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Give gifts to family while you’re still in good health

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Talk of permanently repealing the federal estate tax has died down. So you still have to plan for the likelihood that the estate tax will be revived, under less favorable terms, after it vanishes for just one year in 2010.

Strategy: Be proactive. Take full advantage of the annual gift-tax exclusion each year. This can slash a future estate-tax bill or wipe it out completely.

If your family will still owe federal estate tax upon your death (see related article), the impact will be softened by the federal estate-tax exemption in effect for that year.

Caution: It’s best to start a gift-giving program while you’re in good health. Otherwise, the IRS may question its validity. In particular, the IRS is suspicious of certain “deathbed gifts” (see related article).

If you haven’t already done so, begin giving generous gifts to family members this year. Under the annual gift-tax exclusion, you can give each recipient up to $12,000 per year without paying any federal gift tax. This exclusion doubles to $24,000 a year for joint gifts by a married couple.

Example: Say you have three adult children and seven grandchildren. If you and your spouse give each one the maximum $12,000 this year, you can transfer $240,000 ($24,000 x 10) free of gift tax. By systematically using this technique, you can reduce your taxable estate by $1.2 million ($240,000 x 5) in just five years.

What’s more, you also can use your lifetime gift-tax exemption of $1 million to shelter gifts above the annual gift-tax exclusion. But this reduces the available estate-tax exemption. Currently, the effective estate tax shelter is $2 million for decedents dying in 2007 with a maximum tax rate of 45%. The exemption amount is scheduled to increase to $3.5 million for 2009 before the estate tax is repealed in 2010—and 2010 only. Bad news: When the estate tax returns in 2011, the available estate tax shelter will be only $1 million.

Once you transfer amounts to family members through gifts, subsequent income generated by the funds is taxed to the recipients. Assuming most— or all—of the family members are in lower tax brackets than you are, the overall income-tax savings for the family can be substantial.

Caveat: To the extent that the unearned income of a grandchild under age 18 exceeds an annual threshold ($1,700 for 2007), the excess is taxed at the top marginal tax rate of the grandchild’s parents. Beginning in 2008, the reach of this so-called “kiddie tax” is generally being extended to children under age 19; under age 24 for full-time students (see SBTS, July 2007).

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