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Jerusalem (Platts)--26Nov2014/914 am EST/1414 GMT

Israels finance ministry has approved a proposed model for gas export tax, Finance Minister Yair Lapid said on Tuesday.

The draft was prepared by a finance ministry team of experts headed by Finance Ministry director general Yael Andorn. Lapid said in a statement that the draft proposal was approved by the ministerial committee on legislation. The proposal will now be presented to the Knesset for final approval in the coming weeks.

The proposal calls for a netback model for determining the transfer price for taxation purposes on exports. The state would determine the expected profit for each export deal and then subtract the accepted return on investment on this kind of transaction. In addition, a mechanism would be established to guarantee that the gas price in export deals is not lower than the average price in the domestic market.

In March 2011, the Knesset passed a new tax law for the oil and gas sector, which was based on the recommendations of a finance ministry appointed committee. The committee, however, left open the issue of taxation on exports.

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Trusts serve an integral role in the administration of family wealth. Relatively stable state tax systems have long provided for the collection of trust income taxes. However, taxpayers in three recent cases have successfully challenged the constitutional foundation on which the state income taxation of many trusts is based. While these are positive developments from a tax planning perspective, trustees now face difficult tax compliance and reporting issues in carrying out fiduciary obligations. Trustees, beneficiaries and their advisors should carefully consider action that could substantially reduce state income tax obligations.

Trust Income Taxation

Increasing tax rates and enhanced enforcement efforts have placed a premium on the jurisdiction where a trust is located. California now levies tax as high as 13.3 percent1 and, like most states, doesnt provide a preferential capital gains rate. Our mobile society has also resulted in trusts that have lost deep connections with any particular jurisdiction and given rise to trusts with limited contacts in multiple states. Trusts are more frequently being created in tax-free jurisdictions that cater to trust business.

A trust is the relationship among the grantor, trustee and beneficiary, and that relationship defines the arrangement governing the trust property. The trustee holds equitable title to the property.2 In contrast to a corporation that owes its legal existence to state filings, a common law trust isnt a juridical entity, and it must sue, be sued and transact business in the name of the trustee. The elusive nature of the trust arrangement creates taxation issues.

State Tax Regimes

States have created a patchwork of tax regimes. Most states assess a tax with respect to all of the income of a resident trust and that portion of the income of a nonresident trust thats sourced to the state. The definition of a resident trust isnt uniform, and various state tax regimes may result in inconsistent income tax treatment with the same property being subject to tax in multiple jurisdictions.

There are eight tax haven states that dont impose a trust income tax: Alaska, Florida, New Hampshire, Nevada, South Dakota, Texas, Washington and Wyoming. Many states are quasi-tax haven states because the tax only applies in the event a beneficiary lives in the state, like Delaware, or only applies if a resident of the state created the trust (for example, Connecticut, Pennsylvania, Illinois and New York).

Taxing states generally base a tax on one or more of the following factors: 1) location of trust administration,2) residence of the trustee, 3) residence of a beneficiary, 4) residence of the grantor, and 5) the creation of the trust under a will probated within a state.

Testamentary vs. Inter Vivos

There are two ways to create a trust. Testamentary trusts are formed under a decedents will, and inter vivos trusts are created by a revocable or irrevocable conveyance during an individuals lifetime.

The generally accepted view is that a state has a permanent connection with a testamentary trust; therefore, the testamentary trust cant change its tax situs, even if an otherwise identical inter vivos trust could do so. The rationale for this general rule isnt compelling, and two cases from the late 1990s illustrate the point.

In District of Columbia v. Chase Manhattan Bank3 and Chase Manhattan Bank v. Gavin,4 the courts upheld the income taxation of testamentary trusts on the basis of the decedents in-state residence. In each case, the court pointed out that the probate court exercised supervision over the trusts since inception, which included annual accountings, trust-related litigation and trustee succession.

