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An Early, Untaxed Bequest

The $22,000 is more than most families can afford, but that doesn't mean the mechanism should be ignored. For example, a child who has earnings can have an individual retirement account. IRA contributions, of course, are limited to $3,000 a year, but suppose your teenage daughter worked last summer as a lifeguard and earned $5,000. You could open a Roth IRA for her at a good mutual fund and fund it with a gift -- of up to the $3,000 limit.

If you can manage to do that for several years, and maybe she picks it up herself later on, you can have set her on the road to real money for her retirement -- tax-free.

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The annual exclusion can also be leveraged.

For example, parents or grandparents looking ahead to a young child's college can use the exclusion to put money into a Section 529 plan, which allows tax-free investing when proceeds are to be used for higher education. In fact, there are special gift-tax provisions for 529 plans. First, they are not treated as future interests, so they qualify for the annual exclusion, and second, donors can elect to treat a single gift as though it were made over five years. Thus, a contribution to a 529 plan of $15,000 will be regarded as $3,000 a year for five years, leaving room under the limit for the donor to give the same person as much as $8,000 (and not necessarily via the 529 plan) in each of those five years without going over the limit.

There is another gift-tax break for education: There is no limit on the amount of tuition that one person may pay on behalf of another, as long as the payments are made directly to the educational institution. A similar unlimited exclusion applies to payments for medical care, again as long as the payments are made directly to the care provider.

Another use of the annual exclusion involves life insurance. This device requires professional assistance but can result in substantial tax savings.

Death benefits from life policies are exempt from income tax, but they are included in a person's estate -- if he or she owned the policy. To deal with that, estate planners often set up an "irrevocable life insurance trust," which owns the policy, and have the insured person or family use the annual exclusion to provide money to pay the premiums.

This arrangement, if executed correctly, avoids both income and estate taxes. However, for the premium payments to qualify for the annual exclusion, they must represent a present interest. To accomplish that, the beneficiaries must be given a period of time in which they may withdraw the gift money -- a right known as a Crummy power, after the taxpayer who first used the device. If the beneficiaries don't exercise that right -- which is the idea -- the money can then go to pay the insurance premium.

Finally, experts often advise filing a gift-tax return, especially if you are doing something complex. The return is not required in cases where no tax is due, but filing one starts the statute-of-limitations clock running, meaning that after a period of time the IRS generally can't assess tax or kick the gift back into the estate of a donor who has died.

The Internal Revenue Service issued tables Friday for taxpayers who want to use the newly enacted state and local sales-tax deduction. Taxpayers may now deduct either sales or income taxes. This is a benefit mainly for those in states that have no income tax, but some people in states with both taxes may find they are better off deducting the sales tax instead of the income tax. The tables can help figure that out. They allow taxpayers to deduct an amount related to their income -- in contrast to saving all the receipts and taking the actual amount -- while allowing them to add on big-ticket items such as cars, boats or airplanes. The tables and instructions are available in Publication 600, "Optional State Sales Tax Tables," which is accessible at www.irs.gov. Printed copies will be ready in a few weeks, the agency said. The IRS also will send the publication to all taxpayers who get a Form 1040 package.

A federal court in Atlanta last week shut down a tax scheme that promises people they can avoid income tax by "renouncing" their Social Security numbers and claiming to be "sovereign citizens." The court found that Jonathan D. Luman of Stockbridge, Ga., tells customers they can avoid federal income tax by sending the IRS documents found in his "Tax Buster Guide." That doesn't work, the court said, and it ordered him to halt sales of the program. It has been sold over the Internet to customers in 41 states, the government said.


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