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The estate and gift tax exemptions are going up. What does it mean?

As we all know, the federal government levies taxes on large estates, which are sometimes called "death taxes" by those who would prefer it did not. The gift tax is related, because giving assets to family members before death was often used as a way to reduce the value of an estate and avoid taxation. To prevent that, the gift tax was devised.

Many people misunderstand the gift tax. It is not a tax on the recipient of the gift, but on the giver. The recipient may owe income taxes on the value of the gift, but it is the person doing the giving whom the tax is meant to reach. Additionally, the gift tax is not meant to prevent parents and grandparents from paying for school tuition or medical bills for their adult children. It also doesn't apply to political gifts or those given to qualified charities.

Basically, federal gift and estate taxes work together to ensure that an individual's assets above a certain, generous level, end up being taxed. There is an annual exemption each year, meaning that you don't owe taxes on any gifts or bequests lower than that level. There is also a cumulative exemption for the total given or left to others over the course of a lifetime.

For 2012, the annual exemption for gifts and estate assets is $5 million per person, meaning that no estate or gift taxes are owed for gifts or bequests that total less than that. Once you reach the limit, the tax rate is 35 percent for both.

As things stand now, that rules will change on Jan. 1. Unless Congress takes action, the 2013 annual exemption will drop to only $1 million per person. Gifts and bequests above that amount will be taxed at 55 percent.

With the "fiscal cliff" negotiations dominating national attention, few policymakers have paid much attention to the changes in gift and estate tax law that will go into effect without congressional action.

People with large amounts of money to give to loved ones, however, should consider taking advantage of the high exemption amounts and lower tax rates this year.

Source: Forbes, "Give Now Or Pay Later: Rich Face Dilemma With Fate Of Estate And Gift Taxes Up In Air," Roberton Williams, Dec. 17, 2012

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