U.S. Supreme Court Looking at Two Cases Relating to State Taxation of Trusts

Minnesota and North Carolina appeal to the Supreme Court in Trust Taxation Cases

The United States Supreme Court will review two petitions for a writ of certiorari from the states of North Carolina and Minnesota. Both states lost cases in their respective State Supreme Courts where the state laws were deemed in violation of the United States Constitution under Due Process Clause. Both states have appealed to the U.S. Supreme court for review.

A Breakdown of the Original Cases

Case 1: North Carolina

The Case: North Carolina Department of Revenue, Petitioner v. The Kimberly Rice Kaestner 1992 Family Trust Current North Carolina Practice: North Carolina taxes trusts based on beneficiary residency. The Original Conclusion: “The North Carolina Supreme Court concluded that a trust and its beneficiaries are legally separate – in other words, that beneficiaries are outsiders to a trust. On that basis, that majority (of the NC Supreme Court) expressly disregarded the trust beneficiaries’ in-state residency and other contacts with North Carolina. That analysis led the majority to conclude that the trust at issue lacked a constitutionally sufficient connection with the state.”

Click here to view the case filings.

Case 2: Minnesota

The Case: Cynthia Bauerly, Commissioner, Minnesota Department of Revenue, Petitioner v. William Fielding, Trustee of the Reid and Ann MacDonald Irrevocable GST Trust for Maria V. Macdonald, et al. Current Minnesota Practice: Minnesota taxes trusts based on the residency of the grantor when the trust becomes irrevocable. The Original Conclusion: “The grantor’s connections to Minnesota are not relevant to the relationship between the trust’s income that Minnesota seeks to tax and the protection and benefits Minnesota provided to the trusts’ activities that generated that income. The relevant connections are Minnesota’s connection to the trustee, not the connection to the grantor who established the trust years earlier. A trust is its own legal entity, with a legal existence that is separate from the grantor or the beneficiary. Nor did the court find the grantor’s decision to use a Minnesota law firm to draft the trust documents to be relevant. Thus, the grantor Reid MacDonald is not the taxpayer, the trusts are.”

Click here to view the case filings.

What Are the States Asking For?

Both states believe they have the right to tax the trusts under due process clause, given legal abstractions of trusts. The Minnesota Supreme Court concluded that the trust is separate from the Grantor, but the connections between Grantor and the state of Minnesota were not sufficient to tax the trust. Similarly, the North Carolina Supreme Court ruled that a beneficiary and a trust are legally separate and the connection between the beneficiary and the state of North Carolina are not enough to tax the trust.

The question presented by the State of Minnesota: Does the Due Process Clause prohibit states from imposing income taxes on statutory “resident trusts” which have significant additional contacts with the state, but are administered by an out-of-state trustee? The question presented by the State of North Carolina: Does the Due Process Clause prohibit states from taxing trusts based on trust beneficiaries’ in-state residency?

A Constitutional Reminder: The Due Process Clause of the Fourteenth Amendment provides that [n]o state shall…deprive any person of life, liberty, or property, without due process of law.” U.S. Const. Amend. XIV § 1.)

What Lower Courts Had to Say in Regard to Their Decisions

From Minnesota Writ: “This Court has not spoken on the issue in decades, and its precedents point in opposite directions. As a consequence, state appellate courts are deeply divided on the correct answer. Some state appellate courts have held that a state may impose an income tax on a trust even when the trustee resides out-of-state, so long as the grantor resided in-state when the trust became irrevocable. Other courts have required, on top of grantor residence, that the trust have some additional contacts with the state during the tax year. One other state high court has held that a state may tax a trust as a resident if a beneficiary of the trust resided in the state during the tax year.”

From North Carolina Writ:

“This case asks whether the Due Process Clause prohibits states from taxing trusts based on trust beneficiaries’ in-state residency—a question on which nine state courts have split. Because of the Tax Injunction Act, this federal constitutional question is usually litigated in state courts. State courts are divided in their answers to this question, however, because they lack modern guidance from this Court.”

“With that decision, North Carolina joined the ranks of eight other states that have reached conflicting decisions on the question presented here. Five states have concluded that the Due Process Clause forbids states from taxing trusts based on trust beneficiaries’ in-state residency. Four states have concluded the opposite.”

The United States Supreme Court has not ruled on trust taxation since 1947 (Greenough v. Newport 331 U.S. 486 (1947)) and states say that since state courts are split regarding their rulings of trust taxation that a review by the Supreme Court is needed.

