On May 31, 2017, the Minnesota Tax Court determined that it is unconstitutional to tax certain trusts as Minnesota resident trusts. The statute required that if any Minnesota resident created an irrevocable trust, that trust would be subject to Minnesota income tax for as long as that trust exists, on 100% of the trust’s income no matter the source of that income. If a trust was created by the Minnesota domiciled grantor during their lifetime, after 1996, and was irrevocable, that trust would be taxed forever in Minnesota even though there are no other Minnesota connections. As a result, Minnesota residents could seemingly never take advantage of the income tax benefits of another state’s trust location for the entire life of the trust, even long after the grantor had passed away and when none of the income is earned in Minnesota. Because of this recent court ruling, however, Minnesota residents may now have opportunities like much of the country to create trusts in places like South Dakota. Those trust assets would not likely be subjected to Minnesota income tax.
This development in the definition of “resident trust” in Minnesota comes after much speculation that the statute was unconstitutional. Similar rulings have occurred in states like Illinois, New York, Michigan and New Jersey. In these cases, the courts found that there is not enough connection to a state to only have the initial grantor be a resident; more connection is necessary to give the taxing authorities jurisdiction. As the law stands, there is no way to subject an irrevocable trust located in another state (like South Dakota), with assets outside of Minnesota to Minnesota income tax. This is also the case in states like Illinois and New Jersey. Other states, such as New York and California, included or later amended their statutes to give weight to connecting factors like the location of assets or beneficiaries. This type of amendment, or an appeal of this decision, could happen down the road in Minnesota as well. In much of the country (notably Arizona and Florida) there is no similar resident trust concept for irrevocable trusts. Grantors living in those states can create irrevocable trusts located in states like South Dakota and enjoy the many benefits that come with it.
Talk to your trusted advisor if you think you may be entitled to a refund for taxes a trust paid to Minnesota, or if you have any questions regarding this new ruling.
¹Fielding v. Commissioner of Revenue, Minnesota Tax Court, May 31, 2017