That continuous activity may have been an ongoing connection for the trust in those cases, but not every testamentary trust has that kind of judicial activity in the probate court. Arguably, the ongoing role of probate courts has been exaggerated. The Gavin court cited a 1947 US Supreme Court case stating that there may be matters of trust administration which can be litigated only in the courts of the state that is the seat of the trust.5

However, this statement isnt necessarily true. Often, the will creating a testamentary trust provides for the appointment of successor trustees without court approval, and the trustees arent always required to file accountings or any other form of periodic report with the probate court. Moreover, distribution of the trust assets doesnt always require the supervision of the probate court. Accordingly, the facts of a particular case may undermine the argument that a testamentary trust is forever connected with the decedents state of domicile.

Nevertheless, the use of inter vivos trusts, including revocable trusts, is recommended, when possible, to avoid this questionable distinction in the first instance.

Recent Taxpayer-Friendly Cases

After an extended period of judicial inactivity, 2013 brought three significant cases analyzing the state income taxation of trusts. The cases involve testamentary trusts and inter vivos trusts and were decided under the due process clause and commerce clause.6

In Residuary Trust A. v. Director,7 the decedent, a domiciliary of New Jersey, died in 1998, and he created a testamentary trust. The trustee of the trust was a resident of New York, and the trust was administered outside of New Jersey.

Relying on Chase and Gavin, the New Jersey Division of Taxation maintained that the trust could be subjected to New Jersey income tax on all of its 2006 income for the sole reason that it was a testamentary trust created by a New Jersey decedent, notwithstanding the fact that the trust had limited contacts with New Jersey.

The court disagreed, finding that those cases lacked precedential value in New Jersey and directly conflicted with prior New Jersey decisions.8 As a result, the court found only the portion of the trusts income that was allocated to New Jersey could be taxed by New Jersey.

Its interesting to note that the Division of Taxation relied on guidance that it issued in 2011 as support for its argument that the trusts income from S corporations doing business in New Jersey subjected all of the trust to taxation as a resident trust. The court ignored that guidance because it was issued after the relevant tax year in this case. If the Division of Taxation were relying on guidance issued prior to 2006, it isnt clear how the court would have resolved this issue.

On commerce clause grounds, a taxpayer prevailed in a 2013 Pennsylvania case, McNeil v. Commonwealth of Pennsylvania.9 That case involved two inter vivos trusts created in 1959 by a Pennsylvania resident. Since inception, a Delaware trustee acted as administrative trustee, and the other trustees resided outside Pennsylvania. No trust administration occurred in Pennsylvania, and the trusts had no Pennsylvania assets or source income.

All of the trusts discretionary beneficiaries were Pennsylvania residents, and during the year in question, a beneficiary received a discretionary distribution from one of the trusts.

Relying on the four-part commerce clause test set forth in Complete Auto Transit, Inc. v. Brady,10 the Commonwealth Court held that application of the tax failed the first three parts of the test. The failure of just one prong of the trust would provide a taxpayer victory.

In examining the first part of the testsubstantial nexusthe court distinguished Gavin based on the trusts mandatory distributions. In comparison, the trusts in McNeil were fully discretionary. The court determined that discretionary beneficiaries didnt provide the physical presence required to establish a substantial nexus. Likewise, the settlors residency at the time of trust creation, nearly 50 years earlier, didnt establish a substantial nexus.

Because the trusts income was derived entirely from sources outside Pennsylvania, the court determined that imposition of tax on all of the trusts income was inherently arbitrary and failed the second Complete Auto test (fair apportionment).

With respect to the third commerce clause test, the court found that the tax wasnt fairly related to the services provided by the state because the trusts werent administered in Pennsylvania and didnt benefit from Pennsylvanias societal and legal framework. The court deemed the beneficiaries interest irrelevant because the beneficiaries werent guaranteed any distributions from the trusts and would pay tax on the distributions.

In Linn v. Dept of Revenue,11 the Illinois Appellate Division ruled that the due process clause limited the states power to impose a tax on an inter vivos trust, even though the trust met the statutory definition of a resident trust.

Linn involved a trust established in 1961 by AN Pritzker, an Illinois resident. In 2002, pursuant to powers vested in the trustee under the trust instrument, the trustee distributed the trust property to a new trust sitused in Texas. Although the new trust provided for administration under Texas law, certain provisions of the trust continued to be interpreted under Illinois law. The new trust was subsequently modified by a Texas court to eliminate all references to Illinois law.

