Illinois Estate Tax and the Illinois QTIP Trust
January 24, 2024
Though it has a strange name, the QTIP Trust can be a powerful estate planning tool. Since January 1, 2013, the Illinois estate tax exclusion amount has been and continues to be $4 million, with a graduated rate that is capped at 16%. This means an estate valued at $4 million will not be subject to Illinois estate tax. Unlike the federal estate and gift exclusion figures, the Illinois estate tax exclusion amount is not adjusted for inflation. Therefore, for the foreseeable future, the Illinois exclusion will remain at a flat $4 million.
Illinois shares a few concepts with federal estate and gift tax laws that allow for tax-free transfers regardless of the dollar amount. Specifically, Illinois allows for unlimited transfers to a surviving spouse without triggering estate tax. Said another way, a decedent with a $20 million estate could leave $20 million outright to his surviving spouse and no estate tax would be triggered (whether at the Illinois or federal level) because of the concept commonly known as the “marital deduction”.
But what if a person wanted to allocate his assets to a trust for his spouse’s benefit, rather than transferring the assets outright to the spouse? Can they still qualify for the benefits of the marital deduction using a trust?
Thankfully, the answer is yes! With a Qualified Terminable Interest Property Trust, also known as a QTIP Trust, an estate can reap the benefits of a marital deduction while using a trust. However, the QTIP trust must meet a few requirements to qualify.
QTIP Trust Requirements
To qualify for the benefits of a marital deduction, the QTIP trust must meet the following requirements:
- The surviving spouse must be the sole beneficiary of QTIP Trust for the surviving spouse’s entire life.
- Income must be paid out to the surviving spouse at least annually for the surviving spouse’s entire life.
Because the surviving spouse has a qualifying interest for life, the QTIP Trust will be included in the surviving spouse’s estate for calculating estate tax at the surviving spouse’s death, pursuant to IRC Sections 2044 and 2056.
How to Create an Illinois QTIP Trust
Assuming the terms of the trust itself qualify, the election is made on the Illinois estate tax return (Form 700) by the trust’s executor. If no executor is acting, the person in constructive possession of the property (i.e., the trustee) can also make the election.
Reasons to Create a QTIP Trust
There are two common reasons a person may choose to create a QTIP Trust rather than leaving assets outright to the surviving spouse: (1) to mitigate Illinois estate taxes and (2) to maintain “control from the grave”.
To understand how proper planning can mitigate Illinois estate taxes, consider the following examples:
A husband and wife have $6 million in assets, nearly all of which are titled in the husband’s name. The husband’s Will directs that all assets pass to the surviving spouse, and the husband dies on January 1. The wife dies shortly thereafter. In this scenario, there is no Illinois estate tax upon the husband’s death, but upon the wife’s death (the second spouse to die), the Illinois estate tax obligation would be $456,000 (the tax resulting from a $6 million estate).
The same husband and wife have $6 million in assets, nearly all of which are titled in the husband’s name. Instead of directing that all assets pass to his surviving spouse, the husband creates a revocable trust which provides that, upon his death, all assets are held in trust for the sole benefit of the surviving spouse. The Executor/Trustee makes an Illinois QTIP election of $2 million of the $6 million trust and does not make a QTIP election over the remaining $4 million (utilizing the husband’s Illinois estate tax exemption).
Upon the wife’s death, $4 million is not includable in the wife’s estate because there was no QTIP election made, and those assets continue to be held in the husband’s trust for the wife’s benefit. The share of the trust holding the $2 million for which the Illinois QTIP election was made is includable in the wife’s estate. However, the wife has $4 million of her own Illinois estate exemption to apply to the $2 million. Accordingly, in this scenario, no tax is due at the wife’s death, saving $456,000 in Illinois estate taxes.
Bonus: Illinois Estate Tax Quirks
When calculating Illinois estate tax, the Illinois tax laws are written such that, all else being equal, an estate of an Illinois resident owning physical real estate located outside the State of Illinois will pay less Illinois estate tax than an estate having all its assets located in Illinois. If that same real estate located outside of the State of Illinois is owned through an entity, such as an LLC, corporation, or partnership, then the State of Illinois no longer categorizes that asset as “real estate” and therefore subjects the property to Illinois estate tax as if it was located in the State of Illinois.
Conversely, if a person who is not a resident of Illinois owns physical real or tangible property located in Illinois, then that person’s estate becomes subject to Illinois estate tax.
With proper planning, these issues can be avoided. It is critical to work with a competent advisor to address the intricacies of the Illinois estate tax.
If you would like to learn more about the QTIP trust, reach out to our Trusts & Estates Group.