Act Now! Planning for the Illinois Estate Tax
With the American public focused on the issue of health care reform, and nursing their
hangovers from riding the stock market roller coaster, it is unlikely that many people are losing
sleep right now over the status of the federal estate tax law, let alone the Illinois estate tax law.
But those of us in the estate planning arena are dealing with an Illinois estate tax that until
recently hadn’t really caused much consternation. With the uncertainty surrounding the estate tax
laws causing some clients to hesitate to pursue estate planning right now, I would argue that
recent changes in the Illinois estate tax law, and the current status of the federal estate tax law
make it more critical than ever for clients to make sure their estate plans are up-to-date.
To give you some background, after repealing its former “inheritance tax” in 1982, Illinois
adopted an estate tax, imposed on the value of a decedent’s assets, payable to the state 9 months
after death. The tax was referred to as a “pick up tax,” because it was an amount equal to the
“state death tax credit” allowable under federal estate tax law. This “pick up tax” provided a
source of revenue to the state of Illinois from 1982 to 2005. In 2001, “EGTRRA” (the Economic
Growth and Tax Relief Reconciliation Act of 2001) became federal law. EGTRRA phased out
the “state death tax credit,” and therefore the state “pick up tax,” and therefore Illinois’ source of
estate tax revenue.
It should not come as a surprise that the Illinois government did not take the prospect of
losing that estate tax revenue lying down. In June of 2003, Illinois “decoupled” its estate tax from
the federal estate tax by passing its own separate estate tax law.
The decoupled Illinois estate tax law allows effectively the first $2,000,000 of a
decedent’s estate to pass free from Illinois estate tax. In the years 2003 through 2008, this new
Illinois tax didn’t present too many planning challenges (aside from its calculation involving a
simultaneous equation). However, in 2009, the federal estate tax exclusion amount increased to
$3.5 million per decedent’s estate, while the Illinois estate tax exclusion amount was capped at
$2.0 million. This created an inconvenient dilemma for estate planners: utilize the full $3.5M
federal exclusion on the death of the predeceased spouse, and incur an Illinois estate tax on
$1.5M; or forego the use of $1.5M of the client’s federal exclusion, and avoid the Illinois estate
tax altogether? The Illinois estate tax on a $3.5M estate is approximately $209,124 (the effective
tax rate on that size estate is about 14%). While at first glance, it would appear to be a simple
decision to avoid the tax, there is a catch. By foregoing the use of $1.5M of the federal exclusion
amount, the surviving spouse’s estate may potentially incur a 45% federal estate tax on that extra
$1.5M. It comes down to “pay now, or pay (at a higher rate) later.” Failure to fully utilize the full
federal exclusion could mean additional federal estate taxes of up to $675,000!
The Illinois legislature was empathetic to this awkward situation, and on September 8,
2009, a bill was passed into law, allowing for a “QTIP” tax election which may be made by a
surviving spouse, which would allow full utilization of the decedent spouse’s $3.5M federal estate
tax exclusion amount, while deferring payment of the Illinois estate tax on the extra $1.5M until
the second death. That is good news for those of us estate planners who have been “sleepless in
Illinois,” worrying about how to approach this estate planning dilemma for our clients.
While the new Illinois QTIP election is good news for estate planners, it will be necessary
for clients to consult with their estate planning attorneys to determine how to incorporate the
appropriate provisions into their estate planning documents to facilitate the application of the
QTIP election. Depending on the size of the estate, the nature and ownership of the clients’
assets, and even whether it is a first or second marriage situation, the attorney may recommend
one of several options to address the discrepancy between the federal and Illinois estate tax
exclusion amounts. With appropriately drafted documents, disclaimers and QTIP elections may be
used strategically to minimize the overall federal and state estate taxes imposed upon both
spouses’ deaths. Each client’s situation is unique, however, and must be analyzed independently.
Incorporating flexibility into the estate planning documents is the key to avoiding unnecessary
estate taxes, and to maximizing to the greatest extent possible the portion of the client’s estate
that will ultimately pass to their families and loved ones.
© Kimberly S. Coogan, Attorney at Law, Bellock & Coogan, Ltd., Oak Brook, Illinois