If you are fortunate enough to have amassed a moderate to large estate you should be aware of the need to protect that estate from federal gift and federal and Illinois estate tax. The best way to do that is to start planning early and update that estate plan on a regular basis. Failing to have a comprehensive estate plan in place can result in the loss of a significant percentage of the value of your estate after your death. As you will no longer be here, your loved ones will be the ones who ultimately suffer as a result of your lack of planning. Your Illinois estate planning attorney can help you decide the best tax avoidance tools and strategies to incorporate into your estate plan. However, you should have an overall understanding of how federal gift and federal and Illinois estate taxes work and some of the most common ways to decrease your estate’s exposure to the tax.
The Probate Process
In the United States, even death is taxed, in a manner of speaking. When you die, everything in which you have an ownership interest, including both real and personal property as well as tangible and intangible assets, becomes part of your estate for the purpose of probate. Probate is the legal process that is required of all but very small estates following the death of the estate owner. Shortly after your death, the Executor of your estate must identify and locate all your estate assets and then determine which of those assets are required to be part of the probate process. Not all assets are considered probate assets. A date of death (DoD) value must then be ascertained for all probate and non-probate assets. In addition, the value of all gifts made by you during your lifetime must also be calculated. The sum total of the value of all probate assets and most non-probate assets, together with the value of all lifetime gifts is then potentially subject to federal and Illinois estate tax at the rate of 40 percent. Before any probate assets can be transferred to the intended beneficiary, any federal or Illinois estate tax due from the estate must first be paid out of estate assets.
The Lifetime Exemption
Each taxpayer is entitled to exempt assets from gift and estate tax up to the current lifetime exemption limit. Historically this figure fluctuated frequently and significantly. Thanks to the American Taxpayer Relief Act (ATRA) of 2012, the lifetime exemption limit was permanently set at $5 million, adjusted annually for inflation. For 2016, the lifetime exemption limit is $5.45 million, meaning that a taxpayer can exempt up to that amount from his/her estate before gift and estate taxes are levied. The Illinois estate tax exemption is $4 million and is not adjusted annually for inflation. By way of illustration:
Let’s assume that when you die you leave behind assets totaling $7 million and that you made lifetime gifts totaling another $4 million. Therefore, your potentially taxable estate is valued at $11 million. You can deduct from that figure the lifetime exemption amount of $5.45 million, leaving $5.55 million subject to taxation. At a tax rate of 40 percent, your estate will lose $2.22 million to federal estate taxes and $1.05 million in Illinois estate tax.
Losing $3.27 million to Uncle Sam and the State of Illinois is likely not your idea of a preferred result as it means your loved ones are out over three million dollars that could be used to provide for them in your absence. This is why comprehensive estate planning is crucial.
Common Tax Avoidance Strategies
Every estate is unique; however, there are some commonly used strategies and tools that can help decrease an estate’s exposure to federal gift and estate tax, including:
• Marital deduction – you are allowed to leave an unlimited amount in assets to your spouse, tax-free, when you die. While this may sound like the solution to your tax quandary, beware! Often, depending on the unlimited marital deduction is only a temporary fix to a complicated problem. By leaving your spouse everything, you only delay the inevitable because you have now over-funded his/her estate. When your spouse dies, gift and estate taxes will still diminish the value of the assets left behind unless tax avoidance strategies are employed.
• Annual exclusion – every taxpayer may make an unlimited number of tax-free gifts each year of assets valued at up to $14,000 using the annual exclusion. Moreover, the value of these gifts it not counted against your lifetime exemption limit. Gift splitting allows a married couple to combine their gifts to make gifts valued at up to $28,000. To see how much wealth can be transferred using this strategy, imagine you have four children to whom you and your spouse make annual gifts starting at age 50. By age 70 you will have transferred $2.24 million tax-free.
Trusts – Specialized trusts, such as the Grantor Retained Annuity Trust (GRAT) are designed to allow you transfer appreciable assets with a minimum (or no) tax liability.
For more information, please join us for one of our upcoming seminars or contact the experienced Illinois estate planning attorneys at Nash Bean Ford & Brown, LLP by calling 309-944-2188 to schedule your appointment today.