What Is a Unified Tax Credit?

How the Unified Tax Credit Works

The unified tax credit provides a set amount that any individual can gift during their lifetime before estate taxes or gift taxes apply.

The estate and gift taxes have shared a unified rate schedule since they were combined in 1976 and given the name "Unified Transfer Tax." The same tax rate applies whether property is transferred as an inheritance after death or as a gift. These taxes share the same credit, as well. You can reduce the value of your gifts by the same credit regardless of whether you give them away during your lifetime or after death, but the credit must be applied to your lifetime gifts first.

The credit is technically an exemption. It subtracts from the value of your gifts, exempting that portion from taxation. The cap amount is $12.06 million for tax year 2022 and $12.92 million for 2023.

For example, let's say you gave away $5.92 million in assets during your lifetime. If you left $7 million or less to your heirs in 2023, your estate would not be subject to taxes. However, if your estate was worth more than $7 million dollars, the estate would be subject to taxes. Gifts and estate transfers that exceed the cap amount are subject to taxes.

Although your estate might be taxed if it's above a certain threshold, your heirs won't be taxed on the inheritance they receive after your estate is taxed.

Example of the Unified Tax Credit

The Unified Transfer Tax begins with the value of your assets—their fair market value as of the date of the gift or the date of death—not what you paid for them. The values of all remaining assets, or those you haven't given away during your lifetime, are added together at the time of your death to arrive at your "gross estate."

Your assets include anything you own and even anything you have a financial stake or interest in at the time of your death for estate tax purposes. Only the portion that's attributable to your ownership counts. Say you co-own an estate that's worth $400,000 with someone else. In this case, the portion at risk of taxation would include $200,000 of the home's value.

Any liens against your assets, such as mortgages, are subtracted from your gross estate as deductions. Then you must subtract the value of your lifetime gifts from your unified credit. You can then subtract from your gross estate any portion of the unified tax credit that remains. This is the portion that hasn't been used to exempt your lifetime gifts from taxation. What remains is your taxable estate.

For example, your gross estate might be valued at $15 million. Let's say there are $5 million in mortgages and liens against various items of property, reducing this to $10 million. Carrying on from the earlier example, you gave away $5.92 million more than the annual gift exemption during your lifetime, which reduces your unified credit to $7 million. ($12.92 million less $5.92 million over the gift amount). You can subtract that $7 million from your $10 million estate, ultimately leaving a taxable balance of $3 million.

You don't have to use the value of all your lifetime gifts against your unified credit, however, because the IRS also provides for an annual gift tax exclusion. For tax year 2023, you can exempt $17,000 per year in lifetime gifts per person before resorting to the unified tax credit to shield the balance.

How To Calculate the Value of Gifts

Let's say that you give your child $50,000 in cash to use as a down payment on the home they want to buy. If you gave them the money in 2022, you can subtract $16,000 of money, leaving a taxable gift of $34,000.

You can then apply your unified credit to that $34,000. This would reduce your $12.06 million credit. This is an annual exclusion per person per gift, so you can use it every year. You could have given your child $16,000 on Dec. 31, 2022, and $17,000 on Jan. 1, 2023, without dipping into your unified tax credit.

You can't save up your annual exclusions and add them to your unified credit to offset estate taxes when you die. Likewise, you can't use a stockpile of them to give one very large gift in a single year.

Each year you give any gifts in excess of the annual per-person, per-gift exclusion limit, you must file IRS Form 709, the United States Gift (and Generation-Skipping Transfer) Tax Return. Then you would either pay the gift tax on the balance or apply the value of the gift to your unified credit. This is how the IRS keeps track of your lifetime giving so your estate can settle and close after your death.

The Generation-Skipping Transfer Tax

Form 709 and the unified credit also cover another tax, the Generation-Skipping Transfer Tax. As the name suggests, this tax targets gifts that skip one or more generations, such as if you give your grandchild or great-grandchild a valuable asset instead of your child.

This tax is designed to prevent taxpayers from effectively dodging an additional estate tax that would occur from the money being passed on twice (once to your child, and a second time to your grandchild.)

Estate Taxes After 2025

Even though the unified tax credit and the annual gift tax exclusion are both indexed for inflation, the amount someone can pass on tax-exempt might change after 2025.

The Taxpayer First Act of 2012 set the unified credit at $5 million per person. It was adjusted upward annually from there to keep pace with inflation. It increased to $5.25 million in 2013, $5.34 million in 2014, and eventually up to $5.49 million in 2017.

In 2018, the Tax Cuts and Jobs Act (TCJA) raised the unified credit to $11.2 million. This legislation doubled the $5 million threshold to $10 million, but the TCJA may expire in 2025. That means the credit would go back to the $5 million threshold (although the inflation adjustment will still be in place) if the legislation is not renewed.

So what happens to the credit for gifts made between 2018 and 2025 that might be applied to a reduced credit for deaths after that expiration deadline? Say you give away $11 million while the TCJA was in effect. Will $6 million of that revert to being taxable if you die in 2026?

The IRS indicated in November 2018 that this is not the case. It announced that the increased unified credit would remain in place for gifts made during this time period (2018 through 2025).

Frequently Asked Questions (FAQs)