The Illinois Department of Revenue (IDR) recently attempted to tax a trust that had been moved from Illinois to Texas after the grantor’s death, even though the trust had been moved to Texas. The trustees of the trust had to expend considerable sums fighting off the IDR. This is a lesson that those who have moved to Florida but have not updated their trusts should consider.
Illinois trusts are subject to a five percent (5%) income tax and a 1.5% personal property tax. A non-resident trust is subject to the tax to the extent that the income is generated in Illinois or apportioned to Illinois. Resident trusts, on the other hand, are taxed on all income, regardless of the source. With respect to a trust, if the grantor was a resident of Illinois, at her death it is still considered an Illinois trust, even if none of the trustees or beneficiaries has a nexus to Illinois.
In Linn v. Illinois Department of Revenue, the case involved a trust established in 1961 by A.N. Pritzker, an Illinois resident. The trust was initially administered by Illinois trustees pursuant to Illinois law. In 2002, pursuant to powers vested in the trustee in the trust instrument, the trustee distributed the trust property to a new trust (the “Texas Trust”).
Although the Texas Trust generally provided for administration under Texas law, certain provisions of the trust instrument continued to be interpreted under Illinois law. The Texas Trust was subsequently modified by a Texas court to eliminate all references to Illinois law, and the trustee filed the Texas Trust’s 2006 Illinois tax return on a nonresident basis. At that time no non-contingent trust beneficiary resided in Illinois, no trust office holder resided in Illinois, no trust assets were outside Illinois and Illinois law was not referenced in the trust instrument.
The Illinois Department of Revenue (the “IDR”) determined that the trust was a resident trust and that, as such, the trust should continue to be subject to Illinois income tax. The trustee countered that the imposition of Illinois tax under these circumstances was unconstitutional as a violation of the due process clause and the commerce clause. The court sided with the trustee based on due process grounds (not reaching the commerce clause arguments), and recited the following requirements for a statute to sustain a due process challenge: (1) a minimum connection must exist between the state and the person, property, or transaction it seeks to tax, and (2) the income attributed to the state for tax purposes must be rationally related to values with the taxing state.
The IDR argued that significant connections with Illinois existed, maintaining that the trust owed its very existence to Illinois and listing numerous legal benefits Illinois provides to the trustees and beneficiaries. The court disagreed with the testamentary trust cases the IDR relied on, finding that an inter vivos (revocable – during life) trust’s connections with a state are more attenuated than in the case of a testamentary (after death) trust.
Further, the court found that the Texas Trust wasn’t created under Illinois law, but rather by a power granted to the trustees under the original trust instrument. The court proceeded to dismiss the trust’s historical connections to Illinois and focused on contemporaneous connections finding that “what happened historically with the trust in Illinois courts and under Illinois law has no bearing on the 2006 tax year.” For 2006, the court concluded that the trust received the benefits and protections of Texas law, not Illinois law.
Imagine if the trustees had never decanted the original Illinois trust into a Texas trust. Then Texas law would not have applied and it is likely that Illinois taxes would still have been imposed. Texas, like Florida, has no state income tax. The fact that the trustees were able to move the trust from a state that taxes trust income (Illinois) to a state that does not (Texas) resulted in significant savings for the trust beneficiaries.
This is an important lesson for those that have moved their residences to Florida but have not updated their wills and trusts to Florida law. Chances are, the former home state taxes income, and if the laws of that state are broad reaching (as many are) then taxes may be assessed.
©2015 Craig R. Hersch