What Is Unified Tax Credit & How Does It Work?

KEY TAKEAWAYS

• The unified tax credit provides a fixed amount that a person can gift throughout their lifetime and leave to heirs without triggering any gift or estate taxes.
• The tax credit combines the gift and estate taxes into a single tax system, lowering the individual’s or estate’s total tax burden.
• For individuals and married couples filing jointly, the lifetime exemption from gift and estate taxes in 2022 is $12.06 million and $24.12 million, respectively.
• You may make tax-free gifts to as many recipients as you like in the tax year 2022 up to $16,000 ($32,000 for spouses that are “splitting” gifts) without utilizing any of your lifetime gift and estate tax exemptions.

What Is a Unified Tax Credit?

The unified credit combines the estate and gift tax deductions from two different lifetime tax exemptions. The combined exemption limit covers both the money and assets you leave to beneficiaries after you pass away (testamentary transfers). As well as taxable contributions you make to others while you are still alive (inter-vivos gifts).

Every American taxpayer is eligible for the credit, according to the Internal Revenue Service (IRS).

The unified tax credit is also known as the unified transfer tax. Since being consolidated in 1976 and given the term “Unified Transfer Tax,” the estate and gift taxes have shared a unified rate schedule.

Calls to completely abolish gift and estate taxes, change to an inheritance tax, or go back to a previous gift and/or estate tax structure are in conflict with each other in Congress.

How the Unified Tax Credit Works

If a person transfers significant valuable assets to another person while they are still alive, gift taxes may apply. In addition, estate taxes may apply to any assets left for beneficiaries after a person passes away.

For estate tax purposes, your assets consist of everything you own as well as anything in which you have a financial interest or stake at the time of your death. Only the portion that you can prove that you own counts. So if you co-owned a business property with someone that was worth $500,000 and you had the documents to prove it, the portion of assets that are at risk of being taxed would include the $250,000 value of the business property. 

However, the unified tax credit establishes a limit on how much a person can leave to heirs and gifts during their lifetime before any gift and estate taxes take effect. Technically, the credit is an exemption. It reduces the value of your gifts, making that portion tax-exempt. The cap amount has increased in recent years, from $11.7 million in 2021 to $12.06 million in 2022.

The unified tax credit lowers the individual’s or estate’s taxable income dollar for dollar by combining the gift and estate tax exclusions into a single tax scheme. If an individual or couple intends to gift part of their substantial assets and the value of those assets exceeds the yearly exclusion level, they may be required to submit a gift tax return. 

Gift tax return requirements do not apply to donations made to charity or gifts used to cover another person’s medical or educational costs.

How to Calculate Gifts Value

The gift value is calculated as the value of the gift at the time it was given. This is opposed to when it was purchased or if it is ever sold for a separate price. 

The amount you can give tax-free to any number of recipients without using up any of your lifetime gift and estate tax exemptions is determined annually by the IRS. This is known as the annual gift tax exclusion for a lifetime gift. The exclusion is $16,000 for 2022, a rise from the $15,000 exclusion for 2021.

It’s important to note that the annual exclusion is calculated on a per person basis. This would mean that a married couple that is jointly filing can gift up to $32,000 to any number of people without having to file a gift tax return. If you give someone more than $16,000 in a calendar year, you must report the gift on IRS Form 709.

How Is the Unified Credit Calculated?

To give an example:

Let’s say that you want to give one of your children $50,000 in cash so that they can put down a deposit on a home that they’re looking to purchase. You can subtract the maximum exclusion of $16,000 of that in the year in which you gifted them the money. This would leave a taxable gift of $34,000. 

You can then apply your unified credit to the $34,000. This would then reduce the aforementioned $12.06 million credit to $12,024. Alternatively, you could simply pay the gift tax on the balance in the year that you made the gift. 

This exclusion is annual and on a per person per gift basis, meaning you can use it each year. So essentially, you could give your child $30,000 on December 31st, and then again on January 1st. 

You must submit IRS Form 709, the United States Gift and Generation-Skipping Transfer Tax Return, for each gift you make that exceeds the yearly per-person, annual gift exclusion limit. After that, you could either pay gift tax on the remaining amount or put the gift’s value toward your unified credit. The IRS records your lifetime credit donations in this way so that your estate can be settled and closed after your passing.

Summary

The unified tax credit provides a predetermined financial amount that a person may gift during their lifetime and leave to heirs without incurring gift or estate taxes. The tax credit combines the gift and estate taxes into a single tax system, lowering the individual’s or estate’s total tax burden.

The unified tax credit is an important tax credit to understand. By knowing what the exclusion limits are, you can carefully plan how you gift assets and capital so that you don’t incur any unnecessary taxes. The rules governing estate and gift taxes have an impact on how frequently the unified tax credit changes.

This can help you to save money, and make sure that your friends and family don’t incur further taxes once your will has been actioned. 

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.

Written by Sandra Habiger, CPA

Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington. Sandra’s areas of focus include advising real estate agents, brokers, and investors. She supports small businesses in growing to their first six figures and beyond. Alongside her accounting practice, Sandra is a Money and Life Coach for women in business.