Many successful individuals focus on the federal estate tax, but it’s easy to overlook state estate taxes that can hit much lower wealth levels. Illinois is one of many states with an estate tax, and it applies to estates over $4 million – far below the current federal exemption (around $14 million per person). In other words, a married couple with a net worth well under the federal threshold could still face a hefty Illinois tax bill. Illinois isn’t alone: 12 states (plus Washington, D.C.) impose estate taxes, with exemption amounts ranging from about $1 million (e.g. Oregon, Massachusetts) to around $5–6 million (e.g. Minnesota, New York) and even up to the federal level in one state (Connecticut). If you live in a state with an estate tax, it’s crucial to plan ahead so your hard-earned wealth goes to your family – not the state treasury.
One effective strategy in Illinois, where I practice law, is the credit shelter trust (also known as a “bypass” or “family” trust). This estate planning tool can shield assets from Illinois estate tax by taking full advantage of each spouse’s $4 million exemption. In this article, I’ll start with the basics of how Illinois estate tax works, explain how credit shelter trusts operate, walk through examples of potential tax savings (with tables for different estate sizes), and discuss the pros and cons of using these trusts.
Like all the information on this website, the information in this post is educational in nature and is not to be relied upon as legal advice. If you’d like information specific to your situation, please schedule an appointment with my office. I offer an estate planning session free of charge.
Illinois Estate Tax Basics (and the Problem of Portability)
What is the Illinois estate tax? It’s a tax on the total value of your estate (your assets) when you pass away, if that value exceeds a certain threshold. In Illinois, any estate over $4,000,000 is subject to state estate tax. The tax rates are graduated, up to a top rate of 16%. Importantly, Illinois’ estate tax has a “cliff” effect: if your estate even $1 over $4 million, the tax isn’t just on the excess – essentially the entire estate becomes taxable. For example, an estate valued at $4.01 million would owe tens of thousands in Illinois tax, whereas an estate of $3.99 million owes nothing. This makes planning around that $4 million line especially critical.
Federal vs. Illinois exemption: The federal estate tax exemption is portable between spouses – meaning if one spouse dies and doesn’t use their full exemption, the survivor can add the unused portion to their own exemption. Illinois, however, does not allow portability of its $4M exemption. Each person only gets their own $4M exclusion, “use it or lose it.” This is a big issue for married couples. If the first spouse to die leaves everything to the survivor (which incurs no tax due to the unlimited marital deduction), the first spouse’s $4M Illinois exemption is wasted. Then when the second spouse eventually passes, their estate can only use one $4M exemption – and any value above that could be taxed by Illinois.
Let’s put that in perspective: imagine a married couple with a combined estate of $8 million, all titled in one spouse’s name. If that spouse dies and leaves it all outright to the other, no tax is due at the first death. But now the survivor has an $8 million estate. The Illinois estate tax on an $8 million estate could be roughly $680,000 (a shock to the heirs, especially since no federal tax would be due at that level). This outcome is avoidable with some strategic planning. By taking steps to “equalize” assets between spouses and use both spouses’ exemptions, a couple can potentially pass that same $8 million estate Illinois estate-tax free.
How a Credit Shelter Trust Works
A credit shelter trust is the key tool to preserve each spouse’s $4 million Illinois exemption. The concept is easiest to understand in the context of a married couple’s estate plan:
- When the first spouse dies, instead of leaving everything directly to the survivor, their estate plan directs up to $4 million (the maximum amount that can be shielded from Illinois tax) into an irrevocable Credit Shelter Trust. This funding uses the first spouse’s Illinois exemption to shelter those assets from tax. Any value above that $4M in the first spouse’s estate can still go to the surviving spouse (outright or in a marital trust) so that the excess amount won’t be taxed at the first death (the marital portion qualifies for the estate tax marital deduction). In short, the first spouse’s plan is set to “fill up” their $4M exemption with assets in the trust and pass the rest to the spouse tax-free.
- The Credit Shelter Trust (also called a bypass or family trust) is typically established for the benefit of the surviving spouse and children. The surviving spouse can usually receive income from the trust, and often principal as needed for health, support, etc., depending on how the trust is drafted. The crucial point is that the trust assets are not owned by the surviving spouse outright. Therefore, when the surviving spouse later dies, the assets remaining in the trust are not included in their estate for tax purposes. Those assets “bypass” the second estate and go directly to the couple’s chosen beneficiaries (children, etc.) without any Illinois estate tax, because they were already sheltered using the first spouse’s exemption.
Meanwhile, the surviving spouse still has their own $4 million exemption to cover the assets they do own personally (which include whatever the first spouse left outright plus their original assets). If the surviving spouse’s own estate is kept at or below $4M, or the surviving spouse establishes a credit shelter trust in his or her will, it will also pass free of Illinois tax.
