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Supreme Court rejects taxes on some trusts.

Byline: Barbara L. Jones

It is unconstitutional for Minnesota to tax income received by certain irrevocable inter vivos trusts, the Minnesota Supreme Court decided earlier this month, saving four trusts over $1 million in taxes and interest.<br />The court said in Fielding v. Commissioner of Revenue that under Minn. Stat. sec. 290.01, subd. 7b (a) (2) "resident trusts" were taxed where the trusts had insufficient minimum contacts with the state and there was no rational relationship between the income subject to tax and the protections and benefits conferred by the state. It is a violation of the Due Process Clauses of the United States and Minnesota Constitutions<br />"The State cannot fairly ask the Trusts to pay taxes as residents in return for the existence of Minnesota law and the physical storage of trust documents in Minnesota," wrote Justice Natalie Hudson for the court. Justices David Lillehaug and Anne McKeig dissented, and Justice Paul Thissen did not participate.<br />Minnesota is one of a minority of states that bases the residency of the trust on the residency of the grantor when the trust becomes irrevocable, said attorney Laura Carlson. The majority view is that the trust resides where it is administered, she said.<br />"Our client was intentional about bringing this lawsuit," Carlson said. "People have been saying that the law is unconstitutional for years but no one would [finance] a lawsuit."<br />The opinion is qualified by the facts of the trust creation and administration, said trust attorney Caitlin Abram. "Any post-1995 trust paying income tax needs to assess whether the facts in the ruling applies to that trust," she said. "Some trusts may be entitled to a refund."<br />Ryan Brown, media spokesperson for the Department of Revenue, said the office is reviewing the decision.<br />Minnesota resident<br />The case concerns four generation-skipping trusts established by Reid and Ann MacDonald in 2009 when Reid MacDonald was a domiciliary of Minnesota that were funded with stock in Faribault Foods Inc., a Minnesota S corporation. The trusts became irrevocable on Dec. 31, 2011, when MacDonald was still domiciled in the state. In 2014, all shareholders of FFI stock, including the trusts, sold their shares.<br />Because the trusts were defined to be Minnesota residents (because of MacDonald's Minnesota domicile in 2011), they were subject to tax on the full amount of the gain from the 2014 sale of the FFI stock, as well on the full amount of income from other investments, under Minn. Stat. sec. 290.17, subd. 2(c) and subd. 2(e). The trusts filed returns under protest and sought refunds of more than $250,000 per trust.<br />The Commissioner of Revenue denied refunds but the Tax Court disagreed, granting the trusts' motions for summary judgment.<br />Tax and benefits<br />The court said that in a due process challenge to a tax statute, the court looks beyond the statutory definition of a taxpayer in order to evaluate the relationship between the income taxed and the benefits provided by the state, examining all relevant contacts between the taxpayer and the state. The commissioner relied on the domicile of the grantor and the creation of the trusts in Minnesota by a Minnesota law firm that drafted and retained the documents until 2014. The trusts owned stock in a Minnesota corporation and their choice-of-law provisions named Minnesota. One beneficiary was a resident of Minnesota.<br />The trusts countered that "no Trustee has been a Minnesota resident, the Trusts have not been administered in Minnesota, the records of the Trusts' assets and income have been maintained outside of Minnesota, some of the Trusts' income is derived from investments with no direct connection to Minnesota, and three of the four trust beneficiaries reside outside of Minnesota," Hudson wrote.<br />The case is especially significant for what the court said was irrelevant to the due process analysis, Abram said. The court said that the contacts on which the commissioner relied were irrelevant or too attenuated to comply with due process.<br />The grantor's connection to the state is not relevant to the relationship between the trust income and the protection and benefits conferred by the state. "The relevant connections are Minnesota's connection to the trustee, not the connection to the grantor who established the trust years earlier," Hudson said. Similarly, legal protection afforded by state law to a beneficiary is not equal to protection to a trust, Carlson said.<br />The grantor's decision to use a Minnesota law firm to draft the trusts was also irrelevant, as was the law firm's storage of the documents over time.<br />Moreover, the trusts did not own any physical property in the state although they owned stock in a Minnesota business. But the stock is intangible property for tax purposes, Carlson said. (The dissent considered the Minnesota company stock to be an important factor.)<br />The court also disregarded contacts between the trusts, the grantor or the beneficiaries that predated 2014. "The direct link between the activities that generated the income in the year at issue and the protections provided by the State in that same year establishes the necessary rational relationship that justifies the tax," Hudson wrote. Looking at other historical facts makes taxpayers uncertain about their status and otherwise is an unworkable ad hoc approach, the court said. The trustees had almost no contact with Minnesota in 2014, the court said.<br />The choice-of-law provisions do not justify a tax because "The State cannot fairly ask the Trusts to pay taxes as residents in return for the existence of Minnesota law and the physical storage of trust documents in Minnesota," the court said. It also noted that the inter vivos trusts have not been probated in Minnesota's courts and have no existing relationship to the courts distinct from that of the trustee and trust assets," the court continued.<br />Dissent: Due process satisfied<br />The dissent argued that the trusts were residents of Minnesota, intentionally created that way by the grantor and owed their very existence to the state. It also argued that the choice of law provision invokes the benefits and protections of Minnesota law. The majority's reliance on U.S. Supreme Court decisions regarding the citizenship of the trustee, not the grantor, is misplaced because the pertinent language from those cases was dicta, the dissent said.

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Publication:Minnesota Lawyer
Geographic Code:1U4MN
Date:Jul 25, 2018
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