Illinois Appellate Court: It is Unconstitutional to Tax a Trust with No Current Connection to the State

estate tax, living trust, estate plan, lawyer, attorneyIn 1961, an Illinois resident established a  living trust. The trust property was located in Illinois, and the trustee – the person managing the trust – and beneficiary – the person benefiting from the trust – were also Illinois residents. Given these connections to Illinois, state law clearly governed the trust. But the trust also contained a power of appointment clause, allowing for the distribution of assets to a different trust recipient or to a different trust. Forty years later, new Illinois trustees invoked that power to create a trust for an out-of-state trustee in Texas.

The state of Illinois taxed the new trust property, even though the property is located in Texas, and the trustee and beneficiaries do not reside in Illinois. The Texas trustee sought a declaration in Illinois state court that the tax was not constitutional. The trial court sided with the state, but the appellate court reversed, holding in Linn v. Department of Revenue that it is unconstitutional to tax trust income with no current connection to the state. The state may choose to appeal that decision to the Illinois Supreme Court. In the meantime, it is important to be aware of your rights and obligations regarding trust property.

What Constitutes a “Current Connection”?

A trust is a fiduciary arrangement that allows a third party to hold assets on behalf of a beneficiary. The first thing to bear in mind is that a trust must be in writing. Typically, this is accomplished through a will, deed, or other written agreement. Another rule is that the trustor — the person creating the trust — should specify the rights and responsibilities of the trustee and the beneficiary.

In this case, the trustor specified that the trustee could distribute assets to other recipients or trusts. The trustor did not limit that right to in-state distributions, which is how property ended up in Texas. It is important to remember though, that the location of trust property by itself will not affect tax obligation, and neither will the location of the involved parties. Under Linn, trust property may be taxed, even if the property is located out of state. The same is true even if some of the parties are not Illinois residents. All that is needed is a current connection to Illinois. This could be the property or one of the involved parties.

Current does not mean historic, which is why the property involved in Linn does not count. While the property originated in Illinois, it is not there now. But if the trustee or beneficiary lived in Illinois during the tax year in question, then Illinois tax law might apply. A court will determine what constitutes a sufficient connection under Linn.

If you have a question related to Linn, our experienced Illinois trust attorneys can help. Here are a few situations in which it would be beneficial to seek advice:

  • If the involved parties and/or the trust property have moved elsewhere;
  • If new trust property and/or parties are moving to the state;
  • If you are unsure how far a power of appointment extends; or
  • If you have paid Illinois taxes on a trust that you think might not have a current connection to the state.

Contact us today to address any of these questions or any other estate planning concerns.