Illinois Inherited IRA: No State Income Tax on Distributions, $4M Estate Tax Guide (2026)

Illinois is one of approximately 13 states that fully exempt retirement income — including inherited IRA distributions — from state income tax. Under 35 ILCS 5/203(a)(2)(H), every dollar you withdraw from an inherited traditional or Roth IRA is exempt from Illinois's 4.95% flat income tax. There is no Illinois inheritance tax on the account balance. However, Illinois has a $4 million state estate tax exemption that is not portable between spouses and has not been adjusted for inflation since 2012 — meaning many Illinois estates that are exempt under the federal $15 million threshold (OBBBA, July 2025) still owe Illinois estate tax. This guide covers the full Illinois picture for inherited IRA beneficiaries in 2026.

Part 1: No Illinois income tax on inherited IRA distributions

Illinois imposes a 4.95% flat individual income tax on most income. But Illinois provides a broad retirement income subtraction under 35 ILCS 5/203(a)(2)(H) that covers distributions from retirement plans described in Internal Revenue Code sections 401(a), 403(b), and 408.¹ Section 408 of the IRC governs traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs — including accounts held by beneficiaries (inherited IRAs). Every distribution from an inherited traditional or Roth IRA qualifies for the subtraction.

How the subtraction works: Illinois begins with federal adjusted gross income (AGI) and then subtracts qualifying retirement distributions on Schedule M. An inherited IRA distribution appears in federal AGI as ordinary income on line 4b of Form 1040. On the Illinois IL-1040, that same amount is then subtracted on Schedule M line 9, so it does not enter the Illinois base income calculation. The effective Illinois rate on inherited IRA distributions is zero.

No income cap, no age requirement

Several states with partial retirement income exclusions cap the benefit by age (e.g., age 62 or 65) or by income level. Illinois does not. The 35 ILCS 5/203(a)(2)(H) subtraction applies regardless of how old the beneficiary is, how large the distribution is, or what the beneficiary's household income is. A 35-year-old adult child who inherited a $2 million IRA from a parent pays no Illinois income tax on any annual distribution throughout the 10-year depletion window — whether they earn $80,000 per year or $500,000 per year from other sources.¹

Both traditional and Roth inherited IRA distributions are exempt

Illinois treats inherited traditional IRA and inherited Roth IRA distributions the same way under the retirement income subtraction: both are subtracted from Illinois base income. For inherited Roth IRA distributions, this is largely academic (qualified Roth distributions are already excluded from federal AGI and therefore not in the base before the IL subtraction), but it matters for non-qualified Roth IRA distributions — earnings that would otherwise be taxable federally are also exempt in Illinois. The subtraction does not distinguish between qualified and non-qualified Roth distributions for Illinois purposes.

2026 combined rates: Illinois vs. high-tax states

For a non-EDB beneficiary subject to the SECURE Act 10-year depletion rule, the combined federal and state income tax rate on each inherited IRA distribution is:

Illinois is effectively equivalent to no-income-tax states (Florida, Texas) for the income tax cost on inherited IRA distributions. The 4.95% flat Illinois rate applies only to non-exempt income; retirement distributions are subtracted out. Brackets per IRS Rev. Proc. 2025-32.²

For a large inherited IRA, the cumulative effect of this exemption is substantial. An Illinois beneficiary taking $80,000 per year for 10 years from an inherited IRA in the 22% federal bracket pays approximately $176,000 in total federal income tax over the window. A comparable New York resident in the same federal bracket also pays approximately $50,000–$55,000 in New York income tax on top of that. The Illinois exemption saves the full state-tax differential — in this scenario, roughly $50,000 over the 10-year window relative to a New York beneficiary, without any planning effort. It is automatic.

Part 2: No Illinois inheritance tax

Illinois has no inheritance tax. Unlike Pennsylvania (which levies 4.5%–15% inheritance tax on the IRA balance at death depending on beneficiary class) or New Jersey (which taxes more distant relatives at 11%–16%), Illinois does not impose any tax on beneficiaries based on the size of the inherited account or their relationship to the decedent. There is no Illinois form to file, no rate schedule to apply, and no exemption threshold to track for the inheritance tax — because there is no such tax in Illinois.

