Ten years ago, when the Illinois estate tax exemption was $2 million and the federal exemption $3.5 million, I started working with a couple whose farm was worth about $10 million. The estate tax law was in flux. The Bush tax cut was phasing out the federal estate tax, but it would boomerang back to a mere $1 million exemption in 2011.
The couple wanted to do what they could to reduce what was projected to be a seven-figure estate tax liability. It would take quite a bit more than an ordinary tax-planning will or revocable living trust to solve this.
For the most part, the tax law has only gotten better since 2009. The federal estate tax did disappear for one year, and then came back with a $5 million exemption, indexed for inflation. The Tax Cuts and Jobs Act in 2017 doubled that, freeing almost every family farm from fear of the federal estate tax. The Illinois estate exemption has doubled to $4 million. However, if it catches you, the effective rate bites hard.
The husband and wife have both passed on now, the first in 2013 and the other just this year. Most of their children are carrying on the farming tradition and successfully building estates of their own.
The parents’ estate during the 10-year period appreciated to about $18 million. When Dad died in 2013, the federal exemption was a little over $5 million, and the couple’s property was worth around $13 million. No estate tax was due. This is unremarkable, since with very ordinary estate planning, a married couple can, at the first death, leave everything in excess of the decedent’s exemption to the surviving spouse with no tax.
But what if?
Had our clients settled for this common planning, the first $4 million (the Illinois exemption had reached that level) would have passed in trust for the spouse and children free of any tax, with the excess of $9 million remaining in the mom’s estate.
The real test came this year when Mom died. The $4 million, if left in trust by Dad for Mom and the children, would have appreciated to $5.5 million and still be outside of Mom’s estate. But the $9 million has also appreciated to almost $12.5 million, all of which would be reported in Mom’s estate. How bad would the taxes be?
Since Dad did not use all of his federal exemption in 2013, his leftover exemption was transferred to Mom. So, with the current $11.4 million federal exemption, plus just over $1 million of dad’s unused exemption, Mom’s estate could squeak through with no federal tax. However, the family would still lose $1,264,000 in taxes to the state of Illinois. Even with the doubled Illinois exemption since they first decided to plan in 2009 and the practical elimination of the federal estate tax, the family would have to sell 120 acres to pay the taxes.
But that is not how this story ended. Fortunately, the parents had, even while the estate tax laws were uncertain in 2009, done more than ordinary planning. They set up special asset protection trusts for their heirs and transferred the farm to those trusts. They reported an appropriate part of these transfers as gifts; no tax was due. The parents continued to receive most of the income for life, so never lost the benefits of property ownership.
Now that both parents have died, there is still no estate or gift tax due. The full $18 million is passing tax-free. The asset protection trusts are divided into separate trusts for the children. Each child gets roughly equal tracts of land and gets to decide what to do with it. The child can spend not only the income generated, but also (if they sell land) whatever principal they need to live comfortably.
If there is anything left in their separate trust at the child’s death, the child can leave it to whomever they want, but it will not be counted by the taxing authorities as part of the child’s estate. If the children continue to be relatively successful, the estate tax savings is multiplied. The parents’ extraordinary tax planning will pay huge dividends for their grandchildren, and beyond.
Ferguson is an attorney owns The Estate Planning Center in Salem, Ill. Learn more at thefarmersestateplanningattorneys.com.