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Federal and Illinois Estate Tax

Federal Estate Tax as Impacted by the American Taxpayer Relief Act of 2012:The amount of federal estate tax you may owe is dependent on many factors. One of the most important is the total value of your taxable estate. Virtually all assets that a person owns at death are subject to the Federal Estate Tax. This includes real estate, stocks, bonds, bank accounts, life insurance, IRA's, 401K’s and company profit plans. When you calculate your own estate value, include future appreciation of the assets.

In January, 2013 Congress acted to avoid the “fiscal cliff” by passing the American Taxpayer Relief Act of 2012 (“2012 Taxpayer Relief Act”). This Act prevents many tax hikes from going into effect and retains many favorable tax rules that were set to expire. It also contains permanent estate, gift and generation-skipping transfer tax relief for 2013 and future years. These changes are discussed below along with several important tax concepts.

  • Unlimited Marital Deduction: If you give all your property to your spouse, there is no federal estate tax no matter the size of your estate. This Unlimited Marital Deduction also applies to the gift tax. Therefore, transfers between spouses can be made during life or at death without gift tax or estate tax.
  • Exemption Amount: Under federal estate tax law, at death each person may pass estate tax free assets equal of the “estate tax exemption amount” to anyone (other than a spouse). Anything passing to a spouse is already tax free due to the unlimited marital deduction. The amount of the estate tax exemption has varied over the years, being as low as $60,000 in 1976, increasing to $600,000 in 1987 and recently to $5,120,000 in 2012.
  • Permanent Higher Federal Estate Tax Exemption for 2013 and future years: For estates of individuals dying in 2009, the top estate tax rate was 45% and the estate tax exemption was $3.5 million (amount that each person may pass estate tax free) and a gift tax exemption of $1.0 million. In 2010, the Tax Relief Act provided temporary relief from estate, gift and generation-skipping transfer taxes by reducing the top tax rate to 35% and increasing the exemption to $5 million for 2011 with a further increase for inflation in 2012 to $5,120,000. Under the 2010 Tax Relief Act, these provisions of the law would sunset in 2013, so that top tax rate would be 55% and the estate tax exemption would be $1 million. These sunset provisions were avoided by the passage of the 2012 Taxpayer Relief Act on January 1, 2013. This new law made the estate, gift and generation-skipping exemption amount of $5,000,000 (as indexed for inflation) permanent for 2013 and future years. Based on inflation information, the exemption amount will be $5,250,000 for gifts made and for decedents dying in 2013. In addition, the maximum tax rate was increased slightly from 35% to 40%. While an increase, this rate is significantly less than former top rate of 55%.
  • Portability of Federal Estate Tax Exemption Made Permanent: A new feature was added to the federal estate tax law called “portability” by the 2010 Tax Relief Act. For estates of decedents dying after 2010, the unused federal estate tax exemption (but not the GST exemption) of the first spouse to die may be shifted to the surviving spouse so he or she may use both his or her own exemption and the balance of his or her spouse’s exemption. This will allow the surviving spouse to have the benefit of both exemption amounts at death. However, portability is not automatic. Even if the estate of the deceased spouse is lower than the exemption amount a complete federal estate tax return must be filed at the death of the first spouse to elect “portability.” Also there are special rules in case of multiple marriages. This popular feature of the 2010 Tax Law was made permanent under by the 2012 Taxpayer Relief Act.
  • Generation-Skipping Tax (“GST”) Exemption Unification with Estate Tax Exemption Made Permanent But not Portable: The GST tax is an additional tax on certain gifts or trusts that benefit grandchildren while their parents are alive or that benefit both children and grandchildren. The 2010 Tax Relief Act lowered GST taxes for 2011 and 2012 by increasing the exemption amount from $1 million to $5 million in 2011 as indexed for inflation ($5,120,000 in 2012). This had the effect of making the GST Exemption the same as the estate tax exemption. The tax rate was also reduced from 55% to 35%. The 2012 Taxpayer Relief Act made the increase in the GST exemption permanent at $5 million as indexed for inflation (for 2013 $5,250,000) and slightly increased the tax rate to 40%. However, the GST exemption is not portable, so on the death of the first spouse to die the GST exemption is lost if it is not used.
  • Illinois Estate Tax: Illinois has an estate tax, but no inheritance tax. Illinois has decoupled its estate tax law from the federal rules, so the Illinois exemption amount is no longer the same as the federal exemption. The Illinois estate tax law gives Illinois citizens a $3,500,000 exemption amount for 2012 and a $4,000,000 exemption in 2013. These amounts are less than the federal exemption so a state tax may be owed even if no federal estate tax. In addition, Illinois does not recognize portability. For Illinois estate tax, the exemption of the first spouse to die will be lost if it is not used at the first death.
  • Stepped-up Basis: Property which is transferred at death receives a basis which is equal to the date of death value of the property.
  • What is the meaning of “permanent?” The 2012 Taxpayer Relief Act provides that the changes in the estate, gift and generation-skipping tax law are "permanent." While this has the effect of reversing the “automatic sunset” provisions of the prior law, this does not prevent a future Congress from changing the exemption amount or tax rate at a later time.