We turn now to a general discussion of the United States transfer tax system. In general, the United States taxes the gratuitous transfer of assets held anywhere in the world by a citizen or domiciliary of the United States, subject to certain exemptions, deductions and credits. For simplicity, the following discussion ignores the treatment of non-domiciliary aliens of the United States and is limited to the federal transfer tax system only.

There are three different federal transfer taxes: the Gift Tax, the Estate Tax and the Generation-Skipping Transfer (or "GST") Tax. Each is generally described below. Again, this is an overview of the federal transfer tax system only, and does not address potential taxes imposed by individual U.S. states. A complete analysis of these three taxes is impossible in the space available here. In order to give you any idea how they work, a good deal of oversimplification is necessary.

The Gift Tax
The Gift Tax applies to gratuitous transfers of property during lifetime. The Gift Tax may apply if a transfer is direct or indirect, if a transfer is made to an individual, trust or another entity, and if the property transferred is real estate, personal property, tangible property or intangible property.

The Gift Tax does not, however, apply to all transfers during lifetime. Every U.S. citizen and domiciliary may make tax-free "annual exclusion" gifts every calendar year of amounts up to $12,000 (in 2008) to any number of recipients. This $12,000 base amount is indexed for inflation, rounded each year to the next lowest multiple of $1,000. A married donor has the option to give up to $24,000 to each recipient each year, if both the donor and the donor’s spouse are U.S. citizens or domiciliaries and if the spouse consents to the gift on a gift tax return (a so-called "split" gift).

Also, the Gift Tax does not apply to certain transfers to a U.S. citizen spouse (including outright gifts and transfers in particular kinds of trusts) or to transfers to qualifying charities. A marital deduction and charitable deduction eliminate the Gift Tax on these transfers.

In addition, the Gift Tax does not apply to payments made for a donee's educational and medical expenses, provided that (i) the payments are deemed "qualified" expenses under the Internal Revenue Code, and (ii) the payments are made directly to the educational institution or medical provider. The exclusion for educational and medical expenses is unlimited in amount and available regardless of the donor's relationship to the donee.

Where a gift is made to someone other than a spouse or charity, and where a portion of the gift either exceeds, or does not qualify for, treatment as a $12,000 "annual exclusion" gift, or a qualified educational or medical expense, such portion is a "taxable gift" subject to Gift Tax.

The Gift Tax is calculated on taxable gifts on a graduated scale going up to 45% for that portion in excess of $2,000,000. This top rate will remain at 45% until 2009. In 2010, the top Gift Tax rate will be 35% for that portion in excess of $500,000. The Gift Tax, if any is due, is paid by the donor. In the rare event that the donor does not pay the tax, the donee becomes personally liable for the Gift Tax. However, a donee's liability is limited to the value of the gift.

Now for the tricky part. If you are a U.S. citizen or domiciliary, you have an "applicable exclusion amount" which shields from Gift Tax the first $1,000,000 of lifetime taxable gifts that you make. Unlike the $12,000 annual exclusion gift, which can be made every year to any number of persons, the applicable exclusion amount represents a single, lifetime exemption from paying Gift Tax on cumulative gifts.

The Gift Tax exclusion is extremely valuable. It represents the mechanism by which Congress has exempted those of lesser or moderate wealth from the Gift and Estate Tax.

The Estate Tax
The Estate Tax applies to transfers occurring at death.

The first step in calculating the Estate Tax is to determine a decedent's "gross taxable estate." For U.S. citizens and domiciliaries, this encompasses worldwide assets owned at death. Ownership for this purpose has a broad definition, and your gross taxable estate may include property that you might have thought had been given away prior to your death, such as life insurance policies that you transferred within three years of your death, any lifetime transfers in which you retained certain powers or interests, and certain joint property, among many other examples.

As with the Gift Tax, the Estate Tax does not apply to certain transfers to a U.S. citizen spouse (including outright bequests and transfers in particular kinds of trusts) or to transfers to qualifying charities. The marital deduction and charitable deduction eliminate any Estate Tax on these transfers. Also, the Estate Tax is not applied to any portion of the estate used to pay debts of the decedent or to pay the costs of administering the estate (including, for example, the costs of probate, legal fees, commissions, etc.).

After deductions, the remainder of the estate is subject to Estate Tax. Estate Tax is currently calculated at the same rates as the Gift Tax, going up to 45% for any portion of the taxable estate in excess of $2,000,000. This top rate will remain at 45% until 2009. The Estate tax is scheduled to be repealed on January 1, 2010, but then reinstated on January 1, 2011.

Once the Estate Tax itself has been calculated, any portion of the decedent's applicable exclusion amount that was not used to shelter lifetime gifts from Gift Tax can be used against the Estate Tax. In other words, if you have not made any taxable gifts during your lifetime, your total applicable exclusion amount remains available to exempt the first $2,000,000 of your taxable estate from Estate Tax. Note that the applicable exclusion amount for estate tax will increase to $3,500,000 in 2009, but will remain at $1,000,000 for gift tax.

You should be aware of a significant difference between the Gift Tax and the Estate Tax -- a difference that may have implications for how you plan your estate. Although the rate scale is the same for both the Gift Tax and Estate Tax, the way the tax is computed actually can make the Estate Tax more "expensive" to pay than the Gift Tax. This is because the Gift Tax is imposed only on the amount actually passing to the donee; the amount used to pay the Gift Tax itself is excluded from the calculation. The Estate Tax, however, is imposed on the amount owned (or deemed owned) by the donor, including the amount that is used to pay taxes.

Highlights of the Gift and Estate Taxes
The annual exclusion gift allows you to make outright gifts up to $12,000 (or $24,000 if you split gifts with a spouse) each year to any number of people without making a taxable gift.

The applicable exclusion amount is one of the most valuable tax benefits you possess. With it, you can transfer up to $1,000,000 in taxable transfers during your lifetime or up to $2,000,000 at death (less any portion of the applicable exclusion amount that you utilized during your lifetime) without paying any Gift or Estate Tax. In most circumstances, people with estates under the applicable exclusion amount don't have to worry about the Estate Tax. However, you must structure your estate plan carefully in order to maximize use of your applicable exclusion amount. You should consult with your attorney as to how to do so.

The marital deduction allows the transfer of property outright, or in certain qualifying trusts, to a U.S. citizen spouse completely free of either Estate or Gift Tax. However, care must be taken not to lose your applicable exclusion amount through use of the marital deduction.

Both the Gift and Estate Tax can affect income taxes. This results from the different effects the two taxes have on the "basis" of assets (or their tax cost used in determining gains and losses on disposition). Thus, planning for the transfer of highly appreciated property (such as some residences) requires consideration of the income tax consequences.

GST Tax
You should be generally aware of one other form of transfer tax, and that is the Generation-Skipping Transfer, or "GST," Tax. For many years wealthy families transferred property in trust for their grandchildren in order to bypass estate or gift taxation in their children's estates. Congress caught on, however, and now imposes the GST Tax upon certain transfers that effectively "skip" a generation. The GST provisions are very complicated, but fortunately everyone has an exemption that is now equal to the applicable exclusion amount. Thus, if you are planning on leaving less than $2,000,000 to your grandchildren or other individuals two or more generations below you, you probably do not have to worry about the GST Tax. Because the GST Tax exemption is tied to the applicable exclusion amount, it will increase to $3,500,000 in 2009. The GST Tax is scheduled to be repealed in 2010 and then reinstated in 2011.

State Transfer Tax
In addition to the federal transfer taxes discussed above, many individual states impose their own transfer taxes. These taxes are generally imposed at rates much lower than the federal transfer tax rates. Any amounts paid to the states for transfer taxes (Inheritance or Estate) are allowed as deductions available in determining the federal estate tax. These deductions lower but do not eliminate the cost of the state transfer tax.