Amid political uncertainty, you can't know whether the federal estate tax will be eased or even repealed altogether. In this situation, it makes sense to reduce your taxable estate.

You can do so by giving away assets. A gift tax applies, but you can find shelter by using the annual gift tax exclusion and the lifetime gift tax exemption. These tax breaks enable you to shed assets from your estate without paying tax.

Split decision
Married couples have double exclusions and exemptions. If the assets given away come from only one spouse, the couple can elect to "split" gifts.

Despite the term, spitting gifts doubles the giver's tax shelter, rather than halving the tax benefits. The annual gift tax exclusion, now set at $12,000 per year per recipient, effectively increases to $24,000 with gift splitting. Suppose, for example, a hypothetical Jane Smith has three children. She can give them a total of $36,000 worth of assets in 2008 ($12,000 to each) in addition to any payments she makes for medical bills or school tuition.

In this example, Jane can make that $36,000 worth of gifts without owing gift tax. She won't even have to file a gift tax return. Jane's husband Bob also can give a total of $36,000 to their three children this year. With such gifts, twice as many assets can be removed from their estates in 2008, tax free. This is true even if Bob has minimal assets in his own name and scant concerns about estate tax. By gift splitting, this couple can make the most of their combined gift tax exclusions.

Doubling up
To split their gifts, Jane could give each child up to $24,000 this year, not $12,000. Then Bob would elect to join in the gift. This election is made on a gift tax return. The split must be 50-50 and both spouses must consent to this election.

By consenting, Bob effectively gives $12,000 to each child this year. He uses up his exclusion and cannot make any other tax-free gifts to the children in 2008.

To qualify for gift splitting, spouses must meet certain conditions:

• Both spouses must be U.S. citizens.

• Neither spouse can remarry during the year.

• All gifts made by either spouse to any recipients during the year must be reported as being split 50-50.

Exceeding the exclusion
Suppose you'd like to give more than $24,000 per recipient this year. Gift splitting can still be used as you eat into your lifetime $1 million gift tax exemption.

Suppose, in the above example, Jane and Bob's oldest child, Lynn, wants to buy a house. Jane decides to help by giving Lynn $300,000. One approach is for Jane to use her $12,000 exclusion and go over the 2008 limit by $288,000. If Jane has made no other taxable gifts, she will owe no gift tax.

That doesn't mean this large gift will be tax free, however. Jane's $1 million lifetime gift tax exemption will be reduced by $288,000, reducing her remaining gift tax exemption from $1 million to $712,000. What's more, that $288,000 taxable gift will shrink Jane's estate tax shelter. Suppose Jane dies next year, when the federal estate tax exemption is $3.5 million. Assuming Jane has made no other taxable gifts, her estate tax exemption would be reduced by $288,000, from $3,500,000 to $3,212,000.

Gift and Estate Taxes
	Exemption Amount
Year	For Gift Tax Purposes	For Estate Tax Purposes
2008	$1 million	$2 million
2009	$1 million	$3.5 million
2010	$1 million	Unlimited
Sources: IRS, American Bar Association

 

Instead, Jane and Bob could choose to split the $300,000 gift. Then $24,000 will be covered by the annual exclusion. The excess $276,000 will reduce their lifetime gift tax exemptions and their estate tax exemptions by $138,000 apiece.

Powerful payoff
Gift splitting enables a married couple to give away up to $2 million worth of assets, over and above the amounts sheltered by the annual exclusion, free of the gift tax. Subsequent to the gifts, that $2 million worth of assets might grow to $4 million, $8 million, or more. All of that potential appreciation will escape estate tax.

Of course, you shouldn't give away assets that you or your spouse might need for your own well-being.

Wasted efforts
Gift splitting also may be used for gifts to trusts. Even if the annual $12,000 exclusion can't be used, in some cases the $1 million lifetime exemption may be employed.

However, you should not split gifts to certain types of trusts, including qualified personal residence trusts (QPRTs), grantor retained annuity trusts (GRATs), and grantor retained unitrusts (GRUTs). If you split gifts and the grantor dies during the trust term, the other spouse will lose valuable tax benefits. Suppose, for example, Paul Jones creates a GRAT and transfers assets into it. Based on current interest rates and the duration of the term, the value of the transfer is placed at $400,000.

Paul and his wife Ann split the gift, effectively using up $200,000 apiece of their gift tax exemptions. If Paul dies before the trust term, the trust assets would go back into his estate and the $200,000 worth of gift tax exemption that he used would be restored. However, Ann would not get any refund or tax relief. Thus, she would have used up $200,000 worth of gift and estate tax exemption and received no benefit.

For these types of trusts, one donor should bear all the gift tax consequences.