What is the unified tax credit? How does it change federal gift and estate taxes?

A tax credit can reduce or eliminate your federal tax obligation. One such credit is the unified tax credit, so named because federal gift and estate taxes are integrated into one unified tax system.

The extent of the benefit provided by the unified tax credit depends on the tax year in which you intend to use the credit. If you are still working on your income tax returns from prior to 2009, you may be able to take advantage of this credit to reduce the amount of federal taxes that you owe.

After 2009, your ability to use the unified tax credit is limited by subsequent changes in the law.

Was the unified tax credit repealed?

For 2009 tax returns, every American received an automatic unified tax credit against federal estate and gift taxes of $1,455,800, which is equivalent to transferring $3.5 million tax-free to your heirs.

If you were married, your spouse (also a U.S. citizen) received the same exemption credit, so that you could, as a couple, give a full $7 million to your heirs free of the estate tax. There was no estate tax on the first $3.5 million in 2009, meaning you were not required to pay taxes until the sum reached over $3.5 million in 2009.

In 2010, the federal estate tax part of the unified tax credit was repealed. That meant you could not claim the unified credit for 2010 taxes. The estate tax rate has varied from 55% in 2001, dropping to 45% in 2009, and reappearing in 2011 at a top rate of 35%. Fortunately, while the federal estate tax was repealed in 2010, the gift tax remained in effect. The maximum gift tax rate was also 35% for 2011 and increased to 40% in 2013.

Was the estate tax reinstated?

Though the estate tax was suspended for 2010, it was reinstated for 2011 but not to its original 2002 levels. For 2011, a person could transfer up to $5 million tax-free at death or during his or her lifetime (this special exemption is known as the basic exclusion amount); the unified credit for 2011 was $1,730,800. That base federal exclusion amount is adjusted annually for cost of living increases, as shown below:

2015:  $5.43 million

2016:  $5.45 million

2017:  $5.49 million

2018:  $11.18 million

2019:  $11.4 million

The increase in the base amount in 2018 was due to the passage of the 2017 Tax Acts and Jobs Act. However, under the 2017 Tax Act, the base exemption amount amount reverts in 2026 to the 2017 levels, which are adjusted for inflation). The basic exclusion is equivalent to a unified tax credit of $2,117,800 in 2015, $2,125,800 in 2016, $2,141,800 for 2017, and $4,417,800 for 2018.

Because this unified tax credit has fluctuated fairly significantly since 2001, if you are unsure about how the unified tax credit is applicable to your tax situation for an income tax return due prior to 2010, you should consult with a tax attorney to ensure your potential credit is maximized. If you are considering making gifts this year, you may also want to visit with an attorney that specializes in estate planning to minimize the tax consequences for your estate and your heirs.

Case Studies: Utilizing Insurance With the Unified Tax Credit

Case Study 1: Irrevocable Life Insurance Trust (ILIT)

An ILIT is a trust that owns a life insurance policy, and it can be an effective tool for utilizing the unified tax credit. Let’s say an individual has a significant estate that exceeds the unified tax credit limit. By creating an ILIT and transferring a life insurance policy into the trust, the individual can effectively remove the policy’s death benefit from their taxable estate.

In the event of their passing, the death benefit can be used to pay any estate taxes owed, ensuring that the estate is protected and the unified tax credit is maximized.

Case Study 2: Long-Term Care Insurance

Long-term care insurance can play a crucial role in estate planning and utilizing the unified tax credit. As individuals age, the need for long-term care becomes more likely, and long-term care expenses can quickly deplete one’s assets.

By securing long-term care insurance coverage, individuals can protect their assets and preserve the value of their estate. This allows them to fully utilize the unified tax credit for gifting purposes and ensures that their estate is not diminished by the cost of long-term care.

Case Study 3: Disability Insurance

Disability insurance can be an essential component of estate planning and maximizing the unified tax credit. In the event of a disability that prevents an individual from earning income, disability insurance provides a replacement income source. By securing disability insurance coverage, individuals can ensure that they have a stable income even if they are unable to work.

This allows them to continue making gifts and utilizing the unified tax credit without the risk of depleting their assets or compromising their estate.

Case Studies: Utilizing Insurance With the Unified Tax Credit

Case Study 1: Irrevocable Life Insurance Trust (ILIT)

An ILIT is a trust that owns a life insurance policy, and it can be an effective tool for utilizing the unified tax credit. Let’s say an individual has a significant estate that exceeds the unified tax credit limit. By creating an ILIT and transferring a life insurance policy into the trust, the individual can effectively remove the policy’s death benefit from their taxable estate.

In the event of their passing, the death benefit can be used to pay any estate taxes owed, ensuring that the estate is protected and the unified tax credit is maximized.

Case Study 2: Long-Term Care Insurance

Long-term care insurance can play a crucial role in estate planning and utilizing the unified tax credit. As individuals age, the need for long-term care becomes more likely, and long-term care expenses can quickly deplete one’s assets. By securing long-term care insurance coverage, individuals can protect their assets and preserve the value of their estate.

This allows them to fully utilize the unified tax credit for gifting purposes and ensures that their estate is not diminished by the cost of long-term care.

Case Study 3: Disability Insurance

Disability insurance can be an essential component of estate planning and maximizing the unified tax credit. In the event of a disability that prevents an individual from earning income, disability insurance provides a replacement income source. By securing disability insurance coverage, individuals can ensure that they have a stable income even if they are unable to work.

This allows them to continue making gifts and utilizing the unified tax credit without the risk of depleting their assets or compromising their estate.