Illinois Appellate Court Holds Imposition Of Income Tax On Trust With Insufficient Connections Violated Due Process

The Illinois Appellate Court has held that the imposition of Illinois income tax on an inter vivos trust1 violated the Due Process Clause of the U.S. Constitution because there were insufficient connections between the state and the trust.2 During the tax year in question, the trust did not have the necessary connections with Illinois because all of its business was conducted outside Illinois; the trustee, protector and the noncontingent beneficiary3 resided outside Illinois; and none of the trust's property was located in Illinois. The fact that the grantor was an Illinois resident was not sufficient to satisfy due process.

Background

In 1961, a trust agreement created 20 separate irrevocable inter vivos trusts.4 At the time of the agreement, A.N. Pritzker (the grantor) and Meyer Goldman (the trustee) were Illinois residents and the trust assets were deposited in Illinois. The trustee had the authority to distribute the trust corpus to the beneficiary for each of the trusts after the beneficiary reached 30 years of age. Also, the agreement provided that the trusts would be administered under Illinois law. One of the trusts was for the primary benefit of a relative of the grantor, Linda Pritzker, and was named the "Linda Trust."

The grantor died in 1986 as an Illinois resident and his estate was probated in Illinois. In 2002, three successor trustees of the Linda Trust (at least two of which were Illinois residents) distributed the assets to the trustee of a new trust, Autonomy Trust 3 ("AT3"), for the exclusive benefit of Linda Pritzker. The trustee of AT3 was a Texas resident. The original overall "protector" of AT3 and the rest of the new wave of trusts was an Illinois resident, but he was replaced by a Connecticut resident. AT3 was to be construed and regulated under Texas law, but key terms were to be interpreted under Illinois law. In 2005, a Texas probate court granted the request of AT3's trustee to strike the language referring to Illinois law so that the trust would be construed and regulated only by Texas law.5

In 2006, Linda Pritzker, her children and AT3's contingent beneficiaries were not Illinois residents. The Texas trustee of AT3 administered AT3 in Texas. AT3 had no assets in Illinois. In April 2007, AT3 filed a 2006 nonresident Illinois income and replacement tax return that reported no tax was due because there was no income from Illinois sources. The Illinois Department of Revenue reclassified AT3 as an Illinois resident, taxed all of its income and assessed a deficiency liability. After paying the tax under protest, the trustee filed a complaint arguing that imposition of Illinois income tax on AT3 violated the Commerce, Due Process and Equal Protection Clauses of the U.S. Constitution.6 The trial court granted the Department's motion for summary judgment and explained that the 1961 trust agreement provided Illinois law was to govern any subsequent trusts, which would include...