Monday, February 17, 2014
An inter vivos trust moved from the state of creation is not liable for that state’s fiduciary income tax. The settlor, a resident of Illinois, created irrevocable trusts by agreement with an individual trustee, also a resident of Illinois. The trust terms stated that the trusts were governed by Illinois law. After the settlor’s death, the successor trustees of one of the trusts exercised the power of appointment given the trustees and appointed the trust property to a new trust for the beneficiary of the original trust. The terms of the new trust stated it was governed by Texas law, the state of residence of the beneficiary, except as to certain matters governed by Illinois law. The references to Illinois law were stricken through a reformation proceeding in a Texas court.
After the reformation proceeding, the trustee filed a non-resident Illinois income tax return showing no tax due because the trust had no income from Illinois sources and neither the beneficiary nor the trustees were residents of Illinois. The state tax authorities issued a deficiency notice and the trustee paid under protest.
In Linn v. Department of Revenue, No. 4-12-1055, 2013 WL 6662888 (Ill. App. Ct. Dec. 18, 2013), the trial court held for the state finding that under the original trust agreements, Illinois law governed the trusts and that the provision was sufficient contact with the state to give a constitutional basis for taxation. The trustee appealed and the intermediate appellate court reversed, holding that imposition of the tax violated due process because the trusts have insufficient contacts with Illinois.
Special thanks to William LaPiana (Professor of Law, New York Law School) for bringing this case to my attention.