Thoughtful estate planning is important if you care what will happen to your farm, even if your estate is not going to incur estate taxes. Good planning addresses who gets what, what protections you provide, how to maximize capital gain and income tax savings, and treating everyone fairly. But in addition to those planning opportunities, you still have a variety of transfer taxes to navigate.
Two kinds of transfers are subject to tax. A transfer made from a living person is subject to gift tax unless it is a bona fide sale for true value. A transfer made as a result of death is subject to estate tax.
Illinois imposes a tax on estates (transfers at death), but no tax on gifts. The federal government imposes a tax on both. The best way to understand transfer taxes is to assume that all transfers by gift or on death are subject to tax unless there is a valid exemption that applies. So, what are the exemptions?
Under Illinois tax law, there is an unlimited exemption from tax on gifts. You can give away unlimited dollars or acres without Illinois gift tax. The IRS, however, taxes gifts unless they fit one of two exemptions. Everyone seems to know about the annual exclusion. Gifts of up to $15,000 per person per year are excluded (exempt) from tax.
But what about gifts in excess of that amount? We each have a lifetime exemption of $11,580,000 that can be applied to gifts that don’t qualify for the $15,000 annual exclusion. To illustrate, during 2020, you could give one person $11,595,000 with no tax. But since the gift exceeds $15,000, you have to report it to the IRS and apply your lifetime exemption.
Can you give more away by spreading it among multiple people? Yes, but only by $15,000 for each additional person. The $11.58 million is a total allowed per giver, not per receiver.
One reason the IRS requires you to file a return, report the gift in excess of $15,000, and apply your lifetime gift tax exemption is that the lifetime exemption applies to both lifetime transfers and death (estate) transfers. Whatever amount of that exemption you use up with lifetime gifts is deducted from the amount you can transfer through your estate on death.
The $15,000 never counts against you, but beyond that amount per receiver per year, pick any number: If you give away $7 million during life, your estate is limited to $4.58 million tax free; if you give away $10.58 million during life, then your estate is limited to $1 million. Transfers beyond that $11.58 million total are subject to federal transfer tax of 40%.
Illinois is much more confusing. The Illinois estate tax exemption is $4 million, so transfer of your estate up to that amount is exempt. However, gifts you had to report to the IRS factor into the Illinois estate taxes due at death.
For example, if you die with an estate of exactly $4 million, your Illinois estate tax is zero dollars. If you die with an estate of $5 million, your Illinois estate tax is $285,714. However, if you transferred $5 million by giving $1 million during life and leaving $4 million in your estate at death, your Illinois estate tax is $253,986. But if you transferred $5 million by giving $4 million during life and leaving only $1 million in your estate at death, your Illinois estate tax is only $31,439.
Federal exemption adjustments
The federal lifetime exemption adjusts for inflation each year, but under the current law will be cut in half in 2026. Let’s say inflation takes it to $12 million, and then in 2026 it drops to $6 million. What if between now and then you had given away $11 million in tax-free gifts using your lifetime exemption? If the exemption drops back to $6 million, could the IRS go back and claim taxes due?
The law is not clear, and much can happen between now and then, but regulations issued recently by the IRS say you don’t have to worry. The gifts will have been made using a valid, existing exemption, and would not be taxed retroactively.
Never let estate taxes dominate your estate planning decisions, but keep them in mind.
Ferguson is an attorney who owns The Estate Planning Center in Salem, Ill. Learn more at thefarmersestateplanningattorneys.com.