Minnesota Supreme Court decision in Fielding case may impact taxation of trusts
Nick Fitzgerald, CPA, MBT, CGMA, CliftonLarsonAllen | December/January 2018-19 Footnote
In a 4-2 decision, the Minnesota Supreme Court in July ruled in Fielding v. Commissioner that it was unconstitutional, under the due process clause, for Minnesota to consider four trusts to be taxed as Minnesota "resident trusts."
The ruling is significant for non-grantor trusts created after Dec. 31, 1995, by a grantor who was a Minnesota resident when the trust became irrevocable. However, the Fielding case should not be interpreted as a blanket ruling applicable to all post-1995 irrevocable trusts created by a Minnesota resident; it is critical to analyze the facts and circumstances of each trust to determine whether the application of the Minnesota Resident Trust statue would be considered unconstitutional under Fielding.
Findings in Fielding
Four separate trusts were created on June 25, 2009, by grantor Reid MacDonald, then a domiciliary of Minnesota; each trust was initially funded with shares of nonvoting common stock in Faribault Foods, Inc (FFI), a Minnesota S Corporation. The original trustee for all four trusts was a California domiciliary, Edmund MacDonald. Initially, the trusts were considered "grantor type trusts" for the first 30 months of their existence. However, on Dec. 31, 2011, grantor Reid MacDonald (domiciled in Minnesota) relinquished his power to substitute assets in the trusts and, therefore, the trusts ceased to be "grantor type trusts" and became irrevocable non-grantor trusts. On Jan. 1, 2012, Katherine Boone, a domiciliary of Colorado, became the sole trustee for each trust.
As a result of the above, the trusts became classified as "resident trusts" under Minnesota Statute Section 290.01, subd. 7b(a)(2) and filed Minnesota income tax returns as a resident trust, without protest, in 2012 and 2013. On July 24, 2014, William Fielding, a domiciliary of Texas, became trustee of the trusts.
Shortly thereafter, all shareholders of FFI stock, including the trusts, sold their shares. Because the trusts were defined to be Minnesota resident trusts, they were subject to tax on the full amount of the gain from the 2014 sale of the FFI stock, as well as on the full amount of income from other investments generated in the trusts.
The trustees filed their 2014 Minnesota income tax returns under protest, asserting that the statute classifying them as resident trusts was unconstitutional as applied to them. The trustees then filed amended Minnesota income tax returns claiming refunds for the difference between the taxes owed as resident trusts and the taxes owed as nonresident trusts -- a tax savings of more than $250,000 per trust.
The Minnesota Department of Revenue commissioner denied the trusts' refund claims. Upon denial, Fielding appealed to the Minnesota Tax Court, who found in favor of the trusts. The commissioner then appealed to the Minnesota Supreme Court.
Minnesota Supreme Court ruling
On July 18, 2018, the Minnesota Supreme Court published its decision in Fielding finding that the resident trust definition was unconstitutional as applied to the Fielding trusts. The court determined that it must look at the connections between the trust and the state of Minnesota, and whether the income that the state seeks to tax is rationally related to the benefits being conferred on the trust by the state.
The court looked at the following relevant factors when applying the facts in the Fielding case:
- Domicile of the trustee.
- Location of the trustee's decision-making.
- Location of the trusts' administration.
- Location of the trusts' records.
- Inter vivos trust versus testamentary trust using Minnesota probate court.
The court found the following as irrelevant factors when applying the facts in the Fielding case:
- Grantor's connections with Minnesota.
- Grantor's use of Minnesota legal counsel to draft agreement or represent trustee in tax challenge.
- Minnesota legal counsel storing original trust agreements.
- Beneficiary's residency.
- Trust's owning interests in Minnesota corporate stock or real property.
- Trust's connection to Minnesota outside of tax year at issue.
- Minnesota as choice of law in trust agreement.
CPAs should confer with trustees of post-1995 Minnesota resident trusts and determine the connections between the trust and the state of Minnesota, including whether the income that the state seeks to tax is rationally related to the benefits being conferred on the trust by the state. It is unclear, based on the Fielding case, whether the constitutionality of a testamentary Minnesota resident trust after 1995 will be viewed similar to an inter vivos trust, so caution must be applied in those fact situations. If you have a client that has a similar fact pattern as the Fielding case, the trusts may potentially be eligible for refunds, but you may need to act quickly as the statute of limitations for past years may close.
It is unclear whether there will be any legislation to address the constitutionality of the Minnesota resident trust statute. So, as CPAs, we should be diligent in monitoring continued case law that may be established similar to Minnesota residency case law addressing whether an individual is a Minnesota resident for income tax purposes.
Paul J. Dinzeo, CPA, MBT, JD, CFP is the founder of Summit Hill Professional Trustee Services. He is an MNCPA member, and has appeared in numerous publications, including The Wall Street Journal and The New York Times. You
may reach him at firstname.lastname@example.org.