October 5, 2020
As I write, the 2020 election is approaching. The two presidential candidates’ tax plans will undoubtedly affect your vote. Based on the news in the runup to the election, the outcome might still be in question well after Nov. 3. But one thing is relatively certain: Nothing happening in the 2020 election is likely to change the Illinois estate tax.
The federal estate tax exemption is indexed for inflation and is currently $11.58 million for each person, so a married couple can leave over $23 million to their heirs free of federal tax. Prior to the 2017 tax law, the exemption was half this size. Sadly, nothing in tax law is “permanent,” and without further action, this exemption will revert back to half the inflation-adjusted amount in 2026. As of 2026, the “half” should be around $6 million. One of the proposals by the Democratic presidential nominee, former Vice President Joe Biden, is to reduce the exemption back to half now instead of waiting until 2026.
Whether the exemption is $11.58 million or reverts to half that, the federal tax system is rather forgiving for procrastinators. If a couple fails to proactively plan, and at the first death everything passes to the survivor, that survivor can still take advantage of the deceased spouse’s exemption: the exemption is transferrable to the surviving spouse.
What is the rate of estate tax? If your estate exceeds the exempt amount, the federal tax is 40% on the excess.
Back in Illinois
So how does all of this compare to Illinois’ estate tax?
Per-person exemption. Illinois estate tax exemption is $4 million per person instead of $11.58 million. It does not take a large farm to be worth more than $4 million.
Inflation not figured in. Illinois estate tax exemption is not indexed for inflation. There is no automatic annual increase, so as your farm appreciates in value, the tax is going to get worse.
Use-it-or-lose-it policy. While federal law more or less protects the couple who didn’t plan while both were living — allowing both of their exemptions to be used at the second death — Illinois’ exemption is a use-it-or-lose-it proposition. If the couple wants to ensure they take advantage of both of their $4 million exemptions and pass a total of $8 million tax free, they have to have a plan in place before either of them dies. If they don’t, they will typically waste one of their exemptions. That means everything over $4 million will be taxed instead of everything over $8 million.
Cliff tax. Illinois taxes the entire estate once it crosses over the exempt amount. In the business, we call it a “cliff tax.” If your estate is $5 million, all $5 million is taxed, not just the $1 million excess. It is a very complicated calculation, but for practical purposes, it works out that the tax is a regressive rate, which starts at 28.57% on all assets that exceed your $4 million exemption.
So that $5 million estate would pay $285,714 in tax, which is 5.7% of the entire estate, but 28.57% of the excess over your $4 million exemption. A $6 million estate would pay $456,071 tax, 22.8% of the $2 million excess. As the estate size grows, the rate continues to go down slowly until it bottoms out at around 13%.
State and federal
How do the federal and state estate taxes interact? The Illinois tax actually is a deduction from the taxable federal estate. In other words, if your estate was $15 million, the Illinois estate tax would be $1,609,310. That is deducted from your total estate before the federal tax is calculated, so your federal tax will be based on the net estate of $13,390,690.
Subtract your $11.58 million federal exemption, and the tax would be 40% of the excess: $1,810,690. Send $724,276 to Washington. If the federal exemption drops back to $6 million, the federal tax jumps to $2,956,276 — 40% of the $7,390,690.
Enough tedious numbers. Changes in the federal exemption could substantially increase those taxes or ensure that practically no family farm is hit.
But don’t ignore the Illinois tax, even if the federal tax never touches your estate. If you are married, plan ahead to ensure you get the benefit of two exemptions. Your estate exceeds the available exemptions? That requires more complicated planning, but if you put in the effort with competent professionals, you can still reduce, and usually eliminate, the tax.
Watch Curt Ferguson’s FPVX breakout session comparing the presidential candidates’ estate plans.
Ferguson owns The Estate Planning Center in Salem. Learn more at thefarmersestateplanningattorneys.com. The opinions of this writer are not necessarily those of Farm Progress/Informa.
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