In the case of Fielding v. (Minnesota) Commissioner of Revenue, filed July 18, 2018, A17-1177; 916 N.W.2d 323 (Minn. 2018), the Minnesota Supreme Court found the Minnesota Resident Trust income tax statute Minn. Stat. § 290.01 Subd. 7b(a)(2) unconstitutional under the Due Process Clause of the United States and Minnesota Constitutions as applied to this case. In this case, the grantor created an irrevocable trust that was a grantor trust because the grantor retained a power of substitution over the trust property. The Trust was created in 2009 with a California Trustee. On January 1, 2012 a Colorado Trustee was appointed and finally on July 24, 2014 a Texas Trustee was appointed. For the first 30 months, the Trust remained a grantor trust subjecting the grantor to tax on all trust income. However, on December 31, 2011 the grantor relinquished his power of substitution and the Trust was no longer a grantor trust. The Trust owned S-Corporation stock of a Minnesota based company. In 2014 the Trust sold the company stock and incurred more than $250,000 in income taxes and invested the sale proceeds at an institution outside of Minnesota. The Trust filed the 2014 income tax return under protest and filed for a refund. The Tax Court found the Minnesota tax unconstitutional and the matter was appealed to the Minnesota Supreme Court.
Minn. Stat. § 290.01 Subd. 7b(a) defines two forms of a resident trust, (1) a trust created by will (not reviewed in this case), and (2) a resident trust as “a trust, except a grantor type trust, which …is an irrevocable trust, the grantor of which was domiciled in this state at the time the trust became irrevocable” and that the trust became irrevocable after January 1, 1996. This second definition is of a resident trust is the matter subject to review. An initial issue for the Court’s constitutional analysis is whether the Court should consider all facts and circumstances regarding the trust or whether the only issue is the grantor’s connection to the trust. While the statutory definition looks to the grantor’s domicile, the constitutional analysis requires the Court to examine all the facts and circumstances surrounding the trust. The facts and circumstances approach is consistent with prior cases examining the constitutionality of a tax statute.
When turning to the facts and circumstances of this case, due process is satisfied if (1) there is a “minimum connection” between the state and the person, property, or transaction subject to the tax, and (2) the income subject to the tax is rationally related to the benefits conferred on the taxpayer by the state. There is no argument whether the state can tax Minnesota sourced income. That is not disputed. The question is whether Minnesota can tax all income including income not sourced in Minnesota. The state points to the following facts to justify the tax: the grantor was a Minnesota resident and domiciled here when the Trust was created and became irrevocable, the Trust owned stock in a Minnesota company, the Trust was created by a Minnesota law firm and the original documents were held by the Minnesota law firm, the Trust provides that Minnesota law controls the Trust, and one beneficiary was a Minnesota resident. The taxpayer points to the following facts opposing the residency status: no trustee has been a Minnesota resident, the Trust is not administered in Minnesota, the records are maintained outside of Minnesota, other Trust income is derived outside of Minnesota, and 3 of 4 beneficiaries live outside of Minnesota. The Court found that the state’s arguments are either irrelevant or too attenuated to satisfy the due process arguments. The state arguments do not look to the party paying the tax. The Trust is paying the tax, not the grantor. The fact that the stock owned by the Trust was in a Minnesota company is irrelevant to the fact that the stock is an intangible asset located outside of Minnesota and there is no connection to the grantor. The Trust owns the stock not the grantor. While a Minnesota law firm created the Trust, the law firm did not represent the trustees and storing an original document by the Minnesota firm was a convenience to the grantor not the Trust. The pre-2014 facts that show a connection to Minnesota are irrelevant to the analysis because the Trust is the taxpayer and what is relevant is the facts in 2014 and thereafter. “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.” Historical contacts unrelated to the tax year are not relevant. The tax was found to be unconstitutional.
This case does not decide the constitutionality of a tax upon a resident trust “created by a will of a decedent who at death was domiciled in this state” (Minnesota). The Court noted that testamentary trusts created by a will probated in Minnesota under the statute may be analyzed differently than this case. The Court cited to District of Columbia v. Chase Manhattan Bank, 689 A.2d 539, 544 (D.C. 1997)(finding it constitutional to tax a trust from a will probated in that state), and In re Swift, 727 S.W.2d 880, 882 (Mo. 1987)(probating the will in Missouri was not a sufficient nexus to tax the trusts) to highlight two possible conclusions if and when this second definition of a resident trust is analyzed. Thus it seems the taxation of a testamentary trust created under a will probated in Minnesota is still an open question.
Implications: This case rejects domicile as a justification for taxation and looks to minimum contacts to justify taxation. This creates obvious concerns for Minnesota trustees who administer trusts created in other states and whose grantor was not from Minnesota. Those trustees may need to start filing Minnesota tax returns because the trustee lives in Minnesota or administers the trusts in Minnesota. For trusts that are not administered in Minnesota and have no connection to this state, the trustees may want to strongly consider amending prior tax returns to seek refunds where the only connection to Minnesota was the domicile of the grantor. But the most compelling implication is the anticipated legislative response to this case. It is firmly anticipated that Minnesota will respond to this case with legislation that adopts a minimum contacts and benefits received approach to taxation. Such a definition of resident trust may cast an even wider net than the current definition of a resident trust under the statute. While this case is a victory for these parties, Minnesota attorneys, accountants and trustees may find that trusts begin an immediate exodus from the state to sever all minimum connections with the state to keep the trust from falling under a new resident trust statute. If minimum connections becomes the new tax test, local professionals may find themselves watching their clients sever all ties to save taxes. That is good for the trust but bad for Minnesota professionals.