The Minnesota Supreme Court handed down its decision in Fielding v. MacDonaald et al. The decision rendered the statute that determines when a trust is taxed as a resident to the state unconstitutional as it applies to many different trusts. Previously, Minnesota would tax a trust as a resident perpetually if the Grantor was a Minnesota resident at the time it became irrevocable (among other times). This raised the question of whether this tie to the grantor was constitutional for due process reasons.
This is important for Minnesotans with income that is not sourced from Minnesota. It also potentially makes strategies such as NING style trusts viable. These trusts may be placed into South Dakota to remove state level income tax on the income sourced outside of Minnesota. It is important to do another analysis on whether a trust is a resident and whether the particular income is Minnesota sourced.
The Court relied on the analysis of Luther v. Comm’r of Revenue, 588 N.W.2d 502, 506 (Minn 1999) to determine the permissible basis for Minnesota to tax a taxpayer. This is a two part inquiry. Essentially, due process is satisfied if “(1) there is a “minimum connection” between the state and the person, property, or transaction subject to tax, and (2) the income subject to the tax is rationally related to the benefits conferred on the taxpayer by statute.” Id. This type of inquiry is very common in many areas of the law. It is used to determine whether or not a state or other sovereign has power over a person, business, or trust.
The Court examined what types of connections might signal that a trust has enough contact with Minnesota so that the state can tax all worldwide income. The Court found many facts irrelevant. The Court held that the choice of Minnesota law was irrelevant. The Court also held that the residence of the grantor was not relevant beyond the tax year the trust was established. That was a direct refutation of the statute’s language. This is not enough even though that is all the state has historically had to determine under the current law.
Surprisingly, the Court also held that a beneficiary’s residence was also irrelevant. The beneficiary is not the taxpayer because the trustee is the taxpayer. The Court also held that intangible property had a residency that is the same as the residency of the trustee. The Court went so far as to say that even stock in a Minnesota S-corporation is resident where the trustee is located. This was very interesting.
The Court seemed to imply that simply because a good amount of income is derived from Minnesota does not mean that there is automatically a significant contact with the state. The Court wanted to focus primarily on the trustee only. The trustee’s residence, the location of trust administration, the location of trust records and other factors about the trustee would control.
The trustee needs to take advantage of the protection of Minnesota’s laws to an extent that it justifies the tax imposed. Other states have specifically noted things like the residence of beneficiaries or even the location of the investment advisor. The Court found the beneficiary’s residence to be irrelevant.
The Court also found that since the law firm did not actively represent the trust after formation that this was not a factor. However, it didn’t say that all levels of services from an advisor would be ignored. So that leaves open the question of how many advisors a taxpayer can have in Minnesota before the state could attempt to tax the taxpayer.
It is my personal opinion that simply having an investment advisor in the state shouldn’t tip the balance of this test. The advisor might help the trustee make investment decisions, but the trustee ultimately makes them. I have this opinion because the Court took note that the decision to sell the Minnesota S-corporation stock was made by the trustee while they were not in Minnesota. The Court emphasized where the trustee was when the decision was made.
Likewise, putting too much emphasis on the location of the advisors could prove problematic. If a trust has an asset like S-corporation stock in Minnesota, does the fact that the trustee sought the advice of a Minnesota business broker on the valuation give this connection? What if the sale was the majority of the trust’s income for the year? Does the trust seeking advice from a Minnesota advisor who also facilitated the transaction mean that for that year Minnesota should be able to tax the entire income of the trust? This kind of an analysis would place a great deal of uncertainty in tax decisions and create quite a bit of administrative burden. It is also not practical. Though, advisor activity certainly should be “a” factor.
Ultimately, it is up to the legislature to amend the statute. The Court gave significant guidance on where the boundaries are for this issue. We will have to see what factors that the legislature chooses to fall back upon. I suspect that it will be the same factors as residency for individuals, but focused on the trustee.
Minnesotans should begin considering strategies with trustees in other states. It is unlikely that the legislature will be able to make such a burdensome statute again. It is, in my opinion, quite likely that this type of planning is now viable. As with all things in trusts and tax, each person’s situation may be different. Each taxpayer should consult their tax and legal professional to determine how they might take advantage of this development. The Court’s ruling was narrow and impacted just this particular trust. However, the same reasoning now likely applies to many trusts currently taxed in Minnesota. I would expect some change by the legislature. Otherwise, there will be many more challenges if Minnesota Revenue does not take another look at when they attempt to assess tax.