Most people have heard of the estate, or death, tax, but many who have heard of it may not understand what the estate tax is, how it is calculated, who collects it, or what happens if you do not pay it. This is a brief primer on the Illinois Estate Tax, which is a separate and distinct estate tax from that imposed by the federal government. While not intended to be a fully comprehensive roadmap for either determining when estate taxes are owed, nor how to prepare the requisite filings or submit the necessary payments, this summary will assist in understanding what portion of an estate is taxable, who is responsible for overseeing this process, what can happen if estate taxes are not paid, and what can be done to try to minimize an estate tax burden. Moreover, this summary is not a substitute for accounting to be performed by a qualified tax or financial professional. For specific questions about calculating what estate taxes your estate may owe, you must seek financial advice from your tax professional.
Illinois is one of 18 states throughout the country to impose a state-level tax on a decedent’s estate. Not to worry – unlike other mandatory forms of taxation such as sales and property taxes, not every estate will be subject to the estate tax. The State’s authority to impose an estate tax is found in the Illinois Compiled Statutes, 35 ILCS 405 et. seq. titled the Illinois Estate and Generation-Skipping Transfer Tax Act (“Estate Tax Act”). Over the years, the Illinois estate tax has evolved. As recently as 2012, the estate tax threshold was $2,000,000, while today, that threshold is now $4,000,000. But what does this mean to a taxpayer? A common misconception is that once a person reaches the taxable threshold, then the entire estate is taxed at the estate tax rate. Put another way, many incorrectly believe that once an estate is worth four million dollars, then the entire estate is hit with this tax. Instead, the estate tax is imposed on an estate’s value in excess of the established threshold. In other words, currently, the first $4,000,000 of an estate is exempt from Illinois estate taxation. 35 ILCS 405/2(b)(i)-(iii). According to the Illinois Attorney General, a decedent’s estate worth $4,000,000 or less will not owe any estate taxes to the State of Illinois, while a decedent’s estate worth $5,000,000 will owe estate taxes in the amount of $285,714.00, or approximately 29% of $1,000,000 – the amount in excess of $4,000,000. See Illinois Attorney General 2018 Important Notice Regarding Estate Tax. This being an extreme simplification of estate taxation in Illinois, it is critical to further understand estate tax mechanics.
Payment of the estate tax is typically done during the probate process, which means that period of time after a decedent’s Will has been filed with the appropriate court and a probate proceeding has been initiated. In Illinois, the process begins with the filing of the petition to probate a Will, or a petition for administration of a decedent’s estate when there is no Will. However, for those taxpayers who created a trust prior to death, and a probate court is minimally involved or not involved at all, the obligation to pay estate taxes does not disappear.
Thus, the next question is how to calculate the appropriate tax, and once determined, to whom must the payment be made. Illinois Law requires estate executors, administrators, trustees, or other parties responsible for overseeing a probate or trust estate to file the necessary estate tax return with Illinois Attorney General’s office, and not the Illinois Department of Revenue as with customary income tax returns. 35 ILCS 405/6(d). The Illinois Treasurer is authorized to receive the payment of the estate taxes. 35 ILCS 405/6(e).35 ILCS 405/6(e). However, although not typically a revenue collecting entity, the Attorney General’s does have the duty to exercise general supervision and collection of these taxes. 35 ILCS 405/16(a).
Knowing when estate taxes apply is not an easy answer where sophisticated tax planning strategies may have been established prior to death. Moreover, as with typical income tax calculations, a decedent’s estate should utilize the available exemptions and deductions to either eliminate or reduce taxation on the estate. Such an analysis, of course, should be done in consultation with financial accounting and estate administration professionals. This process includes preparation of the necessary filing that helps determine whether an estate does in fact owe estate taxes. The Estate Tax Act authorizes the Attorney General to prescribe rules and regulations, and in that capacity, the Attorney General’s office requires that Form 700 be prepared by the representative of the estate and filed with the Attorney General’s office. Thereafter, the estate’s obligations shift and payment must be made to the Illinois State Treasurer, not to be confused with any particular county’s treasurer, which was the case until 2012 when the Estate Tax Act modified the of the estate tax payee.
