Thanks to the generous federal gift and estate tax exemption (\$12.06 million in 2022) and the annual gift tax exemption (\$16,000 per recipient in 2022), most gifts are shielded from tax. However, if you’re concerned about the impact of transfer taxes on your gifts, consider making “net gifts.”

#### Understanding how a net gift reduces tax

Rather than get caught up in an endless loop of calculating the tax, reducing the gift’s value, recalculating the tax and so on, there’s a simple formula for determining your daughter’s tax liability: Gift tax = tentative tax / (1 + tax rate). In our example, the tentative tax is \$400,000 (the tax that would have been owed on an outright gift), so the gift tax on the net gift would be \$400,000 / 1.4 = \$285,714. You can confirm that the math works out by assuming that you give your daughter \$1 million and that she agrees to pay \$285,714 in gift taxes. That tax liability reduces the gift to \$1 million – \$285,714 = \$714,287, resulting in a tax liability of 40% × \$714,287 = \$285,714.

By using a net gift technique, you reduce the effective tax rate on the \$1 million transfer from 40% to only 28.57%. Note that if the gift is in the form of appreciated assets rather than cash, the recipient’s payment of the tax liability can result in capital gains taxes for the donor.

#### Going a step further

It may be possible to reduce the effective gift tax rate even further by using a net, net gift. Under this technique, in addition to assuming liability for gift taxes, the recipient also agrees to pay any estate tax liability that might arise by virtue of the so-called “three-year rule.”

Under that rule, gifts made within three years of death are pulled back into the donor’s estate and subject to estate taxes. The U.S. Tax Court has given its blessing to the net, net gift technique, allowing the value of a gift to be reduced by the actuarial value of the recipient’s contingent obligation to pay estate taxes that would be owed if the donor were to die within three years of making the gift.

#### Don’t try this at home

Making net gifts can ultimately reduce gift tax liability, but it’s not a simple technique. Plus, it’s important to correctly document the transaction to pass muster with the IRS. Your estate planning advisor can be a valuable resource.