What The Feds Giveth, Illinois Taketh Away

Last month President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Jobs Creation Act of 2010. The Act extended the Bush-era income tax cuts through 2012 and made dramatic changes to the federal estate, gift and generation-skipping transfer ("GST") tax rules. The Act also increased the federal estate and GST exemptions to $5,000,000. Most notably, it "reunified" the estate and gift tax rules, meaning that the $5 million exemption can be used either during lifetime or at death. The tax rate for federal gift, estate and GST purposes was fixed at 35%. The increase in the federal gift tax exemption was an unforeseen and dramatic change to the transfer tax rules and has opened a whole new world of tax planning opportunities. Like the income tax provisions, the gift, estate and GST rules are only in effect through the end of 2012.

On the surface, any excitement generated by the changes to the federal rules may be overshadowed by recent changes in Illinois. On January 13th , Governor Quinn signed the tax bill passed by the Illinois legislature. The most widely reported changes under the new legislation were substantial increases in the Illinois income tax rates for individuals and businesses. However, the tax legislation also reintroduced the Illinois estate tax. As a result, an Illinois estate tax of as much as 16% can be imposed on each Illinois resident who dies after January 1, 2011 with assets in excess of $2 million.

With the disparity between the $5,000,000 federal estate tax exemption and the $2,000,000 Illinois estate tax exemption, it is important to review existing estate plans to ensure that both federal and state estate tax can be avoided to the extent possible. An estate plan prepared for a married couple with assets in excess of the estate tax exemption typically provides for the creation of trusts designed to take advantage of the federal and state estate tax exemptions while deferring payment of any required estate tax until the death of the surviving spouse. Due to the difference between the federal and Illinois estate tax exemptions, it is possible under older estate planning documents that Illinois estate tax could actually be imposed on the first spouse's death. This can be avoided if specific provisions are included in Wills and trusts. It may not be necessary to modify your current estate plan, but if you have not updated your estate planning documents within the last few years you should consider consulting with a lawyer to ensure that the documents are drafted to minimize your exposure to Illinois estate tax.

There are also unique opportunities available this year and in 2012 to reduce your exposure to Illinois estate tax. Illinois does not impose a gift tax, meaning gifts can be made during lifetime, avoiding imposition of Illinois estate tax on the gifted amounts. The increase in the federal gift tax exemption to $5,000,000 has created an opportunity for families to save several thousands of dollars from ultimate imposition of state estate tax.