Appellate Court Limits Illinois Power To Impose 'Permanent' Tax Residency On Inter Vivos Trusts

Under the Illinois Income Tax Act ("IITA"), an Illinois resident taxpayer is taxable on 100 percent of its income and a non-resident taxpayer is taxable only on Illinois source income. Until December 2013, whether a taxpayer was a resident or a non-resident was determined based on the facts for the tax year at issue for every type of taxpayer, except trusts. That status quo ended December 18, 2013, when the Fourth District Illinois Appellate Court decided Linn v. Illinois Department of Revenue.1 In Linn, the Appellate Court engaged in a fact-intensive analysis to determine that an inter vivos trust's ties to Illinois in the tax year at issue were insufficient under the Due Process Clause of the U.S. Constitution to allow Illinois to tax the trust's income.

The Original Trust

In March 1961, A.N. Pritzker, an Illinois resident, established trusts for the benefit of various family members with Meyer Goldman, another Illinois resident, as trustee. One of these trusts (the "Linda Trust") had Linda Pritzker as its beneficiary. At the time that the Linda Trust became irrevocable, the grantor, the trustee and the beneficiary were all Illinois residents, the trust assets were deposited in Illinois, and the trust was created under and subject to Illinois law. The IITA provides that a trust is a "resident" of Illinois if the trust becomes irrevocable while the grantor is domiciled in Illinois.2 Although the statute does not expressly state so, the Illinois Department of Revenue ("Department") has interpreted that provision to mean that a trust meeting that criterion is a resident in perpetuity. A.N. Pritzker died in 1986 as an Illinois resident, and his estate was probated in Illinois.

The Sub-Trust

In 2002, the trustees of the Linda Trust entered into a trust agreement that created the Autonomy Trust 3 (the "Autonomy Trust") for the benefit of Ms. Linda Pritzker, and distributed assets from the Linda Trust to Lewis Linn, as trustee of the Autonomy Trust. The Autonomy Trust was governed by Texas law, except that specific terms - "income," "principal" and "power of appointment" - were to be interpreted under Illinois law. In February 2004, Lewis Linn filed a complaint in the probate court of Harris County, Texas, seeking reformation of the trust's application of Illinois law to some of the terms, leaving the trust to be regulated entirely by Texas law. The probate court granted the requested relief.

In 2006, Linda and the contingent beneficiaries of...