Illinois Residents May Face an Estate Tax Problem
 
April 17, 2008
 

Married Illinois residents with estates over $2 million may have an Illinois estate tax problem in 2009. Those who live in 12 other states or the District of Columbia already have the problem.

Typically, a married person with a potentially taxable estate provides that at his or her death a “bypass” trust will be created if the other spouse survives. The bypass trust is frequently created with the largest amount that is exempt from federal estate tax, and the trust will bypass the surviving spouse’s estate for estate tax purposes. The rest of the deceased spouse’s assets then usually pass to or remain in trust for the survivor. The purpose of such an estate plan is to defer estate tax until the survivor’s death and minimize tax by fully using both spouses’ exemptions.

In 2009 the federal estate tax exemption is scheduled to increase to $3.5 million from the current $2 million. For many this is very good news, especially single persons, but not necessarily good news for surviving spouses. Many estate plans allocate the amount of the federal exemption to the bypass trust with a corresponding reduction of the marital share. For 2009 that could reduce the spouse’s share by up to $1.5 million. Unfortunately, there is an Illinois estate problem as well. The Illinois exemption will remain at
$2 million unless changed in the state legislature. As a result, taking full advantage of the federal exemption will result in an Illinois estate tax on the estate of the first spouse to die of up to $229,000.

Consider Limiting Your Tax Exposure at the Death of the First Spouse

There is an alternative that probably should be considered. By limiting the bypass share to $2 million and thereby increasing the spouse’s share, the Illinois estate tax can be entirely avoided in the first estate. However, the beneficiaries of the surviving spouse may pay a heavy price. Adding $1.5 million to the survivor’s estate could increase the estate tax at his or her death by up to $869,000 (or more if the estate assets grow). That is four times the Illinois tax avoided at the first death.

One can specify now that the bypass trust is funded either with (a) the amount of the federal exemption (and pay Illinois tax at the death of the first spouse to die) or (b) the lesser of the federal or Illinois exemption (that would produce no tax at the first death but risk a much higher tax at the surviving spouse’s death). Alternatively, one can give the surviving spouse or the successor trustee the option to choose whether or not to pay the Illinois estate tax when the first spouse dies.

For those who might be affected by these issues, we recommend that they consider the alternatives and possibly amend their living trusts before January 1, 2009, when the federal estate tax exemption rises.

For more information, please contact your Holland & Knight attorney or one of the following members of our Illinois Private Wealth Services team at 312.263.3600: Andy Gelman, Don Gillies, Tom Kinasz, Rob Mintz, Jim Moehling, Carl Neumann, Jack Nyweide, David O’Leary, Morgan Ordman, George Pearce, Gale Roberson, Todd Schneider, David Shayne,Tom Skallas, and Mike Zdeb