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Illinois Estate Tax Alert

The Illinois Response to Changes in the Federal Estate Tax. The federal government enacted legislation in 2001 that provided for significant increases in the federal estate tax exemption. In 2008, estates under $2,000,000.00 are exempt from federal estate taxes. This legislation has been well publicized. Less widely reported, however, have been the responses of state governments, which had historically tied their estate tax system to the federal estate tax system.

Many states “decoupled” from the federal estate tax system. Illinois is one state that has passed legislation of its own in response to the changes in the federal estate tax.

Illinois law now provides that it will recognize the increased federal exemption amounts up to the current amount of $2,000,000.00. However, the federal exemption is scheduled to increase to $3,500,000.00 in 2009. The Illinois exemption will not increase. As such, on January 1, 2009, there may be substantial estate tax ramifications for Illinois taxpayers.

The Problem. The documents included in many traditional estate tax planning documents for married couples (a Will or a Revocable Living Trust) contain a formula funding clause under which an amount up to, but not exceeding the federal exemption amount will be held in trust for the surviving spouse. This trust is frequently referred to by estate planning professionals as a “family trust”, “credit shelter trust” or “B Trust”. For decedents in Illinois dying before 2008, this plan would mean that the family trust would receive up to $2,000,000.00 in assets. There would be no estate tax due, and the maximum amount possible would be sheltered from taxes for both Illinois and federal estate tax purposes.

For Illinois estates in 2009, the traditional funding clause may cause additional taxes to be owed. For example, for the 2009 decedent, the formula clause will indicate that the family trust should receive up to the full exemption amount of $3,500,000.00 upon the death of the first spouse. This formula will maximize the federal exemption with a zero federal tax, but will trigger an Illinois estate tax on the difference between the federal and the Illinois tax exemptions upon the death of the first spouse. In 2009, the difference between these two exemptions will be $1,500,000.00. The Illinois estate tax on this amount will equal $229,200.00. This tax would be due upon the death of the 1st spouse.

How Can this Problem be Avoided? One possible solution to this tax problem is to build flexibility into the estate planning documents by redirecting the amount by which the federal exemption exceeds the Illinois exemption into a separate trust. This separate trust will be structured such that your trustee (or personal representative should you only have a Will instead of a trust) has the flexibility to choose whether to subject the separate trust to federal and/or Illinois estate tax. In many cases, the trustee may determine that is more desirable to make an election which will qualify it for the marital deduction such that no tax is due at the death of the first spouse, even though such election will result in not maximizing the full federal exemption amount of $3,500,000.00.

What About Missouri?Missouri’s response to the changes in the federal estate tax in 2001 has been markedly different than Illinois. Missouri currently imposes no estate tax.

What Opportunities do you have?If you are a resident of Illinois or another state which has “decoupled” from the federal estate tax system, it may be time to review your estate planning documents. Our attorneys are licensed in Illinois and various other states. We will be happy to review and discuss your existing estate documentation to determine whether this flexibility is appropriate for your situation.