Take-Away: Yet another state court has found unconstitutional its state income taxing regime that imposes a state income tax on income accumulated in an irrevocable trust, the claimed authority to impose the tax based solely upon the residence of the trust settlor. Fielding v Commissioner of Revenue (MN July 18, 2018.)

Summary: On July 18 the Minnesota Supreme Court found that Minnesota’s law that imposed a state income tax on four separate irrevocable trusts based solely upon the settlor’s Minnesota residence was unconstitutional as a violation of the Due Process clause of both the state and federal Constitutions. This court decision sustained the same conclusion of Minnesota’s Tax Court a year earlier.

The four trusts that were taxed had little contact with Minnesota.  Key factors flagged by the Court in its decision included: (i) there was only an out-of-state trustee serving as fiduciary; (ii) 3 or 4 trust of the beneficiaries did not reside in Minnesota; and (iii) virtually no trust assets were held in, or benefited from, or conducted business under Minnesota’s laws. However, this was not a unanimous decision by the Minnesota Supreme Court.

Conclusion: As various states continue to jockey themselves to attract trust business, the issue of state income taxation of accumulated trust income has become a hot topic. More and more states are refining their state income tax laws, desperate to generate more revenue at the local level, or alternatively to promote themselves as state income tax ‘havens’ to attract dynasty trusts that often accumulate income. My guess is that in the next few years the U.S. Supreme Court will be called upon to provide a common constitutional standard that will guide states that wish to tax irrevocable trusts within their jurisdiction.