Where Concluding States Land

Four state courts have concluded that the Due Process Clause allows states to tax trusts based on trust beneficiaries’ in-state residency:

  • California in McCulloch v. Franchise Tax Board, 390 P.2d 412 (Cal. 1964)
  • Missouri in Westfall v. Director of Revenue, 812 S.W.2d 513 (Mo. 1991)
  • Connecticut in Chase Manhattan Bank v. Gavin, 733 A.2d 782, 802 (Conn. 1999)
  • Illinois in Linn v. Department of Revenue, 2 N.E. 3d 1203, 1209 (Ill. App. Ct. 2013) – but note that Linn ultimately held that the state could not tax a trust merely because the trust’s settlor had been an Illinois resident.

 

Five states ruled against taxation of trusts:

  • New York in Mercantile-Safe Deposit & Trust Co. v. Murphy, 203 N.E.2d 490, 491 (N.Y. 1964)
  • New Jersey in Potter v. Taxation Division Director, 5 N.J. Tax 399, 405 (N.J. Tax Ct. 1983)
  • Michigan in Blue v. Department of Treasury, 462 N.W.2d 762, 764 (Mich. Ct. App. 1990)
  • North Carolina in this current case: North Carolina Department of Revenue, Petitioner v. The Kimberly Rice Kaestner 1992 Family Trust
  • Minnesota in this current case: Cynthia Bauerly, Commissioner, Minnesota Department of Revenue, Petitioner v. William Fielding, Trustee of the Reid and Ann MacDonald Irrevocable GST Trust for Maria V. Macdonald, et al. Note that Minnesota rejected both the residency of Grantor and Beneficiary.)

What is the Impact of the Recent Wayfair Case?

In South Dakota v. Wayfair the United States Supreme Court ruled that states may impose sales tax even if the seller does not have a physical presence in the state.

This case could have an impact on future Supreme Court decisions regarding taxation. Although South Dakota’s decision is not an exact template for other states, it could influence how they craft their laws.

Timing

In the North Carolina case, the writ was filed on October 9th, 2018. The taxpayer filed their brief in opposition on November 30th.

The Minnesota case writ was filed on November 15th and docketed on November 21st. The taxpayers have until December 21st to file their response.

Will the Supreme Court Take Both Cases, or One?

Some Potential Outcomes: Ruling for the states – A ruling for the states would have a significant negative impact on out-of-state trust planning and could potentially send grantors to offshore jurisdictions.

Ruling for taxpayers – This will have a significant impact on the 22 states that still impose taxes on trusts and could potentially be a clear law-of-the-land in which all states would need to amend their tax code to comply.

Both cases declined – This is an implicit win for the taxpayers, and would lead to further haggling at the state level, both in courts as well as legislation.

Because Minnesota’s Fielding case includes both grantor and beneficiary issues, the Supreme Court hearing this case would set more comprehensive precedents regarding the taxation of trusts. With the North Carolina Kaestner case, the only issue at hand is the beneficiary’s residence.

There are still a lot of questions and unknowns about the impact of the court’s decisions and a lot of speculation. Either way, there are sure to be some interesting changes ahead.

Who said trust laws had to be boring?

Understanding Nevada Asset Protection Trusts

Why Nevada’s Asset Protection Trust Laws Keep Your Wealth Safer Than Any Other State

The state of Nevada has dominated the asset protection space and positioned itself as the most beneficial situs to establish an asset protection trust.

Precedent-setting cases and favorable trust laws have launched Nevada to the forefront of the estate planning industry and allowing trustees and estate planners flexibility, privacy, and the power to protect wealth and assets more securely than any other state.

The Benefits of Nevada Law

Nevada’s trust advantages continue to grow and have edged out other states with similar trust provisions. Here are some of the ways that Nevada takes asset protection measures further.

Nevada’s advantages include:

Nevada carries no state or corporate income tax.

Federal taxes take a significant chunk out of trusts and returns made on assets so establishing a trust in a state with no income tax can help preserve a large portion of wealth.

Nevada carries no state or corporate income tax, protecting your wealth from additional taxes and allowing it more unhindered growth.

Nevada carries a 24-month statute of limitations or “seasoning period.”

Every state carries a different statute of limitations ranging from 1.5 years to 5 years. While Nevada carries a two-year statute, the language in the Nevada code reinforces that trusts are actually still protected during the two-year seasoning period.

