The Unified Tax Credit Can Be Applied Against The

The unified tax credit, a cornerstone of the U.S. estate and gift tax system, is designed to mitigate the impact of these taxes on wealth transfers. Understanding how this credit can be applied and its limitations is crucial for effective estate planning.

Introduction to the Unified Tax Credit

The unified tax credit is a single credit that can be applied against both gift taxes and estate taxes. This means that during your lifetime, you can use the credit to offset gift taxes on taxable gifts, and whatever portion of the credit remains unused at the time of your death can be used to offset estate taxes. The term "unified" signifies its applicability to both types of transfers.

This credit is not a refundable credit. This means that if the credit exceeds the amount of tax owed, the excess credit is lost. The credit is equivalent to an exemption amount, which is the amount of assets that can be transferred without incurring federal estate or gift tax.

Historical Context and Evolution

The unified tax credit was introduced as part of the Tax Reform Act of 1976. Before this, estate and gift taxes had separate exemptions. The unification aimed to simplify the tax system and provide a more consistent approach to taxing wealth transfers.

Over the years, the exemption amount associated with the unified tax credit has changed significantly due to legislative changes. For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually increased the exemption amount, but these increases were set to expire. The American Taxpayer Relief Act of 2012 made many of the EGTRRA provisions permanent, including a higher exemption amount. The Tax Cuts and Jobs Act of 2017 (TCJA) further increased the exemption amount, but this increase is set to expire at the end of 2025.

Current Exemption Amount

As of 2024, the estate tax exemption is $13.61 million per individual, meaning that an individual can transfer up to this amount during their lifetime or at death without incurring federal estate or gift tax. For married couples, this amount is effectively doubled to $27.22 million, assuming that both spouses fully utilize their individual exemptions.

However, it's important to note that this higher exemption amount is temporary and scheduled to revert to pre-2018 levels (adjusted for inflation) on January 1, 2026. This scheduled decrease makes estate planning even more critical, especially for high-net-worth individuals and families.

How the Unified Tax Credit Works

Gift Tax Application

When you make a gift that exceeds the annual gift tax exclusion ($18,000 per recipient in 2024), you are required to file a gift tax return (Form 709). While the gift may be taxable, you can use your unified tax credit to offset the gift tax.

Here's a step-by-step breakdown of how the credit is applied against gift taxes:

1. Determine the Taxable Gift: Calculate the total value of gifts made during the year that exceed the annual exclusion.
2. Calculate the Gift Tax: Use the gift tax rates to determine the amount of gift tax owed on the taxable gift.
3. Apply the Unified Tax Credit: Use the unified tax credit to offset the gift tax owed. If the credit is sufficient to cover the entire tax, no tax is due.
4. Track Credit Usage: Keep track of how much of the unified tax credit has been used, as this will reduce the amount available to offset estate taxes.

Estate Tax Application

The unified tax credit can also be applied against estate taxes. The estate tax is a tax on the transfer of your assets to your heirs after your death. The estate tax is calculated based on the fair market value of your assets at the time of your death, less any deductions for expenses, debts, and bequests to charity or a surviving spouse.

Here's how the unified tax credit is applied against estate taxes:

1. Determine the Gross Estate: Calculate the total value of all assets owned at the time of death, including real estate, stocks, bonds, and other property.
2. Calculate the Taxable Estate: Subtract any allowable deductions from the gross estate, such as funeral expenses, debts, and charitable bequests.
3. Calculate the Estate Tax: Use the estate tax rates to determine the amount of estate tax owed on the taxable estate.
4. Apply the Unified Tax Credit: Use the remaining unified tax credit (after any gift tax usage) to offset the estate tax owed.

Portability of the Unified Tax Credit

One important feature of the unified tax credit is its portability between spouses. Portability allows a surviving spouse to use any unused portion of the deceased spouse's estate tax exemption. This can be a valuable tool for married couples with significant assets.

To elect portability, the executor of the deceased spouse's estate must file an estate tax return (Form 706), even if no estate tax is due. This election must be made within a certain timeframe after the deceased spouse's death.

Here's how portability works:

1. Determine the Deceased Spouse's Unused Exclusion Amount (DSUE): Calculate the amount of the deceased spouse's estate tax exemption that was not used to offset estate taxes.
2. Elect Portability: File Form 706 to elect portability of the DSUE.
3. Surviving Spouse Can Use DSUE: The surviving spouse can use the DSUE to offset estate taxes on their own estate.

Potential Tax Implications

Gift Tax

The gift tax is imposed on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The gift tax applies whether or not the donor intended the transfer to be a gift.

The annual gift tax exclusion allows you to give up to $18,000 per recipient in 2024 without incurring gift tax. However, any gifts exceeding this amount are taxable gifts and may be subject to gift tax.

Estate Tax

The estate tax is imposed on the transfer of property at death. The estate tax is calculated based on the fair market value of the assets in the estate, less any deductions for expenses, debts, and bequests to charity or a surviving spouse.

The estate tax can be a significant burden on wealthy individuals and families. However, with proper estate planning, it is possible to minimize or even eliminate estate taxes.

Generation-Skipping Transfer (GST) Tax

The generation-skipping transfer (GST) tax is a tax on transfers of property to skip persons, such as grandchildren or great-grandchildren. The GST tax is designed to prevent individuals from avoiding estate tax by skipping a generation.

The GST tax has its own exemption, which is equal to the estate tax exemption amount ($13.61 million in 2024). The GST tax can be complex, so it's important to seek professional advice if you plan to make generation-skipping transfers.

Strategies for Maximizing the Unified Tax Credit

Lifetime Gifting

One way to maximize the use of the unified tax credit is to make lifetime gifts. By making gifts during your lifetime, you can reduce the size of your estate and potentially avoid estate taxes.

