Why is Everyone Afraid of the Gift Tax?

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I wish a mystery benefactor would give me a dollar every time I read this: "You can give any person up to $13,000 a year. More than that and you could incur a gift tax." The reality is, I could read the statement 130,000 times, receive a gift of a dollar each time, and chances are extremely high that neither I nor my donor would owe the IRS a penny of gift tax.

Confused? You probably read the quoted rule above the way most people do: to mean that the IRS will sock you with some kind of penalty if you give anyone a dime over $13,000. To avoid that outcome, donation-minded taxpayers go into Leona Helmseley-like tax avoidance contortions the minute they get near the $13,000 barrier. A friend of mine, for example, aiming to subsidize her niece's home down payment, felt she had to break the gift into pieces and funnel it through a web of relatives so that no one ended up giving or receiving more than $13,000.

Unnecessary.

The familiar $13,000 rule of thumb, as usually phrased, is misleading. Yes, if you give away more than $13,000 ($26,000 if you're married and giving jointly) to anyone other than a spouse, a charity, or a political organization, you have to file a gift tax form and are said to have given a "taxable" gift equal to the excess over $13,000. But few writers bother to add that the gift tax comes with a whopping big loophole. You owe no tax at all until all your taxable gifts over your lifetime exceed a cool million dollars. You could, for example, give each of your ten children $113,000 towards the purchase of a home and still not owe a dime in gift taxes. There's also no limit if you pay someone's tuition or medical expenses directly, and an extended loophole for gifts to a 529 college savings plan. In short, almost no one ever has to pay the gift tax.

Why even have such a law, then? Because Congress doesn't want rich folk giving their estates away in huge chunks just to dodge estate taxes. For every dollar you use of your million-dollar gift-tax loophole (known as an exclusion), you reduce by one dollar the size of the comparable exclusion you can use against estate taxes. But as you've probably heard, there is no estate tax this year, so it doesn't matter. When the estate tax returns in 2011, the estate tax exclusion will be $1,000,000, although Congress will likely set the limit higher (best guess: $3.5 million) when it finally settles the law.

So, go ahead, be magnanimous. Help your kids with the down payment. Help your favorite nephew buy a car. Your beneficiaries will be delighted and, as long as you stop short of the million-dollar limit, the gift tax will be irrelevant.

More tax tips on CBS MoneyWatch:

Beware this estate tax trap
Estate taxes: What you need to know for 2010
The Best Way to Save for College