Zero exception creditors, including divorcing spouses.

In the recent case of Klabacka vs. Nelson, Nevada sets a new precedent that its asset protection laws are the most robust in the nation.

In a similar case in Delaware, the courts sided with the divorcing spouse, weakening the state’s asset protection laws.

The grantor is able to name an independent financial advisor to manage trust funds.

Anyone can take advantage of Nevada’s favorable trust laws as grantors can name a Nevada resident or a Nevada trust company as trustee or co-trustee, this includes international families and businesses as well as domestic families.

Nevada Asset Protection Trusts are irrevocable but flexible.

In Nevada, the trust settlor is allowed to make decisions regarding powers related to managing the Nevada Domestic Asset Protection Trust (NDAPT). Though the term irrevocable sounds final, in Nevada, there is actually a great deal of flexibility in these trusts.

What is a Nevada Asset Protection Trust?

Simply put, an asset protection trust limits creditor access to the value of the beneficiary’s interest in the trust. The asset protection trust protects the value of the assets and legally protects them from lawsuits and other claims.

Nevada Asset Protection Trusts have proven their strength, holding up in court most recently in the case of Klabacka v Nelson, 133 Nev. Adv. Op. (May25, 2017): Nevada DAPT Protects Against Spousal/Child Support Claims. In this case, a divorcing spouse sought access to her ex-husbands self-settled spendthrift trust and the courts sided with the trust. All alimony, child support, and other claims on the trust had to be taken from liquid assets outside of the trust.

The decision in the Klabacka case reaffirmed Nevada’s asset protection strength as other states are scrambling to keep up. While other states may defer to Nevada’s ruling in the Klabacka case, that is far from a guarantee.

Nevada Residency is not required.

If your trust is established in Nevada you may live anywhere in the world and take advantage of Nevada’s many trust benefits. Nevada also fully protects personal privacy.

Alliance Trust Company of Nevada helps people take full advantage of Nevada’s trust laws and may serve as independent trustee if the grantor is out of state. We’re available to answer any questions regarding Nevada Asset Protection.

Using NING Trusts to Significantly Reduce State Income Tax Liabilities

Why Wealthy Families are Choosing to Shift Their Wealth to the Tax Favored State of Nevada

The state of Nevada is considered a tax-favored environment, allowing maximum tax protection over trusts and estates. That’s just one of the reasons why more and more people are choosing Nevada as to establish their trusts.

The “NING” trust or Nevada Incomplete-gift Non-Grantor trust reduces state income tax liabilities and simultaneously provides asset protection benefits.

For people with substantial income, assets or large capital gains who could generate significant Federal and state income tax shifting a trust from its current state to a state with more favorable tax laws, such as Nevada, could create significant income tax savings.

While moving to Nevada would allow someone to take advantage of these benefits, relocating family is often not an option. However, by establishing a NING and transferring assets from the existing trust into the NING, the trust will only face Federal capital gains taxes.

Non-Grantor vs. Grantor Trusts

Trusts are set up as either grantor or non-grantor, and it’s important to understand the difference.

Grantor trusts expose the creator of the trust to the taxes incurred by the trust. Non-grantor trusts are set up as their own entities incurring all taxes at the trust level instead of passing them on to the owner of the trust.

Things get murky because every state has its own taxation rules and definitions about which trusts should be considered a resident.

For example, to take advantage of a NING or Nevada’s favorable tax laws in general, a non-grantor trust with a Nevada trustee should be established. By establishing a non-grantor trust in Nevada and appointing a Nevada trustee you can be sure that you’ll minimize or completely eliminate taxes from your state of residence.

A New Aggressive Strategy for Substantial Gains

If a substantial gain is on the horizon, wealthy families can take advantage of ING trusts to adopt a more aggressive tax strategy. ING’s help reduce state income tax at the trust level by establishing it one or more years before a large gain becomes available.

One word of caution, there are specific steps you should follow to ensure that your strategy is not viewed as tax evasion, it’s always best to employ professional guidance to understand how to establish your ING ethically.

Structuring a NING for Maximum Benefit

Since the purpose of establishing a NING trust is to avoid additional taxing, it’s important to properly structure the trust to avoid gift tax. Proper structuring also ensures that the trust really is taxed in Nevada instead of the settlor’s home state.