Using this strategy, a married couple can effectively double the amount they pass on free of Illinois estate tax. Instead of only $4 million escaping tax, they can shelter up to $8 million (or more, if the trust assets appreciate over time). In essence, the credit shelter trust preserves the first spouse’s exemption, which would otherwise be lost under Illinois law.
Simplified example: John and Mary are Illinois residents with a combined estate of $8 million. If John dies with a plan that leaves everything to Mary outright, Mary ends up with an $8M estate and will owe Illinois estate tax when she later dies (approximately $680,000 in tax on an $8M estate). But if John’s will or living trust instead funds a credit shelter trust with $4M for Mary’s benefit (using John’s full Illinois exemption) and leaves the remaining $4M to Mary outright, here’s what happens: John’s death triggers no tax (the $4M to the trust is within his exemption, and the other $4M went to Mary under the marital deduction). Mary now has $4M in her name (outside the trust). When Mary dies, her personal estate is $4M – within her own exemption – so no Illinois tax on that either. The $4M in the credit shelter trust passes to the kids free of tax as well. The result: the entire $8 million transfers to their children with $0 Illinois estate tax, instead of a ~$680K tax hit.
Credit shelter trusts were a staple of estate planning back when the federal estate tax exemption was much lower and not portable between spouses. Today, the federal exemption is high and is portable, so for many families federal estate tax isn’t a concern. However, state estate taxes like Illinois’ bring credit shelter trusts back into the spotlight. In Illinois, this type of trust is often a must for affluent couples, because it’s the only way to use both spouses’ $4M allowances. Without it, a couple is essentially throwing away one exemption and could pay hundreds of thousands in unnecessary state tax.
Pros and Cons of Using Credit Shelter Trusts
Like any estate planning strategy, credit shelter trusts come with benefits and potential drawbacks. It’s important to weigh these pros and cons in light of your personal situation and goals.
Pros
- Maximizes Tax Savings: The primary benefit is obvious – for Illinois (and other state) estate tax purposes, a credit shelter trust can save your family a significant amount of money. By preserving both spouses’ state exemptions, you avoid paying up to 16% on that additional $4M that would otherwise be taxable. In other states with estate taxes, similar planning can double the amount shielded from state tax. This is especially valuable if you expect your estate to grow, because all future appreciation on the assets in the credit shelter trust is also outside the surviving spouse’s taxable estate.
- Avoids the Illinois “Use-It-or-Lose-It” Problem: Since Illinois doesn’t allow exemption portability between spouses, the credit shelter trust is essentially a workaround to capture the first spouse’s $4M exemption. Without it, that exemption could be lost forever. For high net-worth couples in Illinois, this strategy is almost a necessity to avoid an otherwise voluntary tax.
- Asset Protection: Assets placed in a credit shelter trust can be protected from certain risks. For example, they are generally shielded from the surviving spouse’s creditors or any lawsuits, since the assets are in a trust rather than in the spouse’s ownership. The trust can also be structured to protect assets in the event the surviving spouse remarries (ensuring the funds ultimately go to the original couple’s children, for instance, rather than a new spouse). This can provide peace of mind that the wealth you’ve built will benefit your chosen heirs in the long run.
- Control and Management: A credit shelter trust can include specific instructions for how the money should be managed and used. This can be useful if one spouse is worried about the other spouse’s financial management or if there are children from a prior marriage. The trust can appoint a trustee to oversee the assets and can ensure that the assets are used for the surviving spouse’s needs during their lifetime, then pass to children or other beneficiaries exactly as planned. In short, it can add a layer of control beyond what an outright inheritance would provide.
- Federal Estate Tax Flexibility: Even though the main motive here is state tax savings, credit shelter trusts can also be drafted to benefit your federal estate tax situation. While the federal exemption is portable, some families still prefer a trust to capture the first spouse’s federal exemption as well (for example, if they believe the exemption might decrease in the future, or to keep future growth out of the estate). The trust approach also avoids the need to file an estate tax return to elect portability. In essence, a bypass trust strategy covers all bases – you’re protected if federal law changes or if your combined estate later exceeds the federal exemption.
Cons
- Complexity and Cost: Setting up a credit shelter trust requires attorney time and legal documents (often incorporated into your wills or a joint living trust). This adds some upfront cost and complexity to your estate plan. Additionally, when the first spouse dies, the trust needs to be administered – meaning retitling assets into the trust, obtaining a tax ID for the trust, and possibly filing annual trust tax returns. For some families, this extra administrative burden is a drawback, especially if the estate isn’t large enough to justify it.
