As we discussed in the Estate Planning Alert dated March 15, 2009, finally, on September 8, 2009, the Illinois legislature amended Illinois law to allow a marital deduction for transfers to a qualified terminable interest property trust ("QTIP"). This amendment will permit the deferral of the payment of Illinois estate taxes on the death of the first spouse until the death of the second spouse. (The amendment has been anecdotally referred to as "The Illinois Spousal Tax Relief Act.") The amendment is best understood by the following illustration:
Assumptions: Assume husband ("H") has an estate of $4,000,000 and wife ("W") has an estate of $3,500,000. H and W have each created credit shelter trusts for the benefit of the survivor to take advantage of the federal applicable exemption of $3,500,000. (The federal estate tax rates are greater than the Illinois estate tax rates. Hence, it is generally advisable to fully fund the credit shelter trust of the first spouse to die in order to take advantage of the federal estate tax savings, even if there is some Illinois estate taxes that must be paid at that time.) H dies in 2009 and W dies in 2010, after the federal law has been amended to extend the applicable exclusion amount of $3,500,000.
Estate tax consequences under prior Illinois law:
On H’s death, there is no federal tax because $3,500,000 of his estate – the amount that will be in a credit shelter trust for the benefit of W – is sheltered by the applicable exemption and $500,000 of his estate is sheltered from estate taxation because of the marital deduction provision of federal law.
The Illinois estate tax on a taxable estate of $2,000,000 – a $4,000,000 gross estate less a $2,000,000 Illinois exemption – is $254,000.
On W’s subsequent death, W’s gross estate is $3,746,000, being $3,500,000 plus $500,000 outright bequest from H less $254,000 Illinois estate tax paid on H’s death. The federal applicable exemption amount is $3,500,000. The tax on a taxable estate of $246,000 at an assumed federal tax rate of 45% is $111,000.
The Illinois estate tax on a taxable estate of $1,635,000 - $3,746,000 less $2,000,000 Illinois exemption and $111,000 Illinois estate tax paid – is $209,000.
Hence, total federal and state death taxes are $574,000.
Estate tax consequences under the new Illinois law assuming H has created a QTIP Trust:
On H’s death, there is no federal tax because $3,500,000 of his estate – the amount that will be in a credit shelter trust for the benefit of W – is sheltered by the applicable exemption and $500,000 of his estate is sheltered from estate taxation because of the marital deduction provision of federal law.
The Illinois estate tax on a taxable estate of $500,000 – a $4,000,000 gross estate less a $2,000,000 Illinois exemption and $1,500,000 marital deduction for H’s transfer of assets to an Illinois QTIP trust – is $129,000.
On W’s subsequent death, W’s gross estate is $3,871,000, being $3,500,000 plus $500,000 outright bequest from H less $129,000 Illinois estate tax paid on H’s death. The federal estate tax on a taxable estate of $371,000 at a federal rate of 45% is $167,000.
The Illinois estate tax on a taxable estate of $3,204,000 – $3,500,000, W’s own estate, plus (a) $1,500,000 QTIP trust and (b) $500,000 outright bequest from H, less (c) $2,000,000 Illinois exemption, (d) $129,000 Illinois estate taxes previously paid and (e) $167,000 estate taxes paid – is $200,000.
Hence, total federal and state death taxes are $496,000.
Conclusion: The creation of a QTIP trust by the first spouse to die allows for a $78,000 overall estate tax savings, in addition to postponing the payment of any Illinois tax until the surviving spouse’s death. The primary reasons for the reduction of aggregate estate taxes is the shelter in a federal estate tax-exempt QTIP trust of $1,500,000 by the first spouse to die and because the federal estate tax rates are higher than Illinois estate tax rates.
Action Plan: The Illinois estate tax exemptions available to a married couple are $4,000,000. If the aggregate estate of a married couple exceeds $4,000,000, there will be Illinois estate taxes to pay, if not at the time of the first spouse’s death certainly on the survivor’s death.
If the aggregate estate of a married couple is more than $4,000,000 and less than $7,000,000, an analysis must be made of the allocation of the ownership of the assets and desired objectives in order to recommend a strategy to achieve the deferral of the payment of the Illinois tax on the first spouse’s death and the maximum estate tax savings on both spouse’s deaths.
If the aggregate estate of a married couple exceeds $7,000,000, and they want to take benefit of the marital deduction provision in the Illinois law to achieve a tax savings of $78,000, if their estate plan document provides that, at the death of the first spouse, the credit shelter trust of the decedent will be funded with the largest amount that will produce no federal tax, i. e., $3,500,000, the document should be modified to limit the size of the credit shelter trust to $2,000,000, which is the amount of the Illinois exemption, and a $1,500,000 QTIP trust should be created. If this action is not taken, $1,500,000 will be taxable for Illinois estate tax purposes at the first spouse’s death, resulting in a tax of $209,000 payable at that time. If the estate plan document provides that, at the death of the first spouse, the credit shelter trust of the decedent will be funded with the largest amount that will produce no federal tax or state tax, i. e., $2,000,000, the document should be modified to eliminate the reference to the state tax, and a $1,500,000 QTIP trust should be created.
Please do not hesitate to contact us if you have any questions about the new Illinois estate tax law or how to achieve the tax savings by implementing a QTIP trust in your estate plan. * * * * *