Part 3: The Illinois estate tax — $4 million non-portable exemption

This is the most important gotcha for Illinois inherited IRA beneficiaries whose decedent was an Illinois resident. While the income tax treatment favors Illinois beneficiaries, the Illinois estate tax can reduce the overall assets transferred by the decedent's estate — even when no federal estate tax is owed.

The $4 million threshold and the federal gap

The Illinois estate tax applies when the decedent's gross taxable estate exceeds $4 million.³ This threshold was set in 2012 and has never been adjusted for inflation. Meanwhile, the federal estate tax exemption has grown significantly — it was $15 million per individual as of 2026, after the One Big Beautiful Bill Act (OBBBA, enacted July 2025) permanently raised the exemption from the prior $13.99 million level and eliminated the scheduled 2026 sunset.²

The gap between $4M (Illinois) and $15M (federal) creates a large zone where an estate owes Illinois estate tax but no federal estate tax:

Illinois estate tax rates are graduated, starting at approximately 0.8% and reaching 16% on the largest estates. The rate structure creates a "cliff" effect near the $4 million threshold: an estate of $3.99 million owes nothing, while an estate of $4.01 million suddenly owes Illinois estate tax on the value above the exemption at the lower graduated rates — but even those lower rates apply to the entire marginal estate value. For estates between $4 million and $10 million, Illinois estate taxes can range from tens of thousands to several hundred thousand dollars.³

Illinois exemption is NOT portable between spouses

Federal estate tax law allows "portability" — when the first spouse dies, any unused federal exemption can be transferred to the surviving spouse via a portability election (Form 706). This means a married couple can shelter up to $30 million from federal estate tax without complex trust planning. Illinois does not have portability. Each Illinois resident has exactly one $4 million Illinois estate tax exemption, and it does not transfer to the surviving spouse at death.

For married Illinois couples, this means: if the first spouse dies and leaves their entire estate to the surviving spouse outright (common for estates below the federal threshold), the surviving spouse's combined estate may later exceed $4 million and owe Illinois estate tax. The solution is a Credit Shelter Trust (also called a Bypass Trust): at the first spouse's death, assets up to $4 million are placed in an irrevocable trust for the surviving spouse's benefit (and eventually children), sheltering those assets from the surviving spouse's estate. Done correctly, a married Illinois couple can shelter $8 million from Illinois estate tax using two Credit Shelter Trusts. Without this planning, a $7 million combined estate could pay Illinois estate tax that could have been avoided with proper structuring.

How the Illinois estate tax affects the inherited IRA beneficiary

An IRA passes to the named beneficiary by contract — outside the decedent's probate estate. But for Illinois estate tax purposes, the IRA balance IS included in the decedent's gross taxable estate at its full value. The estate must pay the Illinois estate tax, but the IRA passes directly to you as beneficiary, not through probate.

This creates a practical problem: the executor must pay Illinois estate tax from estate assets, but the IRA — often the largest single asset — has already passed to you outside probate. The executor may need to use other assets (cash, brokerage accounts, real estate) to fund the Illinois estate tax bill. If other estate assets are insufficient to cover the Illinois estate tax, the executor may seek contribution from beneficiaries who received assets outside probate — including you as the IRA beneficiary. This is relatively uncommon but worth understanding if the decedent's estate was significant and the IRA was a major component of it.

Part 4: Creditor protection for inherited IRAs in Illinois — legally uncertain

Illinois provides strong creditor protection for a person's own IRA under 735 ILCS 5/12-1006, which exempts qualifying retirement plan assets from judgment creditors and bankruptcy proceedings. However, the application of this protection to inherited IRAs — held by a beneficiary, not the original account owner — is legally uncertain.