By 2006, no beneficiaries resided in Illinois, no trust officeholder resided in Illinois, no trust assets were in Illinois and no trust provision referenced Illinois law. Although the trust satisfied the statutory definition of a resident trust, the trustee filed the trusts 2006 Illinois tax return as a nonresident trust.

Relying on Gavin, the Department of Revenue argued that the grantors Illinois residence was a sufficient connection to support taxation. However, the Appellate Court rejected that argument, finding that the Gavin beneficiarys residency in Connecticut was the critical link that satisfied due process in the context of an inter vivos trust.

The court also dismissed the Department of Revenues argument that Illinois provided current benefits and protections to the trustee and beneficiary. Because the trust was administered in Texas by a Texas trustee and had no contacts with Illinois, the court found that the trust received the benefits and protections of Texas law, not Illinois law.

Planning for Existing Trusts

The first step in state income tax planning for an existing trust is determining how much tax might be avoided. Trusts that pay significant state income tax on retained income are the best candidates for planning. Trusts that are required to distribute all income annually wont benefit as much from tax planning because the beneficiary, instead of the trust, is taxed on the distributable net income. However, even trusts that require the distribution of all income are usually subjected to state tax on capital gain income, the avoidance of which can provide significant tax savings.

State income tax planning generally wont benefit trusts that are taxed as grantor trusts under Internal Revenue Code Sections 671 through 678. The trustee of a grantor trust doesnt pay income tax because the grantor, who reports all tax items on his personal income tax return, is responsible for the tax.

Trust Matrix

An analysis of trust connections with taxing states can highlight the potential for tax savings and is essential to an assessment of tax reporting obligations. A matrix including the following items may behelpful: 1) identification of the trust as testamentary or inter vivos, 2) residence of each fiduciary, 3) residence of each beneficiary, 4) location of trust assets, 5) location of stock certificates and other items representingintangible property, 6) source of trust income,7) law governing the administration of the trust, and8) a summary of the tax regime in applicable states.

Some state contacts may be more important than others. Case law, generally, has upheld as constitutional tax systems based on the location of trust administration or the trustees state of residence.12 On the other hand, courts have held that certain contacts with a taxing state are insufficient to establish a nexus for taxation, for example, de minimus amounts of source income13 or modest holdings of non-income-producing in-state real estate.14 Advisors should carefully review applicable tax law regarding the required nexus for taxation.

Tax Situs Planning

The following planning techniques could improve a taxpayers no tax constitutional arguments:

bull; Fiduciary succession: Consider the residency of trust fiduciaries and the process for replacement. A fiduciary succession can minimize contacts with certain states, while increasing contacts with favorable jurisdictions.

bull; Situs: Move trust administration to a favorable tax jurisdiction. This change may involve the transfer of assets, records and trust relationships.

bull; Decanting: Decanting generally describes a distribution of trust property to another trust pursuant to a trustees discretionary authority to make distributions to or for the benefit of beneficiaries. A trust decanting may cleanse a trust of undesirable provisions and move the trust to a favorable jurisdiction. If possible, consider using the decanting laws of the new jurisdiction.

bull; Modification. A judicial or non-judicial trust modification may be used to move a trust to a favorable tax jurisdiction.

bull; Severance: A trust severance may allow a trustee to isolate the elements of a trust causing state taxation. For example, a trust may be divided into one trust with contacts with a given state and another trust without offending contacts.

bull; Governing law: Change the law governing the administration of the trust either in accordance with the terms of the trust instrument or through a judicial or non-judicial modification or a decanting of the trust.

A change to an irrevocable trust can cause unintended consequences for income tax, estate and gift tax and generation-skipping transfer tax purposes. These issues may be more significant than state income taxation. The Internal Revenue Service is currently examining the tax consequences of decanting transactions but has yet to issue any conclusions.15

Tax Filing Considerations

Residuary Trust A, McNeil and Linn provide that the tax imposed by applicable statutes is unconstitutional as applied to particular facts and circumstances. These cases dont invalidate the tax statute, but merely limit the reach of the statute in defined circumstances.

Few situations will align directly with applicable case law, so trustees who believe that a tax is unconstitutional as applied to their facts must wrestle with difficult tax reporting decisions. This struggle may be particularly troublesome for a trustee whos responsible for trust administration and may be personally liable for any tax penalty, as it could evidence a failure to properly administer the trust.

