Is it ever "cheap" to give away your wealth? That depends upon your perspective. For many taxpayers who have spent a lifetime building up their wealth, the IRS will want to tax the transfer of that wealth at death through the federal estate tax. With a maximum federal estate tax rate of 55%, plus an additional 5% surtax on some estates, a large amount of wealth could end up in the hands of the IRS at death. Many taxpayers understand that it may be wise to gift property today, so that it will not be subject to the estate tax upon their demise. The problem is that gifting can also trigger a tax - the federal gift tax. There is a tax tool, known as the annual exclusion, that can help taxpayers beat the gift tax. Essentially, a taxpayer can give up to $10,000 of present interest gifts per donee, per year, and the annual exclusion will insulate the donor from gift tax. How effective can the annual exclusion be?

Consider a husband and wife, each being 65 years old. They have a relatively large estate and would face a 55% estate tax bracket at the second death. They have three adult children. When done properly, husband could give $10,000 to each of their children per year - that's $30,000 annually without triggering a gift tax. Similarly, wife could give away $10,000 annually to each of their three children for another $30,000. That's $60,000! Suppose further that the children are married. Husband could give each of his children's spouses $10,000 per year and so could wife. That's another $60,000 per year, for a total $120,000 annually. Had that wealth been subjected to estate tax at 55%, $66,000 would have gone to the IRS! And remember, each year another gifting opportunity will pass by.

Again, there are tradeoffs at work. Assets that are gifted during life generally do not receive a basis adjustment, while assets that are included in the gross estate generally do receive a basis adjustment. This can mean that inherited assets generate less capital gains tax when sold by a beneficiary compared with gifted assets sold by a donee.