The Gifts That Keep on Taking: How to Navigate the Gift Tax

The idea of a gift tax may seem like a cruel joke -- and it may be, albeit one aimed at the wealthy.

The vast majority of gifts go untaxed, but for those particularly generous souls, there are a few things to keep in mind as you prepare your income tax return.

Most gifts are simply that: transfers of money or property with no strings attached. (No strings on the part of the Internal Revenue Service, anyway.) But gifts that exceed $11,000 start getting tricky.

Big-money gifts to anyone other than your spouse (provided that your spouse is a U.S. citizen) could trigger some estate issues. Generally, if you think you're going to be subject to the estate tax, you're better off whittling down your estate by giving money away during your lifetime, even if that means incurring a gift tax. That's because of how the gift and estate tax (linked in the tax code) are calculated ... but that's a topic for another article.

Let's make one important distinction, though: When financial planners and journalists refer to "tax-free gifts of up to $11,000 per person," the tax referred to is the gift tax, not the income tax. You don't get to deduct the amount of the gift from your income. Because you're not getting a tax break, though, that means the recipient does -- the gift's recipient won't owe any income tax on the gift amount.

If you exceed the tax-free limit of $11,000 per person ($22,000 per person for married couples), you'll have to file a Form 709 along with your income tax return. The form is due by April 15, the year after you made the gift. If you file for an extension for your income tax return, though, the extension also applies to the gift tax return.

Filing the form, though, doesn't equate to paying the gift tax. Because the gift tax is essentially the same as the estate tax, you can give up to $1 million (under current law, moving up to $3.5 million by 2009) over the course of your life without actually owing any tax -- you're simply using up the estate tax exemption.

There's no limit to the total amount you can give in a year. The limitation applies only to how much you can give to one person. A couple with four kids and eight grandkids can give up to $22,000 per child and grandchild. And there's no restriction about the relationship of the giver and recipient, either -- if you're feeling particularly generous one year, you can give up to $22,000 to every neighbor on your block without running afoul of the gift tax.