The federal bankruptcy limitation

In Clark v. Rameker (573 U.S. 122, 2014), the U.S. Supreme Court held unanimously that inherited IRAs are not "retirement funds" within the meaning of the federal Bankruptcy Code § 522(b)(3)(C) exemption. The Court identified three reasons: (1) the beneficiary cannot make additional contributions to the account; (2) distributions must begin immediately; and (3) the beneficiary can withdraw any amount at any time without a 10% early distribution penalty. Because inherited IRAs do not function as retirement savings for the beneficiary, the federal bankruptcy exemption does not cover them.⁴

Illinois's position in the Seventh Circuit

Illinois is within the Seventh Circuit Court of Appeals. Prior to the Supreme Court's ruling in Clark v. Rameker, the Seventh Circuit had itself reached the same conclusion in Rameker v. Clark (714 F.3d 559, 7th Cir. 2013), holding that inherited IRAs held in bankruptcy proceedings were not exempt as retirement funds. This means the Seventh Circuit was at the forefront of limiting inherited IRA protection in bankruptcy — and Illinois residents filing for federal bankruptcy cannot rely on inherited IRA protection.

Illinois state-law protection outside bankruptcy

Outside bankruptcy, in ordinary civil creditor proceedings, 735 ILCS 5/12-1006 exempts retirement account assets from execution. Whether this protection extends to inherited IRAs in non-bankruptcy civil proceedings in Illinois is less clear-cut than in states like Florida or Texas that have explicitly amended their exemption statutes to cover inherited IRAs by name. Legal commentators and Illinois practitioners have noted that the scope of § 12-1006 for inherited accounts is unsettled.⁵ Some courts have found partial protection; others have not.

Practical implication: if you are an Illinois resident with significant creditor exposure (business owner, professional with malpractice risk, or individual with pending litigation), the inherited IRA should be treated as a potentially exposed asset. Unlike Florida beneficiaries (who have explicit statutory protection under FL Stat. § 222.21) or Texas beneficiaries (who have explicit protection under TX Property Code § 42.0021), Illinois beneficiaries do not have a clear statutory shield. An estate planning or asset protection attorney licensed in Illinois can advise on whether additional protective structures — such as taking a spousal rollover to a protected own-IRA, or naming a trust as beneficiary — are appropriate given your circumstances.

Part 5: Illinois is not a community property state

Illinois uses equitable distribution under the Illinois Marriage and Dissolution of Marriage Act (750 ILCS 5/) rather than community property rules. Unlike California, Texas, Arizona, Nevada, Washington, Idaho, Louisiana, New Mexico, and Wisconsin, Illinois does not automatically vest a 50% ownership interest in a spouse for assets accumulated during marriage.

For inherited IRA beneficiaries, this matters when: (a) the decedent's IRA was funded during a marriage, and (b) a surviving spouse may assert community property rights to a portion of the account. Because Illinois is not a community property state, there is no automatic 50% spousal interest in the decedent's retirement accounts. The named beneficiary on the custodian's beneficiary designation form is the proper recipient of the inherited IRA — regardless of who contributed to the account during marriage.

Note that if the decedent spent time living in a community property state during the accumulation period, those assets may retain their community property character. If the decedent moved to Illinois from California, Texas, or another community property state, consult an estate attorney to determine if any portion of the IRA has community property character before assuming Illinois equitable distribution rules apply in their entirety.

Part 6: Distribution strategies for Illinois inherited IRA beneficiaries

Because Illinois does not tax inherited IRA distributions, the planning framework for Illinois beneficiaries is purely federal. The same strategies that apply in Florida or Texas — the other zero-state-income-tax states for inherited IRA distributions — apply in Illinois.

Federal bracket management is the core lever

The 10-year SECURE Act depletion window (for non-EDB beneficiaries) and the Group B annual RMD requirement (for post-RBD decedents per T.D. 10001, July 2024) create a planning problem: how to distribute a potentially large inherited IRA over 10 years without concentrating income in high federal brackets. Since Illinois adds nothing on top of the federal rate, the optimization is purely federal.

Key federal brackets for 2026 single filers (per IRS Rev. Proc. 2025-32):²

For Illinois residents, these rates represent the total income tax cost on inherited IRA distributions — no state addend. Standard deduction for single filers: $15,350 (2026).

Year-10 lump sum trap — federal only, but still severe

An Illinois beneficiary who defers an entire inherited IRA to a year-10 lump sum concentrates all the taxable income in a single federal year. The absence of Illinois income tax does not reduce the federal risk. A $600,000 year-10 lump sum with $80,000 in other income as a single filer pushes distributions through the 22%, 24%, 32%, and 35% federal brackets. Spreading that same $600,000 across 10 years at $60,000 per year — in lower-income years — can keep all distributions in the 22% bracket, potentially saving $60,000–$100,000 in federal tax over the window. Use the 10-Year Withdrawal Optimizer to model the strategy for your balance and income profile.

Social Security and IRMAA — particularly relevant for Illinois retirees

Illinois has a large and growing retiree population. Two federal mechanisms affect Illinois beneficiaries who are retired or near retirement:

• Social Security benefit taxation: inherited IRA distributions count as provisional income (IRC § 86), potentially making up to 85% of Social Security benefits taxable at ordinary income rates. In the 85% zone, the effective federal marginal rate becomes your bracket rate × 1.85 — entirely a federal effect, with no state overlay in Illinois. See the Social Security coordination guide.
• Medicare IRMAA: distributions count toward MAGI and can trigger Medicare Part B/D surcharges with a two-year lookback. The 2026 IRMAA first tier begins at $109,000 MAGI for single filers ($218,000 MFJ).² See the IRMAA planning guide for the full tier schedule and calibration strategies.

Qualified Charitable Distributions

Illinois beneficiaries age 70½ or older can make Qualified Charitable Distributions (QCDs) of up to $111,000 in 2026 directly from an inherited IRA to a qualifying charity, excluding the distribution from federal AGI.² Because Illinois already exempts inherited IRA distributions, the Illinois benefit of a QCD is redundant — there is no additional Illinois tax savings. But the federal benefit still applies: a QCD that would otherwise fall in the 24% or 32% federal bracket saves 24–32 cents per dollar compared to a taxable distribution followed by a separate charitable deduction. QCDs also satisfy the annual RMD obligation for Group B beneficiaries. See the QCD guide for eligibility and execution details.

Illinois inherited IRA — action checklist for 2026

1. Determine your beneficiary category: EDB (lifetime stretch) or non-EDB (10-year rule), and whether Group A (no annual RMDs) or Group B (annual RMDs years 1–9) applies per T.D. 10001. Use the RBD calculator.
2. Confirm Illinois retirement income subtraction applies: verify your custodian or CPA is subtracting the inherited IRA distribution on your IL-1040 Schedule M. Some preparers unfamiliar with the IL exemption mistakenly include it in Illinois base income. The subtraction is mandatory, not optional.
3. Assess the decedent's estate: if the decedent was an Illinois resident with an estate over $4 million, determine whether Illinois estate tax was assessed and whether the executor has (or will) seek contribution from beneficiaries. Get a copy of the Illinois estate tax return (Illinois Form 700) from the executor if the estate was over $4M.
4. Do not expect a § 691(c) deduction for Illinois estate taxes: if the estate paid only Illinois estate tax (no federal estate tax), there is no IRC § 691(c) income-tax deduction for you as the IRA beneficiary. Only federal estate taxes paid on the IRA create a § 691(c) deduction.
5. Evaluate creditor exposure: if you have significant personal liability risk, consult an Illinois asset protection attorney before distributing extensively, as the inherited IRA may have limited creditor protection in Illinois compared to Florida or Texas.
6. Model federal bracket strategy: use the 10-Year Withdrawal Optimizer — no state tax adjustment needed for Illinois residents. The "total tax" figure is your all-in cost.
7. Monitor Social Security and IRMAA thresholds: if you receive Social Security or are approaching Medicare age, keep annual distributions below the $109,000 IRMAA first-tier threshold and model the SS provisional income multiplier.
8. QCDs if age 70½+: up to $111,000 per year directly to charity, excluded from federal AGI, satisfies Group B annual RMD obligation.
9. Credit Shelter Trust for Illinois decedents: if you are advising or helping plan for a future Illinois estate, ensure the estate plan uses a Credit Shelter Trust to double the effective Illinois exemption to $8M for married couples.

