State Tax Snapshot: Another Win for Taxpayers on Nexus for Inter Vivos Trusts

Illinois could not constitutionally tax the income of an inter vivos trust originally formed under Illinois law, but later removed to Texas, because all of the trust's business and property were outside of the state, and its trustee, protector and noncontingent beneficiary resided outside of the state, the Illinois Appellate Court recently ruled in an unpublished decision (Linn. v. Ill. Dept. of Rev., No. 4-12-1055 (Dec. 18, 2013)).

The department argued that the inter vivostrust owed its existence to an Illinois grantor, and that Illinois law provides benefits to the trust's trustee and beneficiary. But the taxpayer countered that the trust was subsequently modified so that it was governed and administered under the laws of Texas, and the trustee, beneficiary and protector of the trust were not Illinois residents.

Critical to the decision was that the case involved an inter vivos trust. “Since an inter vivos trust is not created by the probate of the decedent's will in a state court, its connection with the state has been described as more attenuated than a testamentary trust,” the court said.

 “Moreover,” the court said, “an irrevocable inter vivos trust does not owe its existence to the laws and courts of the state of the grantor in the same way a testamentary trust does and thus does not have the same permanent tie.”

The Illinois ruling follows a Pennsylvania case last year in McNeil Trust v. Commonwealth, 67 A.3d 185, 2013 BL 139336 (Pa. Commw. Ct. 2013) in which the Commonwealth Court of Pennsylvania found that the imposition of Pennsylvania's personal income tax on two inter vivos trusts that were located in, administered in, and governed by the laws of Delaware violated the commerce clause.

In August 2013, Bloomberg BNA published a special report that highlighted the findings of a survey of state tax officials on the issue of trust nexus.

Continue the discussion on the Bloomberg BNA LinkedIn Group. Under what conditions do you believe a trust should be subject to a state’s income tax?

By Steven Roll

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