Gift taxes are something that most of us don't need to worry about. But, if you or someone you know has a large gift to consider, then you need to think about the gift tax effect on that decision.
For the majority of us, all we really need to know is that in 2006, there is a $12,000 exclusion that we can take advantage of (up from $11,000 in 2005). That is, if you want to give something of value to someone (either cash or other property), you can give up to $12,000 to that person every year without worrying too much about gift taxes.
So, if you own a small business that is worth, say, $60,000, you can give $12,000 worth of stock in the business every year, for 5 years, to your child, in order to transfer the entire business to them. Or, you can give $12,000 each to your 5 children and the transfer can be complete in 1 year. As long as no one receives more than $12,000 in one year, no gift tax will be owed when the gift is made and the gift will not be taxed at death as part of the estate tax.
Note the connection to estate taxes. This was done so that whether your estate is taxed at your death, or when you give it away while still living, the IRS will get some portion of it at some time. But, as I noted, both these taxes are not likely to affect the majority of taxpayers. Right now, the gift tax exclusion over a lifetime is $1,000,000. So, you will have to give away that much before you pay any gift taxes. The estate tax exclusion is even higher. For 2006, it is $2,000,000.
As an example, if you gave your $60,000 small business to your child all in one year, you would be required to report that gift on a gift tax return. You would be able to exclude $12,000 as a gift exclusion in that year to your child, and $48,000 would be subject to gift taxes. However, you have the $1,000,000 lifetime exclusion so the amount subject to tax would be subtracted from the exclusion and no tax would be due until you gave away more than $1,000,000 during your lifetime.
In the end, if you believe you have some possible exposure to gift taxes or estate taxes, you should consult with an attorney to review your net worth and the strategies you can employ to minimize your tax exposure.