Unpacking Fielding’s Win in Fielding v. Commissioner of Revenue

Arguments from both sides and the basis for why taxing the trusts in MN was deemed unconstitutional

In Fielding v. Commissioner of Revenue, the court concluded that the contacts on which the Commissioner relied are either irrelevant or too attenuated to establish that Minnesota’s tax on the trusts’ income from all sources complies with due process requirements.

Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.

The 3 Primary Reasons the Minnesota Supreme Court Sided With Fielding

Reason 1

The grantor’s connections to Minnesota are not relevant to the relationship between the trusts’ 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.

Reason 2

The trusts did not own any physical property in Minnesota that may serve as a basis for taxation as residents. The trusts held interests in intangible property, FFI stock.

Although FFI was incorporated in Minnesota and held physical property within the state, the intangible property that generated the trusts’ income was stock in FFI and funds held in investment accounts.

These intangible assets were held outside of Minnesota, and thus, do not serve as a relevant or legally significant connection with the state of Minnesota.

Reason 3

The court did not find the contacts with Minnesota that pre-date 2014 by the grantor, the trusts, or the beneficiaries to be relevant.

The taxpayer—holder of the legal title to the stock in FFI and the other income-producing intangible assets—is the trustee, who is not a Minnesota resident. Intangible assets are appropriately taxed as being resident in the jurisdiction where the owner of legal title—the trustee—is a resident.

The court was left to consider the extremely tenuous contacts between the trusts (or their trustees) and Minnesota during the tax year 2014. The Trustees had almost no contact with Minnesota during the applicable tax year. All trust administration activities by the Trustees occurred in states other than Minnesota.

The Argument: The Commissioner vs. Fielding

The Commissioner of Minnesota

The Commissioner contended taxing the trusts’ worldwide income based on several contacts between Minnesota and the trusts was, in fact, constitutional.

The Facts

  • Specifically, the grantor, Reid MacDonald, was a Minnesota resident when the trusts were created in 2009 and MacDonald was domiciled in Minnesota when the trusts became irrevocable in 2011, and still domiciled in Minnesota in 2014.
  • The trusts were created in Minnesota, with the assistance of a Minnesota law firm, and until 2014, the Minnesota law firm retained the trust documents.
  • The trusts held stock in FFI, a Minnesota “S corporation.”
  • The trust documents indicate that questions of law arising under the trust documents are determined by Minnesota law.
  • One beneficiary, Vandever MacDonald, has been a Minnesota resident at least through the tax year at issue.

Fielding

When Fielding filed tax returns in 2014, they were filed under protest landing in the Minnesota Tax Court. Fielding wins in the tax court. Minnesota appealed to the supreme court.

The Facts

  • No trustee has been a Minnesota resident.
  • The trusts have not been administered in Minnesota.
  • The records of the trusts’ assets and income have been maintained outside of Minnesota.
  • Some of the Trusts’ income is derived from investments with no direct connection to Minnesota.
  • Three of the four trust beneficiaries reside outside of Minnesota.

Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.

The basis for the Minnesota Supreme Court ruling in favor of Fielding

  • A state can only tax entities in a tax year when they receive a benefit from a state and must have reasonable connections to the taxing state.
  • A single factor from the Minnesota Stat. § 290.01, subd. 7b(a)(2) (2016)–the grantor’s domicile at the time the four trusts became irrevocable–was deemed unconstitutional since it relied on that factor alone in defining the trusts as Minnesota Resident Trusts.
  • The court affirmed the decision of the Minnesota Tax Court because in the Fielding case the trust(s) lacked sufficient relevant contacts with Minnesota during the applicable tax year for the trusts to be permissibly taxed as Minnesota residents.
  • The court analogized the case to a hypothetical statute authorizing that any person born in Minnesota to resident parents is deemed a resident and taxable as such, no matter where they reside or earn their income. The court believed this would be undoubtedly outside of the State’s power to impose taxes.

The State lacked sufficient contacts with the trusts to support taxation of the trusts’ entire income as residents consistent with due process.

Attributing all income, regardless of source, to Minnesota for tax purposes would not bear a rational relationship with the limited benefits received by the Trusts from Minnesota during the tax year at issue.

Courts have said that a tax will satisfy due process if (1) there is a “minimum connection” between the state and the person, property, or transaction subject to the tax, and (2) the income subject to the tax is rationally related to the benefits conferred on the taxpayer by the State.

The court conclude that in the context of a due process challenge to the State’s taxation of a taxpayer as a resident, the court will examine all relevant contacts between the taxpayer and the State, including the relationship between the income attributed to the state and the benefits the taxpayer received from its connections with the state. Taxation needs to be fairly apportioned to activities within the state.

The court considered whether the trusts’ contacts with Minnesota were sufficient, under the Due Process Clause, to permit them to be taxed as Minnesota residents.

A state’s tax satisfies due process if there is:

  1. Some “minimum connection” between the state and the entity subject to the tax
  2. A “rational relationship” between the income the state seeks to tax and the protections and benefits conferred by the state. “there must be a connection to the activity itself, rather than a connection only to the actor the state seeks to tax”

MN Supreme Court Sets New Precedent for Defining Resident Trusts

Taxing trusts solely based on grantor residence is now unconstitutional in Minnesota

On July 18, 2018, the Minnesota Supreme Court ruled in Respondents v. Commissioner of Revenue that taxing trusts in perpetuity only based on the test that the grantor was a Minnesota resident while the trust became irrevocable is unconstitutional. This decision supports the ruling decided by the Minnesota Tax Court almost exactly one year ago. Moreover, this decision follows similar logic in cases heard in Pennsylvania, New York, and Illinois.

