Funding a Revocable Trust Triggers a Use Tax

Take-Away: We regularly encourage clients to transfer title to their assets to a revocable trust in order to exploit the probate avoidance features of such a trust. Despite that advice, we may want to tread a bit more carefully when we tell clients to ‘fund their trust’ if that transfer could trigger the payment of a use tax.

Reported Decision: Shakman, as Trustee of the Michael L. Shakman Revocable Trust v Illinois Department of Revenue, Illinois Court of Appeals, 2019 IL. App. (1^st) 182197 (filed

December 12, 2019) No. 18 L 5016

Relevant Statute: Illinois adopted an Aircraft Use Tax Law. [25 ILCS 157/10-1.] That statute imposes a 6.25% tax on the ‘privilege of using an aircraft in Illinois acquired by gift, transfer, or purchase unless certain statutory exemptions apply. This use tax is imposed on the fair market value of the aircraft.

Facts: In 2007, Michael amended and restated his revocable trust. In 2008, Michael bought a Schleicher glider aircraft. Michael paid the Illinois general use tax of $7,370 on that aircraft acquisition. In 2014, as part of his estate planning, Michael executed a Bill of Sale by which he changed legal ownership of the aircraft to himself as the trustee of his revocable trust of which he was the sole beneficiary. When title to the aircraft was transferred to Michael’s revocable trust he filed the Bill of Sale with the Federal Aviation Administration (FAA), but Michael did not pay the Illinois use tax. The Illinois Department of Treasury assessed a use tax of $7,511.01 on the Michael’s transfer of title to his aircraft to himself as the trustee of his revocable trust.

Claims: Michael claimed that the imposition of a use tax on the transfer of title to the aircraft to a revocable trust was improper and he asked for a refund. Michael also sought to have the imposition of the use tax enjoined. The Illinois Department of Treasury claimed that it applied the Aircraft Use Tax law as it is written, and that Michael’s transfer of title to the aircraft to his revocable trust did not fall within any of the 4 statutory exemptions.

Trial Court: The trial judge concluded that whenever an aircraft owner in Illinois files a Bill of Sale with the FAA the owner will incur a use tax under Illinois’ Aircraft Use Tax law, unless one of the 4 statutory exemptions applied. None of the 4 statutory exemptions applied. Consequently, the imposition of the aircraft use tax to change the legal ownership of Michael’s aircraft to his revocable trust was proper, despite Michael being taxed a second time for the use of the aircraft simply because of his routine estate planning.

Legal Issue: The appeal filed by Michael required the Court’s interpretation of the statute’s language of “the privilege of using ..any aircraft..acquired by..transfer.”

Appellate Court: The appellate court sustained the trial judge’s decision that Michael was liable to pay the Illinois use tax a second time.

Illinois has adopted a general use tax. A use tax is imposed on the privilege of using tangible personal property in Illinois “that was purchased at retail from a retailer.” Exempted from the use tax is the sale of tangible personal property sold by a nonretailer.
The Court, citing the Restatement (Second) of Trusts, Section 2 (1959), noted that the fiduciary relationship with respect to property held in trust subjects the person by whom the title to the property is held to equitable duties to deal with the property for the benefit of another person. “But while the trustee and beneficiary may hold legal and equitable title of the property respectively, neither a trustee nor a beneficiary owns property as a natural person does…Thus, the trustee’s role with respect to the trust makes his position unique from that of a natural person, whose actions are not restrained by a trust instrument.”
Michael argued that when he acquired the aircraft in 2008 he acquired the privilege of using it. When he transferred legal title to the aircraft in 2014 to himself as trustee of his revocable trust, that act did not alter Michael’s personal privilege of use that he had acquired in 2008. As such, at all times, the privilege of using the aircraft remained with Michael’s personally. The Court disagreed with Michael’s analysis.
The Court found that a person is either a natural person or a Michael individually, and Michael as trustee, are legally distinct persons under Illinois common law and the Illinois Aircraft Use Act. Thus, the Illinois legislature intended to tax as a transfer Michael’s change of ownership of his aircraft from himself to his role as trustee of his revocable trust. “In other words, Shakman both individually and as trustee of his revocable trust enjoyed the privilege to exercise a right over his aircraft incidental to ownership of that aircraft. As a natural individual, Shakman enjoyed that right unfettered, and as trustee, he enjoyed that right consistent with the language of his revocable trust. Although Shakman is ultimately the same person as a natural individual and trustee, the privileges of use are different by virtue of him being a trustee.”
Rubbing a bit more salt in Michael’s wounds was the appellate court’s observation that while it was sympathetic with his plight of paying close to $8,000 in use taxes for ‘routine estate planning’ it also observed that if Michael were to reverse course and convey title to the aircraft from his revocable trust back into his name alone, he would incur a third use tax of $8,000.

Observations:

State Law Exceptions: The Illinois Court noted in passing that some states, like Virginia and California, have expressly exempted from their use tax laws transfers of title to a revocable grantor trust. [Va. Code Ann. 58.1-1502; Cal. Rev. & Tax Code, Section 6285(b) (1) (2).]
Michigan Use Tax: Michigan imposes a 6% use tax on aircraft that is ‘purchased or transferred’ by an individual who is not a licensed dealer or retailer. There is an exemption from the Michigan use tax for the transfer of items between spouse, mother, father, brother, sister, child, stepparent, stepchild, stepbrother, stepsister, grandparent, grandchild, legal ward or legally appointed guardian with a certified letter of guardianship. I could not find in my limited search an exemption for a transfer of the item to the trustee of a revocable trust, although not-so-common transfer may be exempt from the Michigan use tax may still exist. [www.michigan.gov/taxes/]
Alter Ego Dead? Reading this decision reminds me of the recent federal court decision arising in Michigan, the Larry Winget Trust, where the federal court found Mr. Winget’s revocable living trust to be a separate legal entity from himself individually, effectively rejecting the common law notion that a settlor and his revocable living trust are alter egos of one another. In this Illinois decision, the court attached a high level of significance to the fact that as trustee of his revocable trust, Michael was bound to follow the restrictions and duties imposed on him as trustee under that written trust instrument, effectively curbing his privileges of use as trustee, in contrast to Michael’s privileges of use when he was the sole owner of the aircraft. The appellate court either was unimpressed, or found it easier to ignore, that Michael retained the right to amend or modify the terms of the trust, thus making the differentiating restrictions and fiduciary duties imposed on him as the trustee of the revocable trust, illusory.