Protecting a Family Business from Federal and Illinois State Estate Tax Liability

A family business is often the most significant asset an owner will ever build. It represents decades of work, sacrifice, and reinvestment. Yet without careful planning, a large portion of that business could be lost to estate taxes when the owner dies.

In 2026, family business owners in Illinois face a two-layer estate tax problem that demands close attention. Federal law and Illinois state law each impose their own estate taxes, with different exemption amounts, different rates, and different rules for married couples. Understanding how these two systems work is the foundation of any sound estate plan for a business owner. 

Our Naperville estate planning attorney at the Gierach Law Firm has worked with Illinois families and business owners on these issues for more than 30 years. Call us at 630-756-1160 to discuss your situation.

How Do Federal and Illinois Estate Taxes Apply to a Family Business?

Federal Estate Tax

The federal estate tax applies to the total value of everything you own at death, including your:

• Home
• Bank accounts
• Retirement accounts
• Investments
• Life insurance policies
• Your interest in any business

As of January 1, 2026, the federal estate tax exemption increased to $15 million per person under the One Big Beautiful Bill Act signed into law on July 4, 2025. This means that a single individual can pass up to $15 million to heirs free of federal estate tax. Married couples can preserve up to $30 million between them, because the federal exemption is portable, meaning a surviving spouse can use the unused portion of the deceased spouse’s exemption. Any amount above the exemption is taxed at a top rate of 40 percent.

Illinois Estate Tax

Illinois imposes its own estate tax under the Illinois Estate and Generation-Skipping Transfer Tax Act (35 ILCS 405). The Illinois exemption is $4 million per person. The tax is applied on a graduated scale, with rates that rise to 16 percent on larger estates. There is no Illinois gift tax, which creates planning opportunities. 

But there is also no portability in Illinois. Unlike the federal system, Illinois does not allow a surviving spouse to use a deceased spouse’s unused exemption. That is a critical difference that can cost an Illinois family hundreds of thousands of dollars in avoidable state estate tax if they do not plan around it.

The practical result is that an Illinois family business owner with a $6 million estate would owe no federal estate tax at all but could owe significant Illinois state estate tax on the $2 million above the state exemption. The two systems operate independently of each other, and planning for one does not automatically deal with the other.

What Makes Family Business Assets Endangered by Estate Taxes?

Business interests have unique estate planning challenges. Unlike a stock portfolio, a closely held business cannot be easily divided or partially liquidated to pay a tax bill. If the estate does not have sufficient liquid assets, the family may be forced to borrow against the business, accept unfavorable terms in a rushed sale, or bring in outside investors to cover the tax liability.

The value of the business for estate tax purposes is determined at the date of death, not at cost. If the business has grown substantially over the years, that appreciation is fully included in the taxable estate. 

In addition, the business owner’s estate may include the full value of the business even if other family members have been working in it or have been promised ownership interests. Without proper planning, the IRS and the Illinois Department of Revenue each take their share before any of that value reaches the next generation.

What Factors Drive Up the Taxable Value of a Business?

• Years of retained earnings and reinvested profits that have grown the company’s balance sheet
• Goodwill, customer relationships, and other intangible assets that a formal valuation will capture
• Real estate owned by the business or by the owner and leased to the business
• Life insurance policies owned individually rather than through a trust
• Receivables and inventory that inflate the book value of the business at death

What Strategies Can Protect a Family Business from Estate Tax in Illinois?

Several legal tools are available to Illinois business owners who want to reduce or eliminate estate tax exposure while keeping the business in the family.

Bypass Trust for Married Couples

Because Illinois does not allow portability between spouses, a Bypass Trust, sometimes called a Credit Shelter Trust, is one of the most important tools available to married business owners in Illinois. 

Irrevocable Life Insurance Trust

Many business owners rely on life insurance to provide liquidity for their estate, but if the owner personally owns the policy at death, the death benefit is included in the taxable estate. An Irrevocable Life Insurance Trust, or ILIT, owns the policy instead. 

Grantor Retained Annuity Trust

A Grantor Retained Annuity Trust, or GRAT, allows a business owner to transfer a business interest to a trust while retaining an annuity payment for a fixed period of years. If the business grows during that period at a rate above the IRS’s assumed return, the excess appreciation passes to beneficiaries free of gift and estate tax. 

Family Limited Partnership or Family LLC

A Family Limited Partnership (FLP) or Family Limited Liability Company (FLLC) allows a business owner to transfer ownership interests to family members at a discounted value. Because minority interests in a private business lack both control and marketability, the IRS generally allows valuation discounts of 20 to 30 percent when those interests are transferred as gifts. 

Annual Gifting

Each year, an individual can give up to $19,000 per recipient in 2026 without using any of their lifetime exemption or triggering a gift tax return. Over time, a disciplined annual gifting program can move substantial business value out of the taxable estate. 

Buy-Sell Agreement

A buy-sell agreement establishes in advance what happens to a business owner’s interest when they die, become disabled, or wish to exit the business. It sets the price and the mechanism for transferring the interest, which is important both for business continuity and for estate tax purposes.

Call a Naperville, IL Estate Planning Lawyer Today

There is no one-size-fits-all answer, and the wrong approach can create problems that are far more expensive than the taxes you were trying to avoid. The Gierach Law Firm’s Naperville estate planning attorney brings more than 30 years of experience to Illinois families and business owners facing exactly these decisions. 

Call us at 630-756-1160 to schedule a consultation.