How Gift Tax Works

Distributing Wealth

One of the main purposes of both the gift and estate tax is to spread the wealth. In other words, policymakers decided that high concentration of wealth among the landed gentry -- whom various "Occupy" movements might refer to as "the 1 percent" -- was bad for the rest of Americans. So the tax code takes a hunk of any family's wealth, subject to threshold requirements, every time that it's transferred down the line [source: Cordes].

It's hard to fully grasp the idea behind the gift tax without also understanding the estate tax. Originally enacted in 1916, the estate tax was designed to prevent high wealth from simply transferring from one member of a family to another over generations. When a person dies, the government can take up to 40 percent of their transferable wealth -- land, money and other assets -- before it is distributed to heirs. The tax is limited to high value estates: As of 2014, it kicks in only when the person who died had at least $5.34 million in gross assets and prior gifts [sources: IRS, Cordes].

Wait, what was that about gifts? Yes, the gift tax was created eight years after Uncle Sam started charging the estate tax to combat against the practice by land barons and the like of simply giving away all of their stuff before they die in order to avoid being taxed. So while many gifts aren't taxed, up to a certain amount, they do count toward a person's estate when he or she dies. If the person has $1 million in taxable assets and has given away more than $4.35 million over his or her lifetime, for example, he or she will be subject to the estate tax in 2014 [sources: IRS, Cordes].

Of course, that doesn't necessarily mean that there aren't still a few ways to reduce the tax burdens associated with giving gifts or, well, dying.