State Income Taxation of Trusts – Follow up to Kaestner Decision

I was asked yesterday after the U. S. Supreme Court’s decision in Kaestner last week how Michigan taxes a non-grantor irrevocable trust that accumulates income.

Michigan imposes an income tax on the accumulated income of a Michigan irrevocable trust if the trust is a testamentary trust that is established by a Michigan resident, or the settlor was a Michigan resident at the time the trust became irrevocable.

The Michigan Income Tax Act of 1967 [MCL 206.18(1)(c)] provides: Resident means: Any trust created by will of a decedent who at his death was domiciled in this state and any trust created by, or consisting of property of, a person domiciled in this state at the time the trust becomes irrevocable.

In Kaestner, North Carolina imposed a state income tax on the accumulated trust income solely because one of its beneficiaries was a North Carolina resident, which is far different from Michigan’s statutory basis to impose an income tax on an irrevocable trust. [If the trust had distributed its income to the North Carolina beneficiary, she would have had to include the trust income distributed to her on her personal North Carolina income tax return.]

Michigan’s approach to the taxation of an irrevocable trust is more like Minnesota’s taxation statute in Fielding v. Commissioner of Revenue, 916 N.W. 2d 323 (2018) where the Minnesota Supreme Court found that income taxation statute, based solely on the settlor’s residence,  also was in violation of Due Process Clause where the sole basis for taxing the trust’s accumulated income was the domicile of the trust’s settlor when the trust ceased to be a grantor trust. Last I heard, the State of Minnesota was planning to appeal that decision, so if the U.S. Supreme Court decides to accept that appeal, its decision in Fielding will have more relevance to the taxation of accumulation trusts in Michigan