Landmark Minnesota Tax Decision May Provide Tax Savings Opportunity for Trusts

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The Minnesota Supreme Court recently ruled in Fielding v. Commissioner that Minnesota Statute Section 290.01, defining a “resident trust,” is unconstitutional, as applied to the facts found in Fielding. This ruling is significant for fiduciary (trust) income tax purposes.

Minnesota statutes define a trust as a “resident trust” if (1) the trust became irrevocable on or after January 1, 1996, and (2) the grantor (person who created the trust) was a Minnesota resident when the trust became irrevocable. If the trust is a Minnesota resident trust (as defined by statute), it is subject to Minnesota income tax regardless of whether the trust no longer has any contacts with Minnesota.

In Fielding, there were four separate trusts that became irrevocable in 2011, while the grantor was a Minnesota resident. Despite meeting the statutory definition of a resident trust,  the trustees disputed the  resident trust status of the four trusts, claiming that the two-factor test of the statute violated the due process clause. After the Minnesota Commissioner of Revenue denied the trustee’s claim, the case was litigated in the Minnesota tax court, and eventually was appealed to the Minnesota Supreme Court.

On appeal, the Minnesota Supreme Court considered the reach of Minnesota’s power to tax a trust, analyzing all of the trusts’ contacts with Minnesota as opposed to being confined to the statute’s narrow two-factor test. The Court ruled that all relevant contacts between a trust and Minnesota should be considered when determining a trust’s residency and the right of Minnesota to tax a trust. The Court held the resident trust statute unconstitutional as applied to these trusts, ruling that Minnesota cannot tax a trust based solely on a grantor’s residency when the trust becomes irrevocable. 

The Court discussed the contacts that can be used to determine a trust’s residency, giving particular weight to the trustee’s domicile, the state where the trust is administered, the state in which the trust was created, the circumstances surrounding the creation of the trust, and where the trust property is located. In discussing other factors, the Court determined that the use of a Minnesota law firm to draft the trust and the storage of the trust documents in Minnesota for the benefit of the grantor were irrelevant to the determination of a trust’s residency.

Planning Opportunities. Trustees who, in prior years, filed Minnesota trust income tax returns because a trust fit within the statutory definition of Minnesota resident trust, but the trust had limited contacts with Minnesota (e.g., trustee not located in Minnesota, trust not administered in Minnesota, trust property not located in Minnesota, etc.), should consider the trust’s Minnesota tax-filing status in future years, and should consider filing claims for refund for past years.

Future Legislative Action. Trustees should also carefully follow future Minnesota legislative actions. The Minnesota legislature might amend the definition of a “resident trust” in future legislative sessions so as to subject more trusts to Minnesota taxation, including trusts that are currently administered in Minnesota but do not fit within the definition of “resident trusts” because of the grantor’s out-of-state domicile when the trust became irrevocable.