The tax return preparer, the trustee and the beneficiaries may have different views with respect to tax compliance strategies. The tax return preparer and the trustee must file a true and accurate return under penalties of perjury. The trust beneficiary, on the other hand, may favor relatively aggressive tax filing positions that minimize taxes and maximize trust property.

The trustee has several tax compliance options, including: (1) paying the tax and filing an amended return for a refund, (2) starting the statute of limitations for tax assessment by disclosing the filing position on a return that reports zero state income tax, and (3) not filing any return on the basis that the state lacks jurisdiction over the trustee. The first option may be preferable to minimize the risk of tax penalties.

A trustee may disclose a constitutional tax filing position on a state tax return thats marked as a final return. The legal significance of a final return with respect to tax filing obligations in subsequent tax years is unclear. Some trustees may elect to file a tax return every year to minimize penalties and start the statute of limitations.

The Supreme Court

The Supreme Court will soon rule on Comptroller v. Wynne16 and may ultimately determine that the commerce clause prohibits a state from taxing all the income of its residentswherever earnedby mandating a credit for taxes paid on income earned in other states. This case addresses fundamental state income tax issues of double taxation and, although not a trust income tax case, the Supreme Court ruling could either put a chill on planning or accelerate change in the evolution of trust state income taxation.


1. Cal. Rev. amp; Tax Code Sections 17041, 17043.

2. Restatement (Third) of Trusts Section 2 (2003).

3. District of Columbia v. Chase Manhattan Bank, 689 A.2d 539 (DC 1997).

4. Chase Manhattan Bank v. Gavin, 733 A.2d 782 (Conn. 1999).

5. Greenough v. Tax Assessor of Newport, 331 US 486, 495 (1947).

6. The due process clause of the Fourteenth Amendment of the US Constitution and the commerce clause of the US Constitution both limit the taxing powers of states. US Const. art. I, Section 8 and amend. XIV, Section 1.

7. Residuary Trust A v. Director, 27 NJ Tax 68 (NJ Tax Ct. 2013).

8. Pennoyer v. Taxation Div. Dir., 5 NJ Tax 386 (NJ Tax Ct. 1983); Potter v. Taxation Div. Dir., 5 NJ Tax 399 (NJ Tax Court 1983).

9. McNeil v. Commonwealth, 67 A.3d 1985 (Pa. Comm. Ct. 2013).

10. Complete Auto Transit, Inc. v. Brady, 430 US 274 (1977).

11. Linn v. Department of Revenue, 2 NE3d 1203 (2013).

12. Wisconsin Dept of Taxation v. Pabst, 15 Wis.2d 195 (1961) (finding only incidental administration in state); Pabst v. Wisconsin Dept of Taxation, 19 Wis.2d 313 (1963); Greenough, supra note 5; McCulloch v. Franchise Tax Board, 61 Cal. 2d 186 (1964).

13. Residuary Trust A, supra note 7.

14. Blue v. Dept of Treasury, 462 NW2d 762 (Mich. Ct. App. 1990).

15. Notice 2011-101, 2011-52 IRB. 932.

16. Maryland State Comptroller of the Treasury v. Wynne, 64 A.3d 453 (Md. Ct. of App. 2013).

The annual property tax hearings, generally known as truth-in-taxation meetings, give residents the chance to learn more about the plans and raise questions and concerns.

Here's a list of area upcoming truth in taxation meetings, as provided by Goodhue County.


o Goodhue County, Dec. 2, 6 pm, Government Center Board Room, 509 W. Fifth St., Red Wing


o Cannon Falls, Dec. 2, 6:30 pm, Cannon Falls City Hall, 918 River Road

oGoodhue: Dec. 10, 6:30 pm, Goodhue City Hall, 405 N. Broadway

oKenyon: Dec. 2, 7 pm, Kenyon City Hall, 709 Second St.

oLake City: Dec. 8, 6:15 pm, Lake City City Hall, 205 W. Center St.

oPine Island: Dec. 16, 7 pm, Pine Island City Hall, 250 S. Main St.

oRed Wing: Dec. 1, 7 pