (but a bad deal in ordinary business is not a gift). Thus, I may transfer to you a 1998 Rolls Royce and a 1993 Toyota for $10,000 each. Both are "sales". From the tax standpoint, the first is a gift from me to you and the second a gift from you to me.

One problem is that the Internal Revenue Code uses "exclusions" in several senses. You may exclude from calculation -- need never even bring them into the figuring -- certain gifts for tuition and for medical care. This was introduced relatively recently as soaring tuition costs put parents in the position of making taxable gifts when paying for college tuition for persons they were not legally required to support. That's adding injury to injury.

On the other hand, you may also "exclude" gifts which do not exceed $11,000 (it used to be $10,000 -- you may have that in mind -- but the law was changed to allow adjustment for inflation) to any particular person in any given year. That is, you needn't even report these (they'd come out anyway in the calculation). For the details, see below.

B. Spouses may elect to "split" gifts

There is not a joint gift tax return. Each spouse reports his or her own gifts on their own returns. However, they may elect to treat all (it's an all or nothing proposition) gifts made during their marriage period during the year as made half by each. Each spouse signs the other's return, consenting to splitting. So if A and B got married on June 1, and B died on September 30, all gifts made by either of them between June 1 and September 30 would be split. Gifts made outside that period would be treated as having been made equally by each. At this point in the calculation, each spouse may subtract from their total, the half which is being reported by the other spouse and pick up the amount of the spouse's gifts which they are reporting.

C. Subtract exclusions

Not the tuition and medical care -- those weren't even reported to begin with. Nor the gifts of under $11,000. But what about that $16,000 gift? You were required to report it. But if it had been $11,000 it wouldn't have been taxable. So at this point, you may subtract the exclusion amount and only the excess will be in your return. And if you split with your spouse (and they didn't make gifts to the same person), there's only $8,000 left in your calculations, so the whole thing gets subtracted out (sorry, you can only subtract the lesser of actual gifts or $11,000 -- you can't apply that remaining $2,000 to gifts to someone else).

Until now, we've been treating the exclusion as just mathematical -- $11,000 per person. But not all gifts qualify for the exclusion to begin with. The gift must not be a future interest. So a gift of $3,000, if a future interest, might not be excludable to begin with. What constitutes a future interest is a complex matter that's been the subject of much litigation. A couple of simple rules will clarify most cases. An outright gift is not a future interest. A gift to a minor in a Uniform Transfers to Minors Act Custodianship is not a future interest. Most gifts in trust are future interests,  although special planning and drafting can cure that with the use of Crummey powers.

But even though there may be no taxable gift, there may still be a generation-skipping transfer. Gifts which are excluded from gift tax because of Crummey powers are not exempt from GSTT and you may still want to file a return to use some of your exemption.

D. Subtract Deductions

Gifts to your spouse which qualify for the marital deduction are subtracted. So are gifts to charity.

E. Voila!

You have now calculated the total taxable gifts for the year.

So what?

II. Determine the Gift Tax on This Year's Gifts

A. Take your previous total of lifetime gifts

B. Determine new total lifetime taxable gifts

C. Add this year's gifts to your cumulative total of taxable gifts.

D. Determine the tax on the new total

See the Tables

E. Subtract the amount of tax payable on the old total

F. Result is the tax on this year's gifts

Why so complicated? Why couldn't we just calculate tax on this year's gifts? Because

The gift tax is cumulative

The gift tax is progressive -- you need this calculation to find out what bracket you're in.

You have a lifetime shelter (see below) and this keeps track of its use.

G. Subtract the amount of unused credit

Each taxpayer gets a lifetime credit against gift tax. The credit is calculated as that amount necessary to result in the exemption amount of $1,000,000 [Some genius figured out that if they gave everyone a $1,000,000 exemption (actually this thinking started when the exemption was a lot smaller), it would save more money for those in the higher brackets. A credit reduces everyone's tax dollars by the same amount.] Although the amount of *estate tax* exemption will be increasing to $3,500,000 See the Tables and then after one-year repeal returning to $1,000,000 the gift tax exemption will remain at $1,000,000 except during the time of repeal. See the Tax Act of 2001.

H. Write a check for any gift tax actually payable

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