Sources

1. 35 ILCS 5/203(a)(2)(H) — Illinois Income Tax Act, Base Income Modifications. The Illinois retirement income subtraction (Schedule M, line 9) covers distributions from retirement plans described in IRC §§ 401(a), 403(b), and 408. Section 408 of the Internal Revenue Code covers traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, and distributions to beneficiaries from those accounts (inherited IRAs). The subtraction applies regardless of the beneficiary's age, income level, or filing status. Illinois levies a 4.95% flat individual income tax on base income, but qualifying retirement distributions are removed from base income before the rate is applied. Verified July 2026 per Illinois Department of Revenue guidance and 35 ILCS 5/203(a)(2)(H).
2. IRS — Tax Inflation Adjustments for Tax Year 2026 (Rev. Proc. 2025-32). Federal income tax brackets for 2026: 10% to $11,925 (single) / $23,850 (MFJ); 12% to $48,475 / $96,950; 22% to $103,350 / $206,700; 24% to $197,300 / $394,600; 32% to $250,525 / $501,050; 35% to $626,350 / $751,600; 37% above. Standard deduction: $15,350 (single) / $30,700 (MFJ). IRMAA single-filer first-tier: $109,000 MAGI ($218,000 MFJ). QCD annual limit: $111,000. Federal estate and gift tax exemption: $15,000,000 per individual under OBBBA (enacted July 2025). Illinois residents pay only federal rates on inherited IRA distributions. Verified July 2026.
3. Illinois Attorney General — Illinois Estate Tax Instruction and Fact Sheet. Illinois imposes a state estate tax under the Illinois Estate and Generation-Skipping Transfer Tax Act (35 ILCS 405/) on taxable estates exceeding $4,000,000. The $4M exemption has been in effect since 2012 and has not been adjusted for inflation. Illinois estate tax rates are graduated from approximately 0.8% to 16%. The Illinois estate tax exemption is NOT portable between spouses — unlike federal portability under IRC § 2010(c). The estate tax is reported on Illinois Form 700, filed with the Illinois Attorney General within 9 months of death. Verified July 2026.
4. Clark v. Rameker, 573 U.S. 122 (2014) — U.S. Supreme Court. Unanimous ruling that inherited IRAs do not qualify as "retirement funds" under the federal Bankruptcy Code § 522(b)(3)(C) exemption. The Seventh Circuit Court of Appeals (which covers Illinois) had reached the same conclusion in Rameker v. Clark, 714 F.3d 559 (7th Cir. 2013) before the Supreme Court affirmed. Illinois residents in federal bankruptcy cannot rely on the federal bankruptcy exemption to protect inherited IRAs. Unlike Florida (FL Stat. § 222.21) and Texas (TX Prop. Code § 42.0021), Illinois has no state statute explicitly protecting inherited IRAs by name. Verified July 2026.
5. 735 ILCS 5/12-1006 — Illinois Code of Civil Procedure, Exemption of Retirement Accounts. Section 12-1006 exempts qualifying retirement accounts — including IRAs — from judgment creditor claims in Illinois civil proceedings. The statute provides protection for the account owner's own retirement accounts. Whether the exemption extends to inherited IRAs held by a beneficiary is unsettled under Illinois law; no Illinois statute explicitly names inherited IRAs as protected, and the Seventh Circuit's Clark v. Rameker position limits protection in federal bankruptcy. Beneficiaries with significant liability exposure should consult an Illinois asset protection attorney. Verified July 2026.

Illinois retirement income exemption: 35 ILCS 5/203(a)(2)(H). Federal brackets per IRS Rev. Proc. 2025-32. Illinois estate tax: 35 ILCS 405/, exemption $4M, rates 0.8%–16%, non-portable. Federal estate tax: $15M permanent exemption per OBBBA (July 2025). Federal inherited IRA rules: IRC § 401(a)(9) and T.D. 10001 (July 2024). Illinois is not a community property state (750 ILCS 5/IMDMA). Tax law and state statutes are subject to change — verify current rules at idor.illinois.gov, ilga.gov, and irs.gov before making distribution decisions. Values verified July 2026.