We have gotten a few questions lately on how the lifetime gift and estate tax exclusion are tied together. In brief, transfers made during your lifetime are called gifts and reported on a gift tax return while transfers made at death are also a "gift", but reported on an estate tax return.
The gifts made during lifetime are accumulated with the gifts made at death and totaled together. If this total (lifetime and at death) exceeds your lifetime exclusion then either gift or estate tax is due. For 2012, the combined exclusion amount is $5.12 million. If you make $2 million of gifts during your life, no gift tax is due, however, if you are worth $4.12 million at death, the combined amount of $6.12 is $1 million greater than your lifetime exclusion and thus $350 thousand of estate tax is owed (2012 rates).
These rules apply for federal tax purposes. Many states have an estate tax but no gift tax. Gifts during lifetime may result in lower taxes than waiting until your estate. However, some states that do not impose a gift tax will bring these gifts back into the estate and "tax" those amounts then.
There is some discussion on whether a "clawback" will occur if the current lifetime exclusion drops from $5.12 to $1 million beginning in 2013. This "clawback" might occur if you make a large gift in 2012 and the lifetime exclusion in effect at that time of your estate is less than this gift. Most commentators agree that this clawback will most likely not occur, however, nothing is certain right now with this issue.
Remember, even if a clawback occurs, substantial estate tax savings may result. For example, if you gifted $5 million of farm land in 2012 and at the time of your estate the land is worth $10 million and the lifetime exclusion was $1 million, the maximum amount that would come back into your estate is only $5 million (the 2012 gift value), not the $10 million it was worth at the time of your estate. In this case, you have completely eliminated the estate tax on the $5 million of appreciation created after your gift ($2.75 million of estate taxes eliminated) and if there is any clawback, the payment of it has been deferred for many years.
Conclusion - All gifts are added together, whether made during life or at death, and this total is what you may be taxed on. The 2012 lifetime total not subject to gift and estate tax is $5.12 million. It is not $5.12 million during life plus $5.12 million at death, but simply $5.12 million in total. For 2013, this amount is scheduled to drop to $1 million, but Congress may change it soon.