Taxable Gifts

• The federal government imposes a separate tax on some of the gifts you make each year. However, regardless of whether or not you are subject to the gift tax, your kids will never pay tax on cash or property they receive from you. The only way to ensure that the gifts you make don't require you to pay a gift tax is by not exceeding the annual exclusion for each kid or by making direct payments to medical and educational institutions on their behalf. If you do make a gift that exceeds the annual exclusion amount, you will have an obligation to report it on Form 709, the federal gift tax return. However, this is only a reporting requirement; there are still ways to eliminate the gift tax.
  
  

Direct Payments

• The IRS allows you to pay your kids' medical or tuition expenses, provided you make the payment directly to the organization rather than to your child. Making direct payments can be an effective gift tax planning tool since it doesn't affect the annual exclusion, which you can then use to make additional gifts. However, if your kid has no pending medical expenses or doesn't enroll in school, your only option is to use the annual exclusion.
  
  

Annual Exclusion

• The gift tax law provides you with an annual exclusion to use for the gifts you make to each of your kids. The exclusion is the maximum amount of tax-free gifts you can make to each child per year. For example, the exclusion is equal to $13,000 for the gifts you make in 2011. Therefore, you can write a $13,000 check to each of your kids without having to report it on a gift tax return or pay tax. If you give each of your children a $20,000 check instead, $7,000 of each check is a taxable gift. However, you can use the unified credit to eliminate all or part of the tax that you tentatively owe.
  
  

Eliminating Gift Tax

• If it's necessary for you to file a Form 709 for the gifts you make to your kids, you can choose to use part of your unified credit to reduce the amount of your taxable gift. The Internal Revenue Code provides every taxpayer with a $1 million credit that they can use to eliminate up to $1 million of taxable gifts during their life. To illustrate, suppose you file a Form 709 to report a single $7,000 taxable gift after writing a $20,000 check to your son. You can elect to use $7,000 of your unified credit, thereby reducing your taxable gift to zero. However, the unified credit balance available for future gifts will decrease by the $7,000.