Remember that NING stands for Nevada Incomplete-Gift Non-Grantor Trust, so when assets are transferred to the trust, it must be in the form of an “incomplete gift.”

Transferring assets as an “incomplete gift” allows the owner of the trust to include your investments in your estate without needing to file a Form 709 gift tax return.

NING Trusts vs. DING Trusts

The DING Trust did come before the NING trust, so one may wonder which is the better situs for a trust, Nevada or Delaware?

While both states allow settlors to appoint a grantor for their trust and take advantage of favorable tax laws, several Delaware rulings have allowed divorcing spouses and creditors to gain access to an asset protection trust. Nevada has never allowed such access in rulings and therefore has more iron clad protection than any other state.

How the Other States Feel About ING Trusts

It’s no surprise that other states aren’t happy about non-grantor trusts and their tax-avoidance benefits, some have even gone as far as banning such trusts.

While both Delaware and Nevada have successfully deflected attempts by other states to tax grantors, that likely won’t stop states from attempting to gain access whenever they can.

However, several statutes in the state of Nevada prove that the state values and protects trusts and estates which are established there and is the safest bet when choosing where to create an ING trust.

To learn more about establishing a NING, please contact Alliance Trust Company.

4 Reasons to Consider Establishing a Nevada Dynasty Trust

Unprecedented Protection for Generations

Choosing the right trust strategy to protect your assets is an important and often complex decision. Dynasty trusts are a great option when you need to hold assets for generations, and they minimize or even eliminate many taxes associated with trusts including distribution, estate, inheritance, transfer and more.

Once you’ve decided that a Dynasty Trust is right for you, the next most important decision is where you should establish your trust. Both Nevada and Delaware are considered some of the best places to establish a trust to take full advantage of friendly trust laws, because of precedents set in both Nevada and Delaware, Nevada is often considered the better choice.

If you’re feeling unsure about establishing a Nevada Dynasty Trust, here are five reasons why it’s the best choice to care for your family for generations to come.

Nevada Dynasty Trusts: 4 Things that Set Them Apart

1. Unique Precedents Set in Nevada

Currently, Nevada has the most current and robust precedents set to protect assets while still protecting those affected by life events such as divorce, especially in the case of a Nevada Dynasty Trust with the potential to last up to 365 years.

Currently, Nevada has the most current and robust precedents set to protect assets while still protecting those affected by life events such as divorce, especially in the case of a Nevada Dynasty Trust with the potential to last up to 365 years.

2. Minimize Taxes

With a Nevada Dynasty Trust, your assets will only be taxed at the estate level once with the federal gift/estate tax or lifetime exemption upon transfer into the trust.  The Nevada Dynasty Trust allows you to allocate a generation-skipping-transfer tax exemption which is a powerful way to limit estate tax liabilities, sometimes even eliminating them altogether.

Due to the nature of the Nevada Dynasty Trust, these tax benefits are provided for an extended period of time.

3. Short “Seasoning Period”

Nevada’s seasoning period is one of the shortest in the United States. The statute of limitations during this vesting period is just two years on asset transfers to self-settled spendthrift trusts (domestic asset protection trusts).

During the seasoning period, your assets are not under the full protection of the dynasty trust. For this reason, a short seasoning period is essential to ensure the security of your assets as quickly as possible.

However, the burden of proof that creditors would have to provide to gain access to your trust during the seasoning period is quite challenging in the state of Nevada – another benefit to those looking to establish a trust in the state.

4. Flexible Decanting Statute

Trust decanting is a term taken from wine decanting in which wine is transferred from one container to another, leaving the undesirable sediment behind. With trust decanting, the terms of the trust are changeable after it has been established.

Trust decanting allows trustees to keep aspects of the trust that are still beneficial while leaving old trust provisions which are no longer wanted, needed, or relevant behind.

Nevada allows for trust decanting without the need for court approval, which can be expensive, or notice to the beneficiaries.

Advantageous Trust Laws at Your Fingertips

An important consideration as you prepare to set up your Nevada Dynasty Trust is the use of an independent corporate trustee. Because Dynasty trusts can last hundreds of years, it’s advisable to put an independent corporate trustee in place to avoid needing to transfer trustees due to death or unforeseen circumstances.

Alliance Trust Company of Nevada is a trusted and qualified institution and is available to serve as trustee, directed trustee, or many other capacities if you choose to establish your trust in the state of Nevada.

