**Illinois Estate Tax: The Basics**
As of 2023 Illinois is one of 18 states with an estate tax. The Illinois estate tax has both a exemption threshold and a maximum tax rate, just like the federal estate tax. Both taxes kick in after someone’s death. However, while the federal estate tax is high enough to cover less than 1,000 estates annually, according to the most recent statistics, the Illinois estate tax impacts thousands of estates every year – including yours.
The current Illinois estate tax exemption limit is $4 million (up from $2 million last year). The maximum Illinois estate tax rate is 16%.
Most people understand what estate taxes are, but often people lump the Illinois estate tax in with things like income taxes, sales taxes, and property taxes instead of thinking about it as an estate planning issue. Federal and Illinois estate taxes only come into play when property transfers from one person to another at death. There is no tax that applies to lifetime giving – although that is coming into play in Illinois this year.
When someone dies, the Illinois Department of Revenue uses a couple of methods to determine whether the estate is subject to the Illinois estate tax. The primary driver is that a tax return, the IL-706, will need to be filed on large estates. The IL-706 is very similar to the federal Form 706 that most executors of someone who died in 2022 were required to file. The IL-706 is different than the federal Form 706 used for estates of 2023 decedents in that a IL-706 is due just 9-months after someone dies . The Form 706 deadlines are based on when the decedent died. The current federal Form 706 is due 9-months after the end of the year in which the decedent died.
The second way that the Illinois estate tax is triggered is by having an inheritance above what the Department of Revenue allows without filing a return. This number was previously $40,239, but has now dropped to $4,000. This means that if your direct heir (i.e., child or grand child) receives $4,000 or more from any of your accounts, this could trigger the Illinois estate tax. This doesn’t mean that you’ll owe any estate tax.
For example, if your child will receive $40,000 from your joint checking account, a trust for your child, or a life insurance policy, then the Department of Revenue would require the filing of a tax return just like a decedent whose estate was over $4 million. However, unlike the return owed by the $4 million estate, your child would not owe any estate taxes because your estate was under the threshold required to incur tax liability ($4 million in 2023).
In contrast, the Illinois inheritance tax is a tax imposed on the person who receives the property. If you receive a taxable gift or inheritance you will be the person who owes the tax, not the estate or the deceased person’s estate. The inheritance tax only applies to gifts received by a person while the decedent was alive or after the decedent died. In Illinois and most other states, if the remaining estate is below a certain level, there is no inheritance tax to pay.
**Making Gifts of Assets**
One way to reduce an Illinois estate tax is to start gifting assets away, during your lifetime. Lifetime gifts are NOT part of your taxable estate. The Federal government allows individuals to gift up to $15,000 per person per year without having to pay any additional gift tax. This is known as the annual gift tax exemption. You can gift money to one person each year, or several people the $15,000. For instance, a father could gift $15,000 each to his three children every year without needing to file a gift tax return, and avoid paying any gift tax. But the amount that can be gifted without paying a gift tax is not limited to the annual gift tax exemption. The Federal government has a lifetime exclusion amount for estate tax purposes. Imagine your total estate when you die will be taxed, and the fee is 40%. When you start gifting away your assets as you age, you can use the annual exemption first. But if you gift above the $15,000 number, that excess amount counts toward the lifetime lifetime exclusion amount. So, if your taxable estate at death was $1million, the income tax would be $400,000. If you paid $100,000 in annual gifts to your three children, the remaining taxable estate would be $700,000, and the tax would be $280,000. But, this assumes you have no lifetime exclusion amount remaining on your estate at death. If you do, the taxable estate is reduced by the amount of the exclusion you have available. Today, the lifetime exclusion amount is $5.25 million. This means as of today you can give away $5.25 million in your lifetime avoiding income tax. The same rules apply; you can gift the $15,000 annual exemption without paying tax. Or, you can gift the entire lifetime exclusion if you feel the IRS will allow it. It is always polite to ask before assuming! Of course, the Federal lifetime exclusion amount is indexed for inflation. In 2017 the exclusion is $5.49 million. In 2018, the lifetime exclusion jumps to $11.2 million, and then after that it is indexed for inflation. But remember, the Illinois estate tax exclusion amount is only $4 million currently, but it drops to $2 million in 2018. Planning now, even gifting of the excess over $2 million, will reduce your taxable estate in the future.
**Using Trusts to Minimize Tax**
There are a variety of trust options available to lawfully lower estate taxes, and many fall into one of three main categories:
Irrevocable Life Insurance Trusts (ILITs)
One effective way to minimize Illinois estate tax is to create an irrevocable life insurance trust (ILIT) which can keep the death benefit of any outstanding life insurance policy out of the taxable estate of the decedent. You can create an ILIT yourself or with the guidance of an experienced estate planning attorney.
An ILIT is an estate planning tool that will essentially freeze the value of the estate for tax purposes. Because you will no longer own your life insurance policies once you transfer them to the ILIT, any death benefits paid to the ILIT will not be included in your Illinois taxable estate at the time of your death.
A properly funded ILIT will be an exempt asset that doesn’t require additional gift tax either during your lifetime or when you die. However, you are permitted only to leave your life insurance death benefit to your spouse, which is why this type of estate plan is also called a spousal lifetime access trust (SLAT).
Bypass Trusts
Assets are used to fund bypass trusts that are created on behalf of your children. Your surviving spouse will still be the income beneficiary for these assets, but these trust distributions will not be considered part of your surviving spouse’s taxable estate. Your surviving spouse will have unfettered access to her children’s assets, so long as she remains married to you, she will be the sole beneficiary of their contents. And, because each spouse has an Illinois estate tax exemption, the exemptions aren’t lost just because the assets are left in trust’s for the benefit of the surviving spouse.
