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Federal Estate Tax (Form 706)

A Federal Estate Tax Return (Form 706) must be filed for the estate of each decedent whose “gross estate” exceeds $5,250,000 (for 2013 decedents). A decedent’s “gross estate” consists of all property that the decedent owned or had an interest in as of the date of death, including real estate, retirement accounts, most joint interests, life insurance, personal property, annuities, and property subject to the decedent’s power of appointment.

After calculating the gross estate, the estate may deduct, among other items, funeral expenses, debts of the decedent, administration expenses (including attorney and executor fees), qualified charitable gifts and qualified bequests to a surviving spouse (“marital deduction”). The marital deduction is unlimited, meaning that you can leave $1,000,000,000 (or more) all to your surviving spouse without paying a penny of estate tax (until your surviving spouse dies, of course). This is good news for married couples, but also presents a trap that many fall into by failing to execute an estate plan that effectively utilizes each spouse’s “exemption equivalent” (described below).

After calculating the gross estate and subtracting deductions, there are several credits that the estate may use. The first is the “unified credit” (also known as the “exemption equivalent”). This is currently (in 2013) the $5,250,000 threshold mentioned above – meaning that the first $5,250,000 is not subject to federal estate tax.

The Credit for Tax on Prior Transfers comes into play when your estate includes assets that you received by inheritance from an estate that previously paid estate taxes. The previous transferor must have died within 10 years of your date of death and the credit ranges from 20% to 100% depending on the time between deaths.

The estate tax return also includes a generation-skipping transfer tax component. In a nutshell, this is only applicable if lifetime taxable gifts and estate gifts to “skip persons” (grandchildren and others more than 37.5 years younger) exceeds $5,250,000.

Additionally, many states, including Illinois, now have their own separate estate tax requirements. As of 2013, the Illinois estate tax exemption is $4,000,000. State estate tax applies in the decedent’s state of residence as well as in each state where the decedent owned real property.

The above only scratches the surface of issues that may arise during preparing of the federal estate tax return. The federal estate tax return is not a simple return, and not all accountants or attorneys have experience in preparing them. This office has significant experience in preparing estate tax returns with complex issues. Proper post-mortem estate tax planning and preparation can help avoid audit problems and save significant tax liabilities in many instances.

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Illinois Estate Tax (Form 700)

The State of Illinois levies a separate estate tax on estates of Illinois resident decedents and estate of non-residents owning real property in Illinois. Under current law in 2013, the amount exempt from Illinois Estate Tax is $4,000,000. In the past, the Illinois estate tax was merely a “pick-up” tax that did not increase the total tax bill. In response to the 2001 tax act, Illinois, in 2003, acted to “decouple” its estate tax law from the federal law to avoid losing its cut of the tax that it had come to rely on.

Up until 2009, the Illinois exemption matched the Federal exemption. However, this is no longer the case. The Illinois exemption is scheduled to remain at $4 million, while the federal exemption is scheduled to increase annually for inflation (from $5.25 million in 2013).  The practical effect of this is that some estates no longer subject to Federal Estate Tax will be subject to Illinois Estate Tax due to the lower exemption. From an estate planning perspective, in some situations this may have the unintended effect of either triggering unnecessary Illinois estate tax or reducing the amount sheltered from Federal Estate Tax for married couples doing estate tax planning. Careful planning should be employed for those with estates over $4,000,000 to plan for both Federal and Illinois (*and other states) estate taxation.

* Illinois was not the only state to change its estate tax laws in response to the 2001 Tax Act. Almost half of the states have made changes, with each state’s laws differing in important ways. For people owning property in multiple states or for people changing domiciles, planning for state estate taxes may be very important.

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Fiduciary (Form 1041)

It probably goes without saying that the IRS would not miss an opportunity to tax income, even if it is not distributed to an actual human being. After an individual’s death, but before distribution to a beneficiary, a decedent’s estate and/or trust may earn income on the assets held by the entity. If so, that estate or trust itself becomes a taxpayer that must apply for and receive a tax identification number (TIN), and file applicable income tax returns.

In many important respects, however, fiduciary income tax returns are quite different from individual income returns. The marginal rates are far more compressed as the highest marginal rate is reached at less than $12,000 of income. Furthermore, there are deductions, credits and elections that are unique to fiduciary returns. For these reasons, they should always be professionally prepared. While this office generally does not prepare 1041’s, we do work closely with the estate’s accountant to ensure that the returns are planned and prepared in a timely and advantageous manner and that the returns are well coordinated with any estate tax return(s).

Personal (Form 1040)

The estate’s fiduciary must also file the decedent’s final individual Form 1040 showing all income earned up to the decedent’s date of death. This return should be prepared in coordination with the estate or trust fiduciary income tax returns and the federal and state estate tax returns, if any, in order to bifurcate the taxable year and and appropriately allocate deductions between the entities. While we generally do not prepare the final 1040, we work closely with the estate’s chosen accountant to ensure that the returns are planned and prepared timely and in the most advantageous manner, and that the returns are well coordinated with any fiduciary and estate tax return(s).

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