The New Presence of the Illinois Estate Tax
In our last issue, we examined the changes to the federal estate tax law passed by Congress in December of 2010, which raised the threshold for federal estate tax to its highest amount ever, $5 Million. This law has a significant impact on our estate planning, as the $5 Million amount gives up to $10 Million of “coverage” for married clients, thereby allowing most of our clients to avoid federal estate tax liability. But, as we set forth last issue, the amount is only guaranteed for two years.
Our planners, however, even now cannot completely rely on the $5 Million amount for resolving estate tax exposures, as Illinois has its own estate tax, which takes effect at taxable estate levels of only $2 Million. Thus, if an Illinois resident dies with an estate of, for example, $3 Million (including life insurance, deferred compensation and all other assets), while there would be no federal estate tax because the estate is below the $5 Million threshold, there would be an Illinois estate tax because the estate exceeds $2 Million. The Illinois tax rates begin at 8% and go as high as 16%, so in this example the Illinois estate tax would be in excess of $167,000.
The Illinois estate tax has not always been known as an estate tax. Rather, until January 1, 1983, it was known as the Illinois Inheritance Tax. The tax was levied upon the recipients of inherited property, rather than on the estate itself. Even for surviving spouses, the tax could apply for asset totals beginning at only $20,000! It was a hugely unpopular tax, and had to be enforced by the Illinois Attorney General’s office. Thus, upon learning of the death of one of its depositors or safe deposit box holders, banks were obligated to “freeze” the decedent’s account until a release of the inheritance tax lien could be secured from the Attorney General’s office. Banks actually kept an employee on staff whose job it was to scan the obituary pages of the local newspapers to cross-reference the decedents against their customer list. Funeral directors and attorneys had to direct their surviving clients to rush to the bank to withdraw living expense money before the bank became aware of the death, as the banks had no choice but to freeze the accounts. Estate administration attorneys spent an inordinate amount of their time in those days securing releases for frozen assets.
The inheritance tax was finally abolished January 1st of 1983, to be replaced by the present estate tax system. The replacement Illinois estate tax was basically a “pick-up” tax, whereby there could be no Illinois estate tax unless there was a federal estate tax, and the amount of the Illinois tax was equal to a portion of the federal tax, shared by the federal government with the state. Many states have this system, which is obviously more survivor-friendly than the old inheritance tax system. And estate planning attorneys could do their tax planning solely with an eye toward dealing with the federal estate tax laws, as no additional, separate Illinois tax was possible.
This system worked seamlessly until the federal estate tax exempt amount began to rise steeply in the late 2000s. From 2001 through 2008, the amount grew gradually from $1 Million to $2 Million, but in 2009 jumped to $3.5 Million. When that happened, many states, including Illinois, “de-coupled” from the federal estate tax format and passed new estate tax laws providing that the state estate tax began at a lower amount than $3.5 Million. Thus, Illinois now has the $2 Million threshold for estate tax, and when the federal estate tax threshold amount was raised last December to $5 Million, Illinois again remained at $2 Million. Thus, the amounts between $2 Million and $5 Million are subject to Illinois tax only, and our estate planning counsel must now adjust our client’s existing estate planning documents to respond to that change.
Some amendments to existing trusts and wills are required to maximize our clients’ protection from the state estate tax, especially in the case of married taxpayers. With proper drafting, it is still possible to have no state or federal tax due on the death of the first spouse to die. A spouse with an estate of $5,000,000 or more, who uses the special QTIP election can defer up to $352,158 in Illinois estate taxes that would otherwise be payable upon the death of the first spouse.
We urge our clients whose total joint net worth approaches $2 Million to consult with our estate planning counsel to determine whether modifications to their estate plan could be helpful.