If you don't use your $12,000 annual exclusion by December 31, you lose it. By Mary Beth Franklin, Senior Editor December 10, 2008 One of the least understood tax rules is the federal gift tax. And for good reason: Almost no one has to pay it. In 2007, the latest year for which figures are available, fewer than 8,400 Americans paid federal tax on gifts they made.That's right, when the tax is due, it's paid by the giver of the gift, not the recipient. But it's easy to avoid the tax. For one thing, the law totally ignores gifts of a certain size. The limit is $12,000 in 2008 and it will rise to $13,000 in 2009. In 2009, for example, you can give up to $13,000 each to any number of people without worring about the gift tax. If you're married, you can give up to $26,000 of your money to any number of individuals if your spouse agrees not to give anything to the same person that year. If you give more than the annual exclusion amount, only the excess is a taxable and you must file a gift-tax return (Form 709) to keep track of your largess. Even then, it is unlikely you would owe any gift tax since everyone gets a credit that effectively exempts up to $1 million of gifts over your lifetime. You don't get an income-tax deduction for such gifts, but there's an important advantage: Assets given away during your lifetime –- plus any future appreciation -- won't be in your estate to be taxed after you die. It's particularly important to pay attention to gift-tax rules now. Advertisement President-elect Barack Obama has proposed that the 2009 gift- and estate-tax levels be made permanent: a $1-million lifetime gift exclusion, a $3.5-million per person estate-tax exclusion ($7 million for married couples) and a 45% tax rate. With Democrats controlling both houses of Congress, Republican efforts to permanently repeal the estate tax are on hold for the foreseeable future. Why worry about the gift exclusion as an end-of-year maneuver? If you don't use your $12,000 annual exclusion by December 31, you lose it forever. Each new year presents you with a new exclusion, but you can't reach back to benefit from a previous year's unused allowance. Next year the gift-tax exclusion increases to $13,000. Assume, for example, that a couple plan to give $48,000 to their son. If they give it all during one year, $24,000 of the gift would be sheltered from the gift tax. The other $24,000 would not be sheltered. However, if they gave half the gift in December and the other half in January, the full $48,000 would be protected. If you make a gift by check, be sure the recipient cashes it before the end of the year. When it comes to gifts, the IRS considers that the transaction has been completed in the year the check is cashed. Advertisement Another option is to fund a 529 state-sponsored college-savings plan for your child or grandchild. You can contribute up to five years' worth of gifts at once, meaning you could contribute up to $60,000 per child or up to $120,000 if you and your spouse make a joint contribution this year. Next year those maximum contributions increase to $65,000 for individuals and $130,000 for couples making a joint gift. Contributions to 529 plans are not deductible from federal income taxes, but many states offer tax deductions on state income taxes.