The taxation of trusts in Minnesota
The impact of the Kaestner and Fielding decisions
April 2020 Footnote
Editor's note: Updated April 1, 2020
Two recent court decisions may impact whether Minnesota can constitutionally treat certain trusts as residents. Because Minnesota taxes resident trusts on all their income and gain, and nonresident trusts only pay Minnesota income tax on income properly allocable to Minnesota, the implications of these decisions could be significant.
In June 2019, the U.S. Supreme Court issued a unanimous opinion in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust
, holding that a North Carolina statute that treated a trust as a resident based solely on the trust beneficiaries’ residency in the state violated the due process clause as applied to that particular trust.
Shortly after it issued the Kaestner
decision, the U.S. Supreme Court declined to consider the Minnesota Department of Revenue (DOR) commissioner’s appeal from the Minnesota Supreme Court decision in Fielding v. Commissioner
. The Fielding
case held that Minnesota could not constitutionally tax certain trusts as Minnesota residents when their only connection to the state was the grantor’s Minnesota residency at the time the trusts became non-grantor trusts.
The decisions in Kaestner
are strictly limited to the facts of those cases. However, they both provide guidance in helping to determine whether Minnesota should be able to treat certain trusts as resident trusts.
The Minnesota resident trust statute
The statutory test as to whether a trust is a Minnesota resident varies depending on whether the trust became irrevocable or was first administered in Minnesota after Dec. 31, 1995, or before Jan. 1, 1996. For purposes of the residence trust statute, a grantor trust is not treated as irrevocable.
The Minnesota statutes provide that a trust that become irrevocable or was first administered in Minnesota after Dec. 31, 1995, is treated as a Minnesota resident if it was created by a will of a Minnesota-domiciled decedent or the grantor was a Minnesota domiciliary at the time the trust became irrevocable. (Note that while the statute refers to the grantor’s domicile
, the instructions to Form M2 refer to the residence
of a grantor.)
Pre-1996 trusts are treated as Minnesota residents if they meet two out of three factors: (1) a majority of discretionary investment decisions are made in Minnesota, (2) a majority of discretionary distribution decisions are made in Minnesota, and (3) the trust’s books and records are kept in Minnesota. Pre-1996 resident trusts are not impacted by Kaestner
in analyzing whether a trust has sufficient connections to the state.
In the Fielding
case, the Minnesota Supreme Court held that when analyzing whether Minnesota could treat a post-1995 trust as a Minnesota resident, all relevant connections to Minnesota must be examined. Fielding
contains helpful guidelines for determining what types of connections might be useful.
The Minnesota Supreme Court found that the following connections to Minnesota are relevant in determining whether a trust has sufficient connections to Minnesota to be taxed as a resident:
- Ownership by the trusts of property in Minnesota.
- Trustees’ domicile.
- Trust administration activities of the trustees in Minnesota.
- The use of Minnesota courts by the trusts.
- The court found the following connections to be irrelevant for the trusts at issue:
- Connections to Minnesota for a prior year.
- The grantor’s connections to Minnesota.
- The beneficiaries’ connections to Minnesota.
- The use of Minnesota law firm to represent the grantor in forming the trusts.
- Ownership of stock in a Minnesota corporation.
- The ownership of tangible property in Minnesota by the corporation whose stock was owned by the trusts.
The DOR commissioner petitioned the U.S. Supreme Court for a writ of certiorari in November 2018, asking the U.S. Supreme Court to hear an appeal from the Minnesota Supreme Court’s decision. Taxpayers were in limbo until the U.S. Supreme Court issued its order denying the petition. The DOR did not provide any guidance for the 2018 filing season.
While it was contemplating whether or not to hear an appeal from the Fielding
decision, the U.S. Supreme Court heard an appeal from the North Carolina Supreme Court’s decision in Kaestner
, which involved the constitutionality of a North Carolina statute that treated trusts as residents if they had any North Carolina beneficiaries.
, the U.S. Supreme Court held that if a state taxes trusts on the basis of the residency of a beneficiary, settlor or trustee, the due process clause requires looking at the particular relationship of that resident beneficiary, settlor or trustee to the trust assets that the state seeks to tax. In the case of a tax based on a resident beneficiary, the U.S. Supreme Court required that the beneficiary have some degree of a possession, control or enjoyment of trust assets or a right to receive property. The Court drew parallels to cases involving in-state residency of settlors or trustees, citing cases in which control by a settlor over trust assets would be a sufficient basis to permit a state to tax the trust’s income.
While the U.S. Supreme Court’s decision in Kaestner
was strictly limited to the facts of the case, it contains guidelines that may be helpful in evaluating whether a state can constitutionally tax a trust’s income. The Kaestner
decision also confirmed prior case law that:
- A state can tax income distributed to an in-state resident.
- A state can tax a trust based on a trustee’s residence within the state.
- A tax based on the situs of administration is constitutional.
Planning for Minnesota resident trusts
Minnesota has not revised its statutes following the Fielding
decision. The 2019 instructions to Form M2 indicate that the “resident trust statute is presumed to be constitutional.” There is a new resident trust questionnaire that a trustee is instructed to fill out and attach to the return if a post-1995 trust meets the statutory definition of a resident trust where the trustee believes there may not be sufficient minimum connections to Minnesota to be taxed as a resident trust. Given this guidance, trusts that are statutorily Minnesota resident trusts should continue to file Minnesota returns even if they lack Minnesota connections.
The resident trust questionnaire includes predictable questions such as whether any trustees were residents in Minnesota, whether the trust owned any property in Minnesota or whether trust administration functions took place in Minnesota, as well as questions that are less predictable such as whether any custodian for the trust was a resident in Minnesota. Drawing from Kaestner
, it asks whether any grantors or beneficiaries were residents in Minnesota during the year and whether they had any possession, control or enjoyment of the trust property during the year.
The resident trust questionnaire may be helpful to use as a planning guide for factors that the DOR will consider in determining whether a trust that is statutorily a resident cannot constitutionally be treated as such by the state. In taking steps to move a trust outside of Minnesota, tax planners should be mindful of the bases on which other states impose taxes. Changing a trustee to one located in a jurisdiction that taxes on the basis of trustee residence or place of administration may create additional state income tax liability for a trust.
provide helpful opportunities for trusts that no longer have any connections to Minnesota. However, it is likely that the DOR will review claims of nonresidency by trusts that fall within the statutory definition carefully. Tax planners and preparers should proceed with caution and be cognizant of ongoing developments within this area.
Karen Sandler Steinert is a shareholder in the trusts & estates group at Fredrikson & Byron, P.A. She has extensive experience providing estate, gift and income tax advice to individuals, families and business owners, including advising trustees on state income tax matters. You may reach her at firstname.lastname@example.org or 612-492-7372.