If you are not familiar with Fielding v. Commissioner of Revenue and Respondents v. Commissioner of Revenue, learn more by clicking here.

Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.

Current Definition of a Resident Trust In Minnesota

Until now, Minnesota had to look back over two decades when designating a trust as a Minnesota resident.

Two common scenarios designate a trust as a Minnesota resident.

  1. A non-grantor trust typically created by a will of a decedent domiciled in Minnesota at the time of death.
  2. An irrevocable trust in which the grantor was a Minnesota resident when the trust became irrevocable.

The Commissioner of Revenue utilized the second scenario when taxing the Fielding gains in 2014. The grantor, Reid MacDonald lived in Minnesota when the four trusts became irrevocable in 2011 as planned when the trusts were established in 2009.

Fielding’s Winning Arguments

In 2014, one of the four trustees, Fielding, sold stocks from the trust realizing substantial gains. Within the current law, the Minnesota Department of Revenue collected taxes on the gains under protest.

Fielding takes his protest to the Minnesota Tax Court. Fielding’s Reasoning For Protest

  • Three of four beneficiaries lived outside of Minnesota
  • The trust’s investment accounts were administered in California
  • None of the trustees lived in Minnesota
  • The trust records were not located in Minnesota

However, on the sole basis that the grantor lived in Minnesota when the trusts became irrevocable, Minnesota collected taxes on the gains of the trusts.

Fielding won his case in the Minnesota Tax Court.

The Minnesota Department of Revenue appealed, and the case landed in the Minnesota Supreme Court, but Fielding wins again.

How will the Minnesota Department of Revenue and the Minnesota Legislature react to losing Respondents v. Commissioner of Revenue?

While the timings of any rulings and enactment of statutes is uncertain, we may speculate on what’s to come.

We reached out to our Minnesota network for insight.

Bill Lunka, with SALT Partners, a state and local tax consulting firm in Minnesota. Mr. Lunka told us that, “It is likely that the Department would respond to the Fielding decision by proposing legislation to overcome the constitutional defects in the current law. He said that “The Minnesota Legislature could change the definition of resident trust that would look to the location of the trustees and/or beneficiaries as a basis for determining whether a trust’s income is taxable in Minnesota during any given year.”

Mr. Lunka also noted that if Minnesota goes down the path of determining a trust’s residency based on the location of the trustees he thinks many trustees will, if possible, make the decision to move the trustees outside Minnesota.

At Alliance Trust Company of Nevada, we will closely monitor how the Fielding case impacts Minnesota resident trusts as new legislation materializes. It will be advantageous for many to evaluate their “Minnesota trusts” ensuring they are in a situs allowing the greatest tax and protection benefits.

Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.

MINNESOTA SUPREME COURT TO DEFINE “RESIDENT TRUSTS”

Respondents v. Commissioner of Revenue to set precedent for trusts administered in Minnesota

Case Background

Last year (2017), the Minnesota Tax Court ruled that treating irrevocable trusts as residents in Minnesota for income taxes is unconstitutional in Fielding v. Commissioner of Revenue. The state of Minnesota appealed the ruling bringing the case to the Minnesota Supreme Court where a new ruling is expected to be decided this month (June 2018).

In 2009, Reid MacDonald established four irrevocable trusts, one for each of his children, while residing in Minnesota. The trusts were deemed to become irrevocable in 2011, at which time the grantor resided in Minnesota.

No trustees were Minnesota residents. All but one beneficiary resided outside the state of Minnesota. The trusts only held investment accounts administered in the state of California.

However, the trusts owned stocks of a Minnesota company (Faribault Foods) and sold them in 2014 to a third party placing significant proceeds in an investment account.

In 2014, the four trusts filed a Minnesota Fiduciary Income Tax Return as resident trusts. Each trust paid their tax liabilities under protest with the argument that Minnesota’s definition of resident trust was unconstitutional and therefore, each trust filed refund claims.

The U.S. Constitution states that taxes imposed by a state must have a justified and contemporaneous relationship with the benefits and protections offered by the state.

Because the trusts were administered in California, they were receiving no benefits or protections from Minnesota. Thus, the Minnesota Tax Court concluded that denying the trusts’ refunds was an error by the Commissioner. Courts in New York, Pennsylvania, and Illinois reached similar conclusions regarding cases focused on the constitutionality of taxes.

The Minnesota Department of Revenue appealed the Fielding decision, and the case is now being decided in the Minnesota Supreme Court.

Alliance Trust Company of Nevada is hosting a panel discussion on the Fielding case and its impacts on August 27, 2018, in Minneapolis, MN. Click here to learn more.

Constitutional Basis of Appeal

Two primary issues are being presented to the Minnesota Supreme Court.

  1. Are the four irrevocable trusts connected to Minnesota sufficiently enough to justify the taxation of the trusts as residents of Minnesota for the 2014 tax year while adhering to the Constitution’s Due Process Clause?
  2. Should the Constitution’s Commerce Clause disallow Minnesota from taxing the trusts as Minnesota residents for 2014?

If the Court decides in favor of Fielding, the impacts are far-reaching.

Location, Location, Location

Should the court decide in favor of Fielding, the precedent set could impact living trusts that were originally established in Minnesota and then amended as irrevocable while residing outside of Minnesota. If a trust paid income tax to Minnesota after being administered in another state while the grantor resided outside of Minnesota, the trust would be entitled to a refund.

At Alliance Trust Company of Nevada, we believe there are opportunities for decanting Minnesota trusts to domiciles with no income tax, such as Nevada, while also gaining asset protection advantages.

We are closely monitoring the Fielding case and will provide an update when a decision is reached.

Learn how the recent Nevada Supreme Court case, Klabacka v. Nelson, set a precedent for asset protection in Nevada.

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