Illinois Governor Patrick Quinn signed into law Illinois SB 2115 as Public Act 96-789 on September 8, 2009. The new law authorizes a state only “QTIP” marital deduction election to be made upon the first spouse’s death, which will (1) permit the full utilization of the Federal estate tax exemption upon the first spouse’s death, and (2) defer Illinois estate taxes that could otherwise be due upon the death of the first spouse.

As a result of the new law, married Illinois residents should have their estate planning documents reviewed because if appropriate planning is not in place, Illinois estate taxes which otherwise could have been deferred until the death of the surviving spouse may instead be due and owing at the first spouse’s death.

Background

“Bypass trust” planning (often referred to as Martial Trust-Residuary Trust planning) has been a staple of well-drafted estate plans. In the past, the bypass trust has been funded upon the first spouse’s death with an amount of assets equal to the available Federal estate tax exemption. Assets in the bypass trust can be available for the benefit of the surviving spouse, even though the assets of this trust are excluded from the surviving spouse’s taxable estate upon the surviving spouse’s death. Bypass trust planning ensures that the Federal estate tax exemption of the first spouse to die is fully utilized.

As a result of legislation enacted in 2001, many states (including Illinois) have enacted their own separate estate tax regime. Prior to 2009, the Federal and Illinois estate tax exemption amounts had been the same so that funding the bypass trust with the maximum federal exemption did not result in any Illinois estate tax. As of January 1, 2009, however, the Federal estate tax exemption increased to $3.5 million, while the Illinois estate tax exemption was frozen at $2 million.

This $1.5 million gap between the Federal and Illinois exemption amounts created an issue with respect to funding the bypass trust. If the bypass trust is funded with the full Federal exemption amount of $3.5 million, an Illinois estate tax of approximately $210,000 would be due.

Estate Plans Should Be Reviewed

Many estate plans were designed to fund the bypass trust based solely on the Federal exemption amount, which will cause an Illinois estate tax to be paid at the first spouse’s death.

Newer estate plans are often designed to fund the bypass trust with the lesser of the Federal and Illinois estate tax exemptions. While this funding mechanism will eliminate Illinois estate taxes at the first spouse’s death, it will also waste a portion of the first spouse’s Federal estate tax exemption since the Illinois estate tax exemption ($2 million) is less than the Federal exemption ($3.5 million). The benefit of the new Illinois QTIP legislation is that the Federal estate tax exemption may now be fully utilized without incurring an Illinois estate tax at the first spouse’s death.

Significance of New Law – Example

Assume Husband, a resident of Illinois, dies in 2009 with a taxable estate of $10 million and has his entire Federal and Illinois estate tax exemption amounts remaining ($3.5 million and $2 million, respectively). Husband’s estate plan directs the funding of the bypass trust with the lesser of the Federal and Illinois exemption amounts—$2 million. The remaining $8 million passes to a Marital Trust for Wife. Under this scenario no Federal or Illinois estate taxes will be due on Spouse A’s death, but $1.5 million of Husband’s Federal estate tax exemption has been wasted.

The recently enacted Illinois QTIP legislation allows the full use of the Federal estate tax exemption without the payment of Illinois estate taxes at Husband’s death by allowing the Executor of Husband’s estate to make a “state only QTIP election”. This will allow a full marital deduction for Illinois purposes, and also utilize Husband’s remaining $1.5 million Federal estate tax exemption amount. The result is that both the Federal and Illinois estate tax exemption amounts are fully utilized and no Federal or Illinois state estate tax will be due at Husband’s death.