Making Gifts: The $13,000 Rule

One simple way you can reduce estate taxes is to give some or all of your estate to your children (or anyone else) during their lives in the form of gifts. Certain rules apply, however. There is no actual limit on how much you may give during your lifetime. But if you give any individual more than $13,000 (in 2009), you must file a gift tax return reporting the gift to the IRS. Also, the amount above $13,000 will be counted against a $1 million lifetime tax exclusion for gifts. Each dollar of gift above $1 million reduces the amount that can be transferred tax-free in your estate.

The $13,000 figure is an exclusion from the gift tax reporting requirement. You may give $13,000 to each of your children, their spouses, and your grandchildren (or to anyone else you choose) each year without reporting these gifts to the IRS. In addition, if you're married, your spouse can duplicate these gifts. For example, a married couple with four children can give away up to $104,000 in 2009 with no gift tax implications. In addition, the gifts will not count as taxable income to your children (although the earnings on the gifts if they are invested will be taxed).

Note that there is a conflict between the gift tax law and the Medicaid law.  While you can make these $13,000 annual exclusion gifts without any negative gift tax ramifications, if you apply for Medicaid benefits within 5 years of making these gifts, Medicaid will consider the gifts a divestment and will apply a penalty.  The penalty is that you would be ineligible for Medicaid for a period of time.  See Some Common Medicaid Questions for the effect of gifts on Medicaid eligibility.