A tax credit is said to be unified when it applies to two—or sometimes more—separate taxes. The taxes are different, but they share some major similarities. The most common unified tax credit in the U.S. is the one that spans estate and gift taxes. In this case, the unified tax credit provides a set amount that any individual can give during their lifetime before any gift or estate taxes apply.
To apply the unified credit to your best advantage, you first need to understand how these taxes work and how the credit can be used. This can be complicated because the Internal Revenue Service (IRS) offers a few other breaks for these taxes, and they can change slightly from year to year.
Below, you'll learn everything you need to know about the unified tax credit and how it can benefit you.
Definition and Example of the Unified Tax Credit
The unified tax credit applies to two or more different tax credits that apply to similar taxes. In the case of estate and gift taxes, the unified tax credit provides a set amount that any individual can gift during their lifetime before any of these two taxes apply.
The estate and gift taxes, for example, 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 in 2022, up from $11.7 million in 2021.
For example, let's say you give away $5.06 million in assets during your lifetime. You'd have just $7 million left of that $12.06 million credit with which to shield your estate from taxation at the time of your death. Gifts and estate transfers that exceed $12.06 million are subject to tax.
The unified credit is per person, but a married couple can combine their exemptions. As of 2021, married couples can exempt $23.4 million. In 2022, couples can exempt $24.12 million.
The highest margin for taxes on gifts and estates is a significant rate of 40%, but the IRS refrains from taxing the value of these assets when they're both coming and going. The recipients of your generosity don't have to pay an inheritance tax at the federal level, and gifts aren't taxed as income, either.
- Alternate name: Unified Transfer Tax
How the Unified Tax Credit Works
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.
The unified credit increased dramatically in 2018 and continues to increase with inflation each year, but the change may not be permanent.
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 $5.06 million during your lifetime, which reduces your unified credit to $7 million. ($12.06 million cap minus $5.06 million given away). 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. In 2022, you can exempt $16,000 per year in lifetime gifts per person before resorting to the unified tax credit to shield the balance, up from $15,000 in 2021.
You only have to use your unified tax credit to exempt gifts you made in 1977 or later.
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. You can subtract $15,000 of that in the year you give it to them, leaving a taxable gift of $35,000.
You can then apply your unified credit to that $35,000. This would reduce your $12.06 million credit to $12.025 million—or you can simply pay the gift tax on the balance in the year in which you made the gift. This is an annual exclusion per person per gift, so you can use it every year. You could give your child $30,000—$15,000 on December 31 and another $15,000 on January 1—without dipping into your unified tax credit.
Unfortunately, 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 on a really big gift in one 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.
You can give gifts to your spouse and pass your property to them at death without paying any taxes, provided that your spouse is a U.S. citizen. This "unlimited marital deduction" allows you to ignore the value of any gifts or bequests that pass to your spouse. Spouses don't count against either the annual exclusion or the unified credit.
Another Unified 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 a generation, such as if you give your grandchild or great-grandchild a valuable asset instead of your child. This tax was launched in 1976 to prevent taxpayers from effectively dodging two or more estate taxes on the same assets—both when they pass to the next generation and when that recipient dies and the gift transfers to their heirs.
Will You Have To Pay More in 2025?
The unified credit is further complicated by recent legislation and by the fact that it's indexed for inflation, as is the annual gift tax exclusion.
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.
Then came the Tax Cuts and Jobs Act (TCJA) in 2018, when the unified credit rose to $11.2 million. This legislation doubled that $5 million threshold to $10 million—but only until the TCJA potentially expires in 2025. The credit will plummet back to the $5 million range 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 shrunken 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).
The TCJA did not impact the annual gift tax exclusion. This, too, is indexed for inflation, but it can only increase in $1,000 increments, and it doesn't increase in some years at all. It remained at $14,000 from 2013 through 2017. It then increased to $15,000 in 2018, where it remained until 2022, when it bumped to $16,000.
- The federal unified tax credit provides the same exemption from taxation for gifts made during life or from an estate after an individual's death.
- Lifetime gifts and gifts made from an estate share the same exemption, and the value of lifetime gifts is applied to the exemption first.
- Lifetime gifts are also granted a small annual exclusion.
- An estate is only taxed on the balance of its value after the value of all lifetime exemptions over the gift tax annual exclusion are exhausted.
- Gifts made to spouses who are U.S. citizens aren't subject to the gift tax or the estate tax.