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2011 Gift Tax Exclusion - Annual Exclusion vs. Lifetime Exemption

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Recently I met with a new client who was really confused about gift taxes. The client mistakenly thought that under the provisions of the new estate and gift tax laws for 2011 and 2012 he can give away $5 million to his daughter over the next two years and won't suffer any tax consequences at all. He also mistakenly thought that Congress was extremely generous in raising the $13,000 annual gift tax exclusion to $5 million for the next two years.

Unfortunately I deal with this confusion often because the federal gift tax has two "exclusions" or "exemptions" associated with it, one that applies on an annual basis and one that applies over the taxpayer's entire lifetime. The former is commonly referred to as the "annual gift tax exclusion" and the latter is commonly referred to as the "lifetime gift tax exemption."

The annual gift tax exclusion is the amount that can be given away by a taxpayer in any one year to any number of people free from any federal gift tax consequences at all. In other words, a lump sum gift or even a series of smaller gifts made to the same person during the course of a year that don't exceed the annual gift tax exclusion aren't really considered gifts at all - they're simply considered "freebies" when it comes to federal gift taxes. For 2011, the annual gift tax exclusion is $13,000.

In contrast, the lifetime gift tax exemption is the amount that can be given away by a taxpayer over his or her entire lifetime to any number of people that will be free from gift taxes but will reduce the amount that can be given away by the taxpayer tax free after death. In other words, the lifetime gift tax exemption is tied directly to the federal estate tax exemption such that if you gift away any amount of your lifetime gift tax exemption, then this amount will be subtracted from your estate tax exemption after you die. For 2011, the lifetime gift tax exemption is $5,000,000, which is the same as the federal estate tax exemption.

Confused? Don't worry, you're not alone. In my experience gift taxes are by far the most misunderstood and complicated of all of the taxes out there. If you're not sure about your gift tax liability, then consult with your estate planning attorney or tax advisor.

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