Illinois Estate Taxes – Planning for State-Level Peculiarities

The saying goes, “Nothing in life is certain except death and taxes.”  But there’s more under the hood than what that quote’s author spoke about. The estate tax is just one of many different taxes out there, and there are differences between the federal estate tax and the estate tax at a state level. The federal estate tax grabs the headlines more often – will changes be coming in 2025? – but it’s at the state level where many more families can be impacted. I’ve written about the federal estate tax and strategies in a few other places here on the Mission Wealth Insights blog (for background on the federal estate tax, check this article out!). Still, this article will look more deeply at one of the 13 states/territories with an estate tax at the state level – Illinois.

The Illinois Estate Tax – Differences from the Federal Estate Tax

Similar to many other states with an estate tax, Illinois has a much lower threshold for when an estate could owe estate taxes. In Illinois, this threshold is $4,000,000 per person. It’s important to note that the threshold is just that in Illinois – if an Illinois resident passes away with $3,999,999.99 to their name, they owe no estate taxes. If that same person found a penny and their estate was now equal to the Illinois threshold, then their entire estate is now looked at for tax purposes.

This is different than at the federal level, where we receive a credit to use against our estate so that we’re only paying taxes in effect on everything over the $13,610,000 federal estate tax credit exemption. In Illinois, the Attorney General has specifically stated that the $4,000,000 exclusion “is a taxable threshold and not a credit against tax.”  That one penny significantly impacts the final taxes owed by that person’s estate.

Illinois has 21 different tax brackets for its estate tax.  The lowest rate is 0%, and the highest is 16%.  The chart below outlines the different brackets.

Illinois also differs from the federal estate tax in that the $4,000,000 threshold is not a figure that can be combined with the surviving spouse’s threshold. In Illinois, just like at the federal level, one spouse can transfer assets to the surviving spouse without triggering any estate tax complications – this is called the “unlimited marital deduction.”  However, another key difference comes into play: at the federal level, where one spouse has an excess or unused exemption, the surviving spouse can file for “portability” and combine it with their own.  In Illinois, you can’t. It’s a use-it or lose-it offer. 

Planning Strategies for the Illinois Estate Tax

There are several ways to effectively plan for the Illinois estate tax and limit your potential future tax liability. 

1. Threshold/Exemption Planning with Trusts
   As previously mentioned, unlike the federal estate tax exemption, the Illinois threshold is not a combinable tax credit. This means that for a married couple, the design of your estate plan needs to be different to effectively use each of your potential $4,000,000 thresholds.

   For example, say that Bob and Marcia live in Illinois and have all their life. They have 2 adult children whom they would like to leave their estate. Bob and Marcia have worked hard, lived within their means, and made smart investment decisions with their wealth management team.  Their total net worth is $6,000,000, and they’ve been responsible in their estate planning. Their estate plan leaves all of their assets to the surviving spouse at first death and the balance to their kids equally once they’ve both passed. However, this plan has a hidden danger as it does not include setting up a Credit Shelter Trust at the first spouse’s death. 

   Once Bob passes away, his estate is administered as the plan outlines, and everything continues in Marcia’s name. Because Bob left everything to his spouse, no estate tax has been triggered in Illinois. Sometime later, Marcia passes away. Because Marcia’s estate is valued at $6,000,000, everything is considered for estate tax purposes. According to the Illinois Attorney General’s estate tax calculator, Marcia’s estate would owe $456,071 in taxes. The remaining $5,543,929 was transferred to her children.

   With additional planning, Bob and Marcia could have potentially avoided all the state-level taxes. The results look different if their plan called for a Credit Shelter Trust to be funded at the first death. At Bob’s death, $3,000,000 would go into this irrevocable trust for Marcia’s benefit. Marcia could continue to use the assets as she needed. This also would reduce Marcia’s net worth to $3,000,000.  Then, at Marcia’s death, no tax would be due as she is under the threshold for her estate being taxable. The other benefit to this planning is that any appreciation inside the trust is sheltered from the estate tax.

   It’s important to note that careful planning includes being aware of beneficiary designations on accounts. Beneficiary designations can allow for a smoother transition of assets at death but can also undo any careful threshold planning done in revocable trusts. Beneficiary designations override anything in a Trust or Will, so even if your plan calls for setting up a Credit Shelter Trust at the first death, the beneficiary-designated assets will not get picked up by that careful planning.

2. Gifting
   Illinois does not have a gift tax. However, the federal gift limits still apply. Currently, the annual exclusion at the federal level is $18,000 per recipient. If you give someone more than that, you must file a gift tax return.

   For every dollar you gift over the federal exclusion amount, your Illinois threshold is reduced by that same amount. If you give $200,000 in overages in your lifetime, your Illinois threshold is reduced by $200,000. Illinois also includes any gifts made in the last three years of a lifetime.  With careful planning, gifting can drastically reduce your estate and the possible tax liability over time. 

3. Changing Residence
   It’s easier said than done, but another option would be to move from Illinois to one of many states that do not have an estate tax. This includes Wisconsin, Michigan, Indiana, Ohio, and Missouri in the Midwest. Iowa has an inheritance tax that is currently being phased out. It is important to note that Illinois doesn’t give up its claim to you if you simply leave the state for more than half the year each year. Illinois uses a facts and circumstances test to determine if someone is a resident of the state and, therefore, subject to estate taxes. Also important to note is that if you maintain assets in Illinois, most frequently in the form of real estate, Illinois has specific rules around non-residents and how the estate taxes may apply. Suppose you maintain assets over the $4,000,000 threshold in Illinois. In that case, you’ll owe estate taxes in proportion to the value of your estate in Illinois and the total value of your estate.

4. Charitable Giving
   Charitable giving is another effective strategy to reduce your possible Illinois estate tax. Like gifting, you can give to charity during your life and reduce your estate. There are no limits to charitable giving beyond what you can effectively deduct on your income tax return and what your financial plan can support. At death, any charitable bequests produce a dollar-for-dollar offset to your estate. 

Illinois Outlook

Illinois residents must think about how their wealth plan is set up, not just during their lifetime but beyond. Many families tend not to want the Illinois Department of Revenue involved as a charitable beneficiary on their estate. With the right amount of estate and tax planning, steps can be taken to limit or eliminate possible estate tax burdens in the future.

As of this writing, there is legislation in the Illinois legislature to change estate tax rules, namely, to change the threshold to a true credit, increase the amount to $6,000,000 per person, and allow the credit to be combined between spouses. There are also additional rules to help protect farmers, so family farms are not required to be sold when the farm changes hands between generations.

At Mission Wealth, we’ll continue to monitor these proposed changes and their potential impacts on our clients. If you have any questions, please contact our wealth advisory and strategy team today.

This article is not intended to provide any specific tax or estate planning advice. Advisory services are only offered to clients or prospective clients where Mission Wealth and its representatives are properly licensed or exempt from licensure. Consult a tax professional or attorney for specific advice.