Exploring the Previously Taxed Property Credit

Estate Planner Mar-Apr 2000

Paying estate tax can reduce the amount of property that passes to the intended recipient. Paying estate tax again on that property if the recipient dies soon after the first death could greatly reduce the amount of property received by the subsequent beneficiary. Fortunately a credit reduces this otherwise draconian result. The previously taxed property credit does just what its name implies — it provides a credit for estate tax previously paid on property subject again to estate tax within 10 years of the death that triggered the previous tax. The idea behind the credit may sound simple, but understanding when and how to use the credit can be much more complicated.

Determining the Credit

Consider, for example, a 70-year-old man in frail health who just lost his mother, his only living parent. If he dies within 10 years of his mother’s death, his estate will receive a credit for the estate tax paid on the property previously taxed in his mother’s estate that he leaves to his children.

His credit is subject to two limitations:

1. The amount of pro-rata tax paid on the property included in his mother’s estate. For example, if the property that passed to the son represented 25% of the value of the mother’s estate and incurred estate taxes of $300,000, the first limitation would be $75,000 (25% of $300,000).

2. The amount by which the son’s estate tax was increased by assets received from his mother being included in his estate. This amount is greater than a pro rata amount would be because the progressive tax rate increases from 37% to 55% and the second limitation counts the increase in tax at the higher rates when property is added to the estate.

The credit is further limited by how close the two deaths occur. The credit is reduced by 20% for every two years that the survivor lives. For example, if the son dies within two years of his mother, then 100% of the credit is available. If the son survives his mother for more than two years but less than four years, his estate is entitled to 80% of the credit.

More Tax-Saving Opportunities

An estate doesn’t have to incur estate taxes on the previously taxed property to take the credit. For example, if the mother at death gave her son the right to live in her house for his lifetime, the son’s estate would not have to pay any estate tax on the right because it expired on his death. Nevertheless, the son’s estate is entitled to the credit based on the estate tax paid on his mother’s estate.

Similarly, if the mother left property in trust for her son and he had the right to receive all trust income for his life, that right would not trigger tax in his estate but could instead reduce estate tax in his estate owing to the credit because he is not deemed to own the underlying property.

Often the credit can be used in planning for a husband and wife situation. Generally, because of the use of the marital deduction and applicable exclusion amount, no estate tax is due on the death of the first spouse. Yet, pre-death or post-death planning strategies can force an estate tax on the death of the first spouse that will permit the use of the credit on the surviving spouse’s estate.

The end result is that the total of the estate tax in both estates minus the credit is smaller than the estate tax payable under the more traditional approach when all tax is deferred until the surviving spouse dies. The starting point for planning is when the deaths of a husband and wife will likely be within a few years, at most, of each other.

Don’t Go It Alone

If you have questions about the previously taxed property credit, please let us know. Our professionals would welcome the opportunity to help you determine if this tax tool is right for your particular circumstances.