 

Fielding Luncheon Panel Discussion Summary

Experts in MN taxation, MN trust and estate law, and trust migration and decanting discuss possible outcomes from the fielding decision

On August 27, 2018, Alliance Trust Company of Nevada hosted a panel discussion at Seven Steakhouse in downtown Minneapolis. Attendees included Minnesota tax and trust law professionals from prominent firms throughout the state of Minnesota.

The Panel

Jouko Sipila, the Minnesota representative for Alliance Trust Company of Nevada, put together an outstanding panel to discuss possible impacts from the Fielding decision including one of the Faegre Baker Daniels attorneys that represented Fielding, an expert in MN taxation that assisted in drafting the law at issue, and an expert in trust migration and trust decanting.

Caitlin Abram, Partner at Faegre Baker Daniels

Caitlin was an integral part of the Fielding legal team. Caitlin carries vast experience in complex trust and estate transactional and litigation matters.

Caitlin started the conversation by explaining the background on the Fielding Case.

Click here to learn more about the Minnesota Supreme Court case, Fielding v. Commissioner.

Case insights from Caitlin

  • The Fielding decision will likely impact the wealth management industry in Minnesota.
  • Loss of fee income could lead to loss of tax revenue in the state, so a solution is in Minnesota’s best interest.
  • If you’re considering following in Fielding’s footsteps here are some things you need to consider:
    • Is there enough money at stake to make it worth filing claims for refund?
    • What are the connections to Minnesota among the trust’s stakeholders?
    • How do your facts differ from the Fielding case?
  • In the Fielding case, the taxpayer did not receive enough benefit from the state to justify taxation.

Bill Lunka, Director at SALT Partners

Bill is an esteemed Minnesota taxation expert bringing four decades of state and local tax experience (including 29 years with the MN Dep. of Revenue) to the discussion.

Bill discussed his views on how the Minnesota Revenue and Legislature might react to the Fielding decision. He noted that the uncertain political landscape in the state makes it challenging to predict how the law might be changed.

Case insights from Bill

  • Trusts holding real property in Minnesota will likely be subject to taxation because they receive protection benefits form the state.
  • In light of the Fielding decision, the Minnesota government has four options:
    • Do nothing.
    • Go back to the pre-1995 law.
    • See what other states are doing with the definition of a resident trust to resolve the defects identified by the Minnesota Supreme Court in the definition of a “resident trust.” Those problems include:

      • The Court found that using the residence of the grantor as the basis for the determination of the residency of the trust, a separate legal entity, was invalid.
      • Determining the residency of a trust in later tax years based on an event in a prior tax year (i.e., when the trust became irrevocable) was not valid under the Due Process Clause.
      • Making sure the state taxes appropriately according to income earned and benefits enjoyed.
    • Relitigating similar cases to Fielding would be an ineffective strategy for the Department of Revenue.

The most likely option for Minnesota is to see what other states are doing. A possible definition of a resident trust that Minnesota could follow is California’s definition of a resident trust.

Click here for more details about the California definition.

  • Existing Minnesota trusts could benefit from filing their taxes under protest as was done in the Fielding case.
  • Ultimately, practitioners need to have their clients plan and do so conservatively.

Greg Crawford, President of Alliance Trust Company of Nevada

Greg Crawford is an expert in both Nevada and California trust laws, trust migration, as well as trust decanting. Nevada is one of the fastest growing trust jurisdictions because of industry-leading tax benefits and asset protection laws. Learn more about Nevada’s favorable tax laws here.

Case insights from Greg

  • Greg explained the California Model and the implications a similar model could have on the taxation of Minnesota trusts.
  • The state of Nevada has worked hard to make its trust laws flexible to handle different situations including dynasty trusts, directed trusts, and more.
  • Trust structures need time, and there needs to be additional motives, such as a more comprehensive review of the estate plan or asset protection.
    • Decisions motivated by taxation will catch the eye of the tax authorities.

Final Thoughts

Cases such as Fielding v. Commissioner often make grantors and trustees reevaluate their trust protections. Decanting your trust may be the best option to ensure its operating in the most beneficial way possible.

Greg Crawford, President of Alliance Trust Company, is a trust migration and decanting expert located in Nevada. With some of the most favorable tax and protection laws in the world, Nevada is a highly advantageous situs to administer your trust.

Greg and his team are ready to help you ensure your assets are protected in every possible way.

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