When making lifetime gifts, it's important to consider the annual gift tax exclusion. You can give up to $18,000 per recipient in 2024 without incurring gift tax. You can also use your unified tax credit to offset gift taxes on gifts exceeding the annual exclusion.

Creating Trusts

Trusts can be a valuable tool for estate planning. There are many different types of trusts, each with its own unique benefits and drawbacks.

Some common types of trusts used for estate planning include:

• Revocable Living Trust: A revocable living trust allows you to maintain control over your assets during your lifetime while also avoiding probate after your death.
• Irrevocable Life Insurance Trust (ILIT): An ILIT can be used to remove life insurance proceeds from your taxable estate.
• Qualified Personal Residence Trust (QPRT): A QPRT can be used to transfer your home to your heirs while still living in it.
• Grantor Retained Annuity Trust (GRAT): A GRAT can be used to transfer assets to your heirs while minimizing gift tax.

Charitable Giving

Charitable giving can be a tax-efficient way to reduce the size of your estate. Bequests to qualified charities are deductible for estate tax purposes.

You can also create a charitable trust, such as a charitable remainder trust (CRT) or a charitable lead trust (CLT), to provide income to yourself or your heirs while also benefiting a charity.

Proper Use of Portability

As mentioned earlier, portability allows a surviving spouse to use any unused portion of the deceased spouse's estate tax exemption. It's important to properly elect portability by filing Form 706.

Portability can be particularly valuable for couples with unequal estates. For example, if one spouse has significantly more assets than the other, portability can ensure that the full estate tax exemption is used.

Common Misconceptions

• "I don't need to worry about estate tax because I'm not wealthy." Even if you don't consider yourself wealthy, your estate could still be subject to estate tax. It's important to understand the current exemption amount and the value of your assets.
• "Estate planning is only for the rich." Estate planning is important for everyone, regardless of their net worth. Estate planning can help you protect your assets, provide for your loved ones, and minimize taxes.
• "I can avoid estate tax by giving away all my assets before I die." While lifetime gifting can be a valuable estate planning tool, it's not a foolproof way to avoid estate tax. Gifts exceeding the annual gift tax exclusion are still subject to gift tax, and the unified tax credit may be used to offset these taxes. Additionally, the "three-year rule" includes certain gifts made within three years of death back into the estate.
• "I don't need a will because my spouse will inherit everything anyway." Even if you want your spouse to inherit everything, you still need a will. A will can ensure that your wishes are followed and can simplify the probate process. Additionally, a will can address issues such as guardianship of minor children.

Case Studies

Case Study 1: Lifetime Gifting Strategy

John and Mary are a married couple with a combined net worth of $25 million. They are concerned about estate taxes and want to minimize their tax liability. They decide to implement a lifetime gifting strategy.

Each year, John and Mary give $18,000 to each of their three children and five grandchildren, for a total of $288,000 per year. Over a period of 10 years, they give away $2.88 million, reducing the size of their estate by that amount.

They also create irrevocable trusts for the benefit of their children and grandchildren and fund these trusts with assets that are likely to appreciate in value. By doing so, they remove these assets from their taxable estate and transfer them to their heirs with minimal gift tax.

Case Study 2: Portability Election

David dies in 2024 with an estate of $7 million. His estate tax exemption is $13.61 million, so no estate tax is due. However, his executor files Form 706 to elect portability of the unused exemption amount to his surviving spouse, Sarah.

Sarah dies in 2025 with an estate of $18 million. Without portability, her estate would owe estate tax on $4.39 million ($18 million - $13.61 million). However, because she can use David's unused exemption amount of $6.61 million, her estate owes no estate tax.

Case Study 3: Charitable Remainder Trust

Elizabeth is a widow with no children. She has a large estate and wants to benefit her favorite charity while also receiving income during her lifetime. She creates a charitable remainder trust (CRT).

Elizabeth transfers assets to the CRT, which pays her a fixed income each year for the rest of her life. When she dies, the remaining assets in the CRT will go to her favorite charity. Elizabeth receives a charitable income tax deduction for the present value of the remainder interest that will pass to the charity. The assets in the CRT are removed from her taxable estate, reducing her estate tax liability.

FAQ

• What is the unified tax credit? The unified tax credit is a single credit that can be applied against both gift taxes and estate taxes.
• What is the current estate tax exemption amount? As of 2024, the estate tax exemption is $13.61 million per individual.
• What is portability? Portability allows a surviving spouse to use any unused portion of the deceased spouse's estate tax exemption.
• How do I elect portability? You must file Form 706 to elect portability.
• What is the annual gift tax exclusion? The annual gift tax exclusion is $18,000 per recipient in 2024.
• What is the generation-skipping transfer (GST) tax? The generation-skipping transfer (GST) tax is a tax on transfers of property to skip persons, such as grandchildren or great-grandchildren.
• What are some strategies for maximizing the unified tax credit? Some strategies for maximizing the unified tax credit include lifetime gifting, creating trusts, charitable giving, and proper use of portability.

Conclusion

The unified tax credit is a valuable tool for minimizing estate and gift taxes. Understanding how the credit works and how to maximize its benefits is crucial for effective estate planning.

While the current high exemption amount provides significant relief, it's essential to remember that this is temporary. With the scheduled decrease in 2026, now is the time to review your estate plan and take steps to protect your assets and provide for your loved ones.

Estate planning can be complex, so it's important to seek professional advice from an attorney, accountant, or financial advisor. These professionals can help you understand your options and develop a plan that meets your specific needs and goals. By taking proactive steps, you can ensure that your estate is protected and that your wishes are followed.