- Loss of Full Step-Up in Basis: One oft-cited trade-off involves capital gains taxes. Assets in a credit shelter trust do not get a second “step-up” in income tax basis when the surviving spouse dies, because those assets aren’t included in the surviving spouse’s estate. By contrast, if those assets were left outright to the spouse, they would get a step-up in basis at the spouse’s death (potentially reducing capital gains taxes for the heirs if the assets had appreciated). In plain English: choosing to save on estate tax via the trust might forgo a tax break on unrealized capital gains. For example, if a stock worth $4M doubles to $8M inside the bypass trust, that $4M of gain won’t receive a step-up at the second death – heirs could owe capital gains tax when they sell. If the stock had instead been in the spouse’s estate, the entire $8M value could get a new tax basis at death, potentially erasing those capital gains for tax purposes. Families need to consider the balance between estate tax saved and potential capital gains tax later. In Illinois, the estate tax maxes out at 16%, whereas long-term capital gains tax might be 20% federal (plus state tax on the gain). Depending on the numbers, it might be a reasonable trade-off or a reason to draft the trust to permit flexibility (some trusts give an option to include assets in the surviving spouse’s estate if advantageous for basis step-up – known as disclaimer trusts or using powers of appointment).
- Reduced Flexibility for Surviving Spouse: When assets go into a trust at the first death, the surviving spouse doesn’t have unrestricted access to those funds (unlike assets they own outright). A well-drafted credit shelter trust will give the spouse broad rights to income and even principal for their needs, but it’s not the same as having complete control. For most couples this isn’t a problem – the trust is often designed to make the limitation almost invisible to the spouse’s lifestyle. But in some cases, spouses may feel constrained or just find the trust structure inconvenient compared to outright ownership. It’s important that both spouses are comfortable with the arrangement and trust the chosen trustee (which can often be the surviving spouse themselves, if given that role, though usually with an independent co-trustee for any distributions to themselves beyond health/maintenance).
- Not Necessary for Smaller Estates: If your total estate is firmly under $4M (or under $8M for a married couple) and you don’t expect it to grow beyond those limits, a credit shelter trust may provide little to no tax benefit. In that case it could add complexity without much upside. Illinois residents with modest estates (below the taxable threshold) might opt for simpler plans. However, one should project future growth and also consider other reasons (like asset protection or control) before dismissing the trust concept entirely.
- Potential for Law Changes: Estate tax laws do change. As of this writing, there are even proposals in Illinois to raise the exemption or change it to a true credit or to allow portability for spouses. If Illinois in the future were to, say, increase its exemption or adopt portability, a credit shelter trust might become less critical purely for tax reasons. (Of course, it would still carry the other benefits listed above.) There’s also the federal landscape: in 2026, the federal exemption is set to drop roughly in half (back to around $6–7 million per person under current law). If that happens, federal estate tax might again be a concern for more people, and credit shelter trusts could regain importance federally. In summary, the value of the trust planning might evolve as laws change, but estate plans can be updated. It’s wise to stay in touch with your estate planning attorney and financial advisors to adjust your plan if thresholds move significantly.
Conclusion
A credit shelter trust is a tried-and-true strategy to minimize estate taxes and ensure your wealth passes efficiently to your heirs. For high net-worth families in Illinois, it’s often the cornerstone of an effective estate plan, given Illinois’ low $4M exemption and lack of spousal portability. By using a credit shelter (bypass) trust, a married couple can shield up to $8 million (or more with growth) from Illinois estate tax – which can translate into saving hundreds of thousands of dollars that would otherwise go to the state. This kind of trust also provides the side benefits of protecting assets and controlling distribution after the first spouse’s death, which many find attractive.
Of course, it’s not a one-size-fits-all solution. The decision to implement a credit shelter trust should consider the size of your estate, your family’s needs, and other factors like capital gains implications and administrative complexity. Some couples might prioritize the simplicity of leaving everything outright, especially if estate tax isn’t a big worry for them, or they might use alternative strategies (like making lifetime gifts or charitable bequests) to reduce the taxable estate.
In any event, the key takeaway is that if you reside in Illinois (or another state with an estate tax), don’t overlook state estate tax exposure in your planning. Start with the basics – know the state’s exemption and rules – then explore tools like credit shelter trusts to see if they align with your goals. With a relaxed yet informed approach, you can craft an estate plan that keeps more of your legacy in the family and less in Uncle Sam’s (or Illinois’) pocket. Always consult with an experienced estate planning attorney and financial advisor who understand Illinois law to tailor the strategy to your situation. With proper planning, you can enjoy peace of mind knowing you’ve sheltered your assets for the next generation while staying on the right side of the law and taxes. Enjoy the confidence of having a plan that lets you focus on life, knowing your estate will be taken care of according to your wishes. Cheers to smart planning and securing your family’s financial future!