This often-overlooked exclusion allows you to give away a certain amount each year per person without being subject to gift tax. Although the exclusion amount was indexed for inflation starting in 1997, it hadn't changed because inflation has been low and the amount can increase only in $1,000 increments. However, according to early calculations by independent tax experts, the exclusion should finally jump to $11,000 ($22,000 for couples) in 2002.

Many taxpayers may say, "so what," now that the Tax Relief Act dramatically raises the exemption amount for gift and estate taxes, beginning in 2002. The lifetime gift exemption jumps to $1 million in 2002, and the estate tax starts at $1 million and rises to $3.5 million by 2009. Estate taxes are scheduled to be fully repealed in 2010. Despite the changes, the annual gift-tax exclusion still serves a useful purpose in many cases.

First, keep in mind that estate taxes will continue to be imposed until 2010, and then the estate tax will be fully repealed for only one year. It's reimposed starting in 2011 unless Congress passes new legislation to continue the repeal. Consequently, reducing the size of tax-vulnerable estates remains important.

For example, say you die in 2009 with a $3.5 million estate. That amount would normally be exempt from estate taxes under the current schedule. However, let's say you've made taxable gifts of $1 million during your lifetime to your three children and three grandchildren. Now only $2.5 million would be exempt from estate taxes, leaving $1 million exposed to estate taxes. However, by using the new $11,000 annual exclusion amount, you and your spouse could reduce that exposure by annually giving away to your heirs a total of $132,000 a year.

The benefits could be even greater by donating appreciating assets. A couple might give away to a child $22,000 in growth stocks, which the child might later be able to sell for $55,000 (on which the child would pay capital-gains tax). Not only is the $22,000 out of the parent's estate, so is the $33,000 in subsequent gains.

Second, under the Tax Relief Act, the lifetime gift-tax exemption remains fixed at $1 million, unindexed for inflation, and it is scheduled to continue even after the estate tax is repealed. Furthermore, many people don't realize that it is no longer unified with the estate tax. Any lifetime gifting that exceeds the $1 million threshold will be subject to tax, even if the estate-tax exemption is higher than that amount.
Gift

Consequently, the annual gift-tax exclusion will be valuable should you want to give away more than $1 million during your lifetime. Furthermore, because the annual exclusion is indexed, the dollar amount will increase faster and faster over time.

The increase to $11,000 also will help taxpayers funding 529 college savings plans and state prepaid tuition plans. Currently, a parent or grandparent (or anyone else for that matter) can put into one of these plans up to $50,000 (or $100,000 as a couple) at one time because the government allows you to count it as five years' worth of $10,000 annual gifts. The increase to $11,000 will allow you to bump your contribution up to $55,000, or $110,000 as a couple.

The increased annual gift-tax exclusion also will be helpful for people making Crummey gifts. These are gifts commonly made to fund annual premiums for life insurance held inside an irrevocable trust. As long as taxpayers follow the Crummey rules, they will be able to put in $11,000 into the trust annually for each beneficiary free of gift tax.

Keep in mind that you can contribute, tax free, an unlimited amount on behalf of a person if that gift goes directly to an educational organization to pay for tuition (not through the person benefiting from the payment) or to a health-care provider for qualified medical services. Thus, a grandparent could pay a grandchild's annual $20,000 tuition bill without any of the gift counting toward the $1 million lifetime exemption-and could still make another annual $11,000 gift directly to the child gift-tax free.