Legal Definitions - applicable exclusion credit

The applicable exclusion credit is a federal tax credit that allows individuals to transfer a certain amount of wealth, either through gifts made during their lifetime or assets passed on at their death, without incurring federal gift or estate taxes. This credit effectively "excludes" a specific value of assets from taxation up to a cumulative lifetime limit, known as the "exclusion amount." When an individual makes taxable gifts during their life, a portion of this credit is used. Any remaining credit is then applied to their estate upon death to reduce or eliminate estate taxes.

• Example 1: Lifetime Gifting

  Sarah wants to help her daughter buy a house and decides to gift her $1 million. Without the applicable exclusion credit, this gift would be subject to federal gift tax because it significantly exceeds the annual gift tax exclusion. However, Sarah can use a portion of her lifetime applicable exclusion credit to cover the $1 million gift. This means she won't owe any gift tax on this transfer, but the $1 million will reduce the total amount of wealth she can transfer tax-free later in life or at death.

• Example 2: Estate Planning

  John passes away, leaving an estate valued at $15 million. At the time of his death, the federal estate tax exclusion amount (which is covered by the applicable exclusion credit) is $13.61 million. John's estate will use the applicable exclusion credit to cover the first $13.61 million of his estate, meaning no federal estate tax is due on that portion. Only the remaining $1.39 million ($15 million - $13.61 million) would potentially be subject to federal estate tax, significantly reducing the overall tax burden.

• Example 3: Combined Use of Credit

  Maria made several large gifts totaling $5 million to her grandchildren over her lifetime. When she passes away, her remaining estate is valued at $10 million. The lifetime exclusion amount at her death is $13.61 million. Maria already used $5 million of her applicable exclusion credit during her lifetime for the gifts to her grandchildren. This means she has $8.61 million ($13.61 million - $5 million) of her credit remaining. Her estate will apply this remaining $8.61 million credit to her $10 million estate, making $8.61 million of it tax-free. The remaining $1.39 million ($10 million - $8.61 million) would then be subject to federal estate tax. This illustrates how the credit is a cumulative lifetime benefit, used for both gifts and estate transfers.