United States

Taxation of Illinois resident trust found unconstitutional


For decades, Illinois has taxed non-grantor trusts created by Illinois residents either during their lives or at death. These so-called “resident trusts” were subject to tax on all income, regardless of the source of the income, unless another state taxed a portion of the income and a credit for the tax paid was available. Where the trust no longer had connections to Illinois–especially where the settlor of the trust moved to Florida, none of the trust beneficiaries resided in Illinois and the trust assets were not administered in Illinois–Illinois’ assertion of taxable nexus appeared unconstitutional. In Linn v. Department of Revenue, 2013 Il App (4th) 121055 (Dec. 18, 2013), Illinois’ expansive assertion of nexus was tested. The Illinois Appellate Court in the Fourth District ruled against the Illinois Department of Revenue in December 2013, finding that the assertion of nexus against a trust that was effectively decanted to Texas where there were no longer any connections to Illinois violated the due process clause of the U. S. Constitution.


With tax season around the corner, taxpayers should take a fresh look at trust situs, from a compliance perspective and a planning perspective. Illinois’ theory that since there was once a constitutional basis for taxing a trust, there will always be a constitutional basis for taxation, has been debunked. As demonstrated by Linn, with the right facts and circumstances, a trust can be decanted to a non-tax state, even if it was once an Illinois resident trust. Trusts that have filed Illinois returns due to the residency of the settlor should review the facts and circumstances of each open tax year to determine whether filing an amended return is warranted. Decanting Illinois trusts to non-tax or low-tax states should be considered.


In Linn, the trustees of an Illinois resident trust in 2002 decanted the trust share for one of the beneficiaries to a Texas trust by exercising the trustee’s authority under a limited power of appointment. Neither the primary beneficiary nor any of the contingent beneficiaries was domiciled in Illinois in 2002 or in 2006, the tax year at issue in the case. None of the trust assets were situated in Illinois, and the trustee was not an Illinois resident. The Illinois Department of Revenue asserted that because the settlor of the original trust was an Illinois domiciliary at the time he created the trust in 1961 and upon his death in 1986, the trust should continue to be subject to Illinois income tax. The court rejected this argument and noted that since the trust was an inter vivos trust, the fact that the settlor died an Illinois resident made the state’s argument even more attenuated.

At this point, the Illinois Department of Revenue and the Illinois Attorney General have not yet moved to appeal this decision to the Illinois Supreme Court. Since it is hard to imagine better facts for the plaintiffs, the Attorney General is no doubt wary of an adverse decision from the Illinois Supreme Court that would be binding on all Illinois courts (the Linn decision is only binding in the Fourth District). However, there are certainly tax advisors who will use the Linn decision as a basis for contending that a trust is no longer an Illinois resident trust, filing a non-resident trust return, and reporting no income. Another option for the Illinois Attorney General would be to push for a legislative solution that works around the Linn decision.

For trusts that have filed Illinois returns due to the residency of the settlor, decanting Illinois trusts to non-tax or low-tax states should be considered, and the facts and circumstances of each open tax year should be reviewed to determine whether filing an amended return or modifying a filing position is warranted.

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