While most of the Estate Tax Act outlines the method and manner of payment of estate taxes, the reality is that not all estates obligated to pay do in fact what is owed. As a result, the Estate Tax Act also imposes certain penalties for failure to comply with the law. The first type of penalty occurs when an estate fails to file the appropriate return. 35 ILCS 405/8(a) provides a penalty of a minimum of 5% of the tax due as an additional penalty if the return is filed within one month of the due date, with additional 5% increases each month thereafter until reaching a maximum of 25%. Additionally, the second type of penalty arises where the estate has filed the requisite return yet failed to pay the appropriate tax to the State Treasurer. Specifically, 35 ILCS 405/8(b) imposes a minimum penalty 0.5%. Similar to the filing penalty, there is a monthly increase of 0.5% each subsequent month until the taxes due have been paid, within a cap on the increase being 25% of the taxes owed.
In order to avoid penalties, it is important to know that extensions can be granted for appropriate reasons. 35 ILCS 405/8(c) instructs on such extensions. §405/8(c)(1) permits an automatic extension in the event the Internal Revenue Service has permitted its own extension for the federal estate tax return filing deadline. In the absence of an IRS extension, §405/8(c)(2) also authorizes the Attorney General to extend either or both the filing deadline and the payment deadline. The standard by which the Attorney General grants an extension request is a “reasonable cause” standard whereby the estate’s representative must demonstrate that either a timely filing or the payment was impossible or impractical. Nevertheless, the Estate Transfer Tax does authorize the Attorney General to waive imposition of penalties for either or both the late filing and late payment, even in circumstances where the federal government has not granted a similar waiver. §405/8(d)(1)-(2). Of course, if tax forms are not filed, or taxes owed are not paid, the Attorney General, with assistance from State’s Attorneys, are authorized to initiate legal actions and to prosecute cases “as may be deemed necessary and proper.” §405/16(a)
Knowing the framework for why an estate tax is owed, when the estate tax return and payment is due, and how an estate tax is applicable to an estate, is certainly important. But it is likewise vitally important to know that certain strategies to limit estate taxes are available. This requires consultation with financial and legal professionals that equipped with the knowledge and expertise to achieve these goals. Sophisticated estate planning prior to death, and knowledgeable estate administration after death is essential to minimizing an estate’s tax liability.
That being said, the first step to ensure your estate’s exposure to tax liability is limited is to have in place the necessary estate planning tools. Examples of estate plans tools include: a traditional family trust that can own your property while you retain management and control as the trustee; a family limited partnership where your family members can participate in the partnership as limited, and not general, partners; a qualified personal residence trust where your real estate is held irrevocably in trust for a fixed period of time after which the real estate is then transferred to your designated beneficiaries; an irrevocable life insurance trust where the insurance policy benefit is owned by the irrevocable trust and therefore is not considered a part of your estate for purposes of calculating estate taxes; or, utilizing inter vivos gifts where you simply gift your assets to your intended heirs during your lifetime while ensuring that these gifts comply with the appropriate permitted exemptions from taxation.
Of course, there are significant advantages to each of these sophisticated tax planning vehicles. They are created by complex legal documents, and if structured incorrectly the assets within could be subject to the taxation you were attempting to limit. Moreover, there is no one-size-fits-all approach when considering which estate plan is the best for your family and assets. At the very least, a simple estate plan can substantially limit, or eliminate, the need for any probate action to be filed in Court which often times significantly increases both the length of time before your heirs can receive their inheritance, as well as legal fee expenses.
Achieving these goals requires consulting with an experienced estate planning attorney and qualified tax professional to discuss how to ensure that your assets will not be burdened by the time and expense of a probate case or the financial burden of taxes that could have been limited. The Estate Planning and Estate Administration attorneys at Fornaro Law are experienced in both creating your desired estate plan documents and administrating your estate.
By Mark Lara