A program of lifetime giving will go a long way toward reducing the size of your gross estate, minimizing the federal estate tax upon your death. The tax law allows you to annually gift $12,000 ($24,000 if you are married) to as many beneficiaries as you’d like, tax free. This is known as the annual gift exclusion.

If both spouses choose to gift $24,000, this is known as a split gift. You must file a gift tax return, form 709, to show that you and your spouse agree to use gift splitting. This form must be filed in the year that the gift was made, even if half of the split gift is less than the annual exclusion amount of $12,000 apiece. You can locate IRS tax form 709 at www.irs.gov/pub/irs-pdf/f709.pdf. 

If you have accumulated an estate worth more than $1 million ($2 million for a marital estate), any amount left in the gross estate over that is subject to the federal estate tax, which can be anywhere from 18 percent to 45 percent for 2008. The tax is graduated upward and is dependent on the amount of overage. This $1 million/$2 million amount is known as the unified credit and is allowed to pass after your death estate tax free.

Before the federal estate tax is determined, your gross estate will be further reduced by funeral expenses, estate administration expenses, your personal debt, claims against the estate, uninsured theft and casualty losses, charitable contributions, and the marital deduction. The marital deduction is the amount of assets you pass on to your spouse. This is a tax-free transfer that does not need to be reported on form 709. The amount that can be transferred to a spouse is unlimited.

Income-producing assets can be shifted from your higher income tax bracket to a child or grandchild in a lower income tax bracket. Any transfer of assets over the $12,000/$24,000 limit will trigger the federal gift tax, which can be paid in the year it was given or subtracted from your unified credit upon your death. The taxable gifts must be reported on form 709. If you die within three years of making the gifts, they go back into your gross estate and are subtracted from your unified credit amount. This is known as the Gross-Up Rule.

Certain types of gifts are excluded from the gift tax rule. Those include gifts to charities and political organizations. Tuition and medical expenses that you pay directly to the educational or medical institution on behalf of a loved one or friend are also exempt from the gift tax rule for expenses that qualify. This type of gifting allows you to transfer wealth tax free while decreasing the size of your gross estate. You can contribute up to $4,000 a year to a Roth IRA for an employed child or grandchild. While the contribution is not a tax deduction, it is a tax-free gift because it is well within the $12,000/$24,000 limit, and it grows income tax free.

While there are many benefits to a program of lifetime giving, there are a few disadvantages. The cost basis for assets that have increased in value are revalued on the date of your death, eliminating the capital gains on appreciated assets such as stocks, bonds, or real estate that you leave to your heirs. This is known as step up in cost basis. If these appreciated assets are gifted in your lifetime, your heirs lose the benefit of the step up in cost basis and assume your original cost as well as the burden of the capital gains tax. Gifting valuable assets could put you over the $12,000/$24,000 per beneficiary a year limit, triggering an out-of-pocket tax payment if you want to leave your unified credit amount intact. Finally, there is always the chance that tax law changes may be more favorable in the future.