The income tax consequences of  making a gift are straightforward:  neither the donor nor the donee incurs any income tax.  Although it is fairly clear why the donor has no income on account of the gift, it is less clear why the donee should have none, since the donee’s net worth, often a bellwether as to whether an item will be includible in income, has clearly increased.

In any event, the tax law clearly states that “gross income does not include the value of property acquired by gift, bequest, devise or inheritance.”  Does this mean that the transfer of large amounts of wealth can be effectuated between individuals without tax cost?  No.  Only without income tax cost.

The donee incurs no gift tax liability upon receipt of a gift.  In contrast, the tax law provides that the donor shall be taxed on “the transfer of property by gift,” and thus may make a taxable gift, (subject to an important exception, discussed below.) Gift tax liability depends upon the amount of taxable gifts made by the donor in the donor’s lifetime. Although many taxable gifts may have been made over the years, no actual gift tax liability will result from the first $600,000 in lifetime gifts. Once this threshold is exceeded, however, current gift tax liability will be incurred, at a rate beginning at 37%.

Notwithstanding the above analysis, an important qualification exists with respect to the first $10,000 in gifts of a present interest made to any person in a given year. In effecte, gifts qualifying for the annual exclusion do not constitute a taxable gift. If both spouses “join” in the gift (regardless of which spouses actually owned the property) the exclusion can be leveraged to $20,000. More sophisticated techniques, one of which involves the transfer of partnership interests, can also leverage the annual exclusion.

There is no limit to the number of persons to whom the donor may make annual exclusion gifts. Most importantly, since they are not taxable gifts, the donor’s running total of taxable gifts is not increased. In turn, the donor’s $600,000 reservoir (which is never replenished) of lifetime taxable gifts which can be made without the imposition of tax, will not be depleted by these gifts.

Large amounts of wealth can be shifted without incurring gift tax liability by prudent use of annual exclusion gifts to one or many relatives over a number of years. Substantial tax savings can be also achieved through prudent (and frequent) use of the annual exclusion, since not only has the $600,000 exemption amount been leveraged by each gift qualifying for the annual exclusion, but appreciating property has been taken out of the donor’s estate. However, since the annual exclusion cannot be “credited” toward a future year, its importance in minimizing gift taxes can best be achieved through consecutive yearly transfers.