Should We Give Away the Annual Exclusion?

Abstract

United States gift tax law imposes on the transferor a tax at rates of up to fifty percent on property transfers made during the transferor's lifetime for less than full and adequate consideration in money or money's worth. The tax is calculated on the basis of the fair market value of the property transferred, determined as of the time of the gift. The gift tax is a supplement to the federal estate tax, which is imposed on transfers of property at death at rates up to fifty percent. If there were no gift tax, the estate tax could be substantially avoided by making lifetime gifts. Neither lifetime gifts nor testamentary bequests of property are subject to income tax in the hands of the transferor or the transferee.
There are several exceptions to the gift tax, one of which is the annual exclusion. The annual exclusion permits an individual to make gifts of up to $10,000 a year to any number of persons without incurring any gift tax. The annual exclusion is available only if the donee is given a present right of possession or enjoyment as to the value with respect to which the exclusion is claimed. As is demonstrated below, the annual exclusion can be used, both directly and indirectly, to permit very large amounts to escape the federal transfer tax system. Yet, at the same time, the annual exclusion is not large enough to protect some types of transfers that should be protected from gift tax. In addition, as it is currently designed and used, the annual exclusion injects vertical inequity into the transfer tax system and contributes to horizontal inequity that exists in the system.