Legal Definitions - unified credit

The unified credit, more formally known as the unified estate-and-gift tax credit, is a tax provision in U.S. federal law that allows individuals to transfer a certain amount of wealth during their lifetime and at death without incurring federal gift or estate taxes. It acts as a direct dollar-for-dollar reduction against any gift tax owed on transfers made while living, or against any estate tax owed on assets transferred at death.

Essentially, the unified credit ensures that the first portion of an individual's cumulative taxable gifts and taxable estate is exempt from federal transfer taxes. The amount of this credit is tied to an "exclusion amount" or "exemption equivalent," which is adjusted periodically by law. If the total value of gifts made during life and the value of the estate at death falls below this exclusion amount, no federal gift or estate tax is typically due.

Here are some examples to illustrate how the unified credit works:

• Example 1: Lifetime Gifts

  Sarah, a successful entrepreneur, decides to give her daughter, Emily, a significant sum of money to help her start a new business. Sarah gifts Emily $5 million in a single year. While there's an annual gift tax exclusion (allowing smaller gifts without using the unified credit), a gift of $5 million is well above that. Instead of paying gift tax immediately on the amount exceeding the annual exclusion, Sarah uses a portion of her unified credit. This credit directly offsets the gift tax that would otherwise be due, effectively allowing her to transfer the $5 million without paying federal gift tax at that time. The amount of unified credit used for this gift reduces the total credit available for future gifts or for her estate upon her death.

• Example 2: Estate Planning

  Mr. Henderson passes away with an estate valued at $10 million. His will dictates that his assets be distributed among his children and grandchildren. Before the unified credit is applied, his estate might appear to be subject to federal estate tax because it exceeds the current exclusion amount. However, the unified credit is automatically applied to his estate. This credit allows a substantial portion of his estate (equal to the exclusion amount) to pass to his heirs completely free of federal estate tax. Only the portion of his estate that exceeds the exclusion amount, after accounting for any unified credit used during his lifetime, would be subject to federal estate tax.

• Example 3: Combined Lifetime and Estate Transfers

  Maria made a large gift of $3 million to her nephew several years ago, using a portion of her unified credit to avoid paying gift tax at that time. Years later, Maria passes away with an estate valued at $8 million. The unified credit is "unified" because it applies to both lifetime gifts and transfers at death. When calculating the federal estate tax for Maria's estate, the $3 million gift she made during her lifetime is added back to her taxable estate for calculation purposes. Then, the total unified credit available to her (the full exclusion amount for the year of her death) is reduced by the $3 million she already used. The remaining portion of her unified credit is then applied to her current estate, reducing or eliminating the federal estate tax on the remaining assets.