This is particularly important in Illinois, where an unlimited marital deduction is available. In this scenario, the surviving spouse does not owe any Illinois estate tax upon your death but will be required to pay the tax when she dies. If you have substantial assets, such as a family business, the tax owed could be significant unless ILITs or bypass trusts are used.
**Establishing Family Limited Partnerships**
The Illinois estate tax includes the value of all property the decedent owned or had an interest in at the time of death. Fair market value of assets is the key factor in determining the size of the taxable estate. The best options for reducing a taxable estate are also the most complex. Family limited partnership is one of those options.
Family limited partnerships are limited partnerships set up to accomplish specific estate planning goals. When properly established and managed, family limited partnerships can be used to reorganize equity within a family with minimal or no transfer tax consequences. Transfer tax includes both gift tax and estate tax. A gift to a family limited partnership can often be discounted on federal and state transfer tax returns in value anywhere from 25 to 30 percent. These partnerships reduce the value of the owners’ estates by virtue of the fact that family limited partnership assets are not subject to death taxes. However, income earned after the creation of the family limited partnership is still taxable in the decedent’s estate.
Transfer tax is a tax on both lifetime transfers of wealth and transfers at death, including the gift and estate taxes. A transfer that is completed and that passes the test of being permanent and uncompensated will qualify as a gift, thus avoiding both the gift and estate tax. How the partnership is structured and how it is funded determines whether the taxpayer has made a completed gift. Complying with federal tax and securities regulations is essential.
FlPs are created by transferring marketable stock and cash to a general partner. Initial contributions typically are approximately 1 percent in interests to the general partner and approximately 99 percent to other partners. Investors’ interests are divided by market value. The general partner can be a separate entity owned by a family member, an attorney or a family business. This entity may also be the sole owner of the family limited partnership.
FlPs can reduce the taxable estate by reducing the decedent’s share of family assets. During life, the general partner controls actions and decisions by special assignment. Under the Illinois Uniform Partnership Act, partnerships are generally governed by a majority vote of the members. The general partner’s interest is enhanced by transferring management and decision-making authority to the general partner.
FlP interests are inherently illiquid, unmarketable and may carry restrictions. Many investments are closely held. FlP shares are generally lacking in other marketability factors. Therefore, an investment’s diminished value can reduce or eliminate federal transfer taxes to the decedent’s estate, which can include inherited IRDA and pension benefits.
Interest in the partnership should be sold or given away before the owner dies. Distributions from the family limited partnership must be probated and included in the taxable estate unless they are made payable to a named beneficiary. Illinois law also provides that certain limited partnerships and LLC are exempt from death taxes.
**Using Charitable Gifts as a Strategy**
Philanthropy is a great way to leave your mark on the world. And with the Illinois estate tax at 16%, you owe it to yourself to consider how it can also be a powerful tax strategy. This is especially true where your estate can make use of charitable donations.
Many estate plans come with a charitable remainder trust (CRT). These trusts are an effective tool for deferring taxes until your trust makes distributions to your heirs. Since your income can fluctuate, they also give you the option to wait to distribute income until your heirs’ tax brackets are lower and thus will pay less taxes overall .
Charitable donations also have a much broader application and can shorten your estate in multiple ways. Like a CRT, contributions before your death offer up a tax deduction, though the deduction is limited to 50% of your adjusted gross income. Another way donations can save you tax money is through the Illinois Property Tax Code. By donating to specific kinds of charities, you may be able to completely exempt your donation from property taxes.
Before making any charitable donation with the goal of saving on taxes, consult your estate planning attorney.
**Using Life Insurance in Estate Planning**
We have written many times about the benefits of life insurance in estate planning. The ability of life insurance to create liquidity for the payment of Illinois estate taxes, to provide immediate and liquid cash at death which can then be used to pay death taxes, is well known.
Many people strategically own life insurance policies where the death benefit may be accessed by beneficiaries (or their spouses) without the imposition of Federal income tax, without being available for the creditors of an insured party, and where the death benefits are available for the payment of estate taxes.
In ILIT’s, the ownership and ability to access a policy are separated, so that the policy may grow for the benefit of a non-decedent party and be used to pay the estate tax of the insured, without inclusion of the death benefit in the taxable estate of the deceased insured. The ILIT is the vehicle of choice for clients who seek to avoid inclusion in their taxable estate, but who also want to preserve control after death.
**Consulting with an Estate Planning Lawyer**
There is a detailed Illinois estate tax issue in play for almost all residents of Illinois. What can you or should you do about it? There are many techniques that can legally reduce or eliminate an Illinois estate tax. These techniques range from fairly simple to highly complex. In using these techniques it is important to remember that estate tax planning is not look back planning, but rather is planning that begins at an individual’s first asset purchase. Much of the planning is focused on early acquisition (e.g., gifting to family members) and building family wealth with very limited ownership by parents (e.g., Joint Tenancy with Rights of Survivorship property ownership between parents and children should be avoided.). In addition, exposing family members to the gift tax exclusion amount early in life is also a very valuable technique .
If you try to implement your own solution at the last moment, you may not be successful. However, it is important to note that Illinois estate tax planning is not an upper middle class game. It only makes sense for individuals, generally, who have estates of over $4.5 million in terms of value (as of January 1, 2024 now $4,650,000 adjusted for inflation). Thus, in reality, at least 95% of the residents of Illinois will ultimately pass with no estate tax to family members because their estates will be less than the $4.5 million threshold and the estate tax law provides for a $100,000 "exemption."
The bottom line is that there are many strategies available to and ranging from relatively simple to very complex. You should consult an estate planning attorney in Illinois to help develop these strategies that are compliant with Illinois law and appropriate to your individual circumstances.