Traditionally, taxpayers with big estates have made large gifts to family members to reduce the eventual tax on their estates. But Congress raised the exemption from the federal estate tax so high this year that most taxpayers figure they don’t have to bother giving away assets as gifts to shrink their taxable estates. Despite that, for some taxpayers, there still are advantages to gifting, especially since Congress also increased the lifetime exemption from the federal gift tax, whose rate currently is a hefty 35%.

How the rules work

The new gift tax rules allow you to give away $5 million ($10 million for couples) over your lifetime without ever paying any federal tax on those transfers of assets. That’s up from a far lower $1 million ($2 million for couples) under the 2010 rules.

It’s important to decide quickly whether you want to take advantage of the new rules, since there’s no guarantee that the higher gift tax and estate tax exemptions will be in effect beyond 2011 and 2012, the years specified in the new legislation.

Because the estate tax exemption could be substantially lower in future years, it isn’t just people with more than $5 million or $10 million in assets who should consider making large gifts to heirs before the end of 2012. Anyone with a few million dollars should consider doing so.

Extra bonus: In addition to the higher lifetime cap on gift tax exemptions, you can continue to entirely exclude the first $13,000 per year — $26,000 for a couple — that you give away to each of your beneficiaries. That amount does not even count against the lifetime gift tax or estate tax totals. If you feel that your heirs are not yet responsible enough to be trusted with large assets, you could instead give assets to a trust, with your heirs named as beneficiaries.

When gifting makes sense

Gifting assets to heirs (or trusts that name heirs as beneficiaries) in 2011 or 2012 makes particular sense if you…

Live in a state with a low state estate tax exemption. Locations with estate tax exemptions of $1 million or less include Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, Ohio, Oregon, Rhode Island and Washington, DC. Four other states — Connecticut, Illinois, Vermont and Washington — have estate tax exemptions above $1 million but below the federal levels. The more you gift, the less likely you will be subject to estate taxes. (Be aware, however, that Connecticut and Tennessee impose state gift taxes.)

Own a family business. Anyone over age 50 who owns a multimillion-dollar family business should put succession plans in place before the end of 2012. Transferring shares in this business to heirs today could prevent a massive tax bill later. A trust could be helpful if you do not yet wish to cede control of the business.

Need asset protection. Physicians, lawyers, investment advisers, business owners, large-scale real estate owners and others at high risk for lawsuits can shift assets to heirs or trusts to keep those assets away from future plaintiffs.

Have a life partner who is not your legal spouse. Married couples can transfer unlimited amounts of assets any time between themselves without gift tax or estate tax consequences, but unmarried couples may face such consequences if they exceed the limit.

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