State Income Taxation of Trusts

Take-Away: The U.S. Supreme Court denied  today the State of Minnesota’s appeal of its state’s Supreme Court’s decision that found Minnesota’s taxation of an irrevocable trust’s accumulated income, solely based on the residence of the settlor when the trust became irrevocable, in violation of due process. That refuse to hear the appeal may have implications for a Michigan irrevocable trust.

Background: In Commissioner, Minnesota Department of Revenue, v. William Fielding, Trustee of the Reid and Ann MacDonald Irrevocable Trust for Maria MacDonald, the Minnesota Supreme Court  held that Minnesota could not tax the income of a trust solely on the basis that the trust’s settlor was a Minnesota resident. The trust’s trustee, trust beneficiaries, and the trust’s administration were not in Minnesota. Almost all of the trust’s assets were also outside Minnesota. As a result the state’s highest court found that Minnesota’s effort to tax the trust’s accumulated income, with so few connections with Minnesota, was a violation of the Due Process Clause of the U.S. Constitution.

Michigan: Michigan imposes its 4.25% income tax on a trust’s income if that trust was established by a Michigan resident at the time the trust became irrevocable. [MCL 206.18(1)(c).] The Fielding decision, and the U.S. Supreme Court’s refusal to hear an appeal by the State of Minnesota, suggest that Michigan trust taxation statute may be highly suspect on due process grounds if the sole basis for Michigan to impose its income tax is that the settlor was a Michigan resident when the trust became irrevocable.

Refund?: If that is the case and the only reason Michigan imposed its income tax was based on the settlor’s residence, then that trust should be reviewed with the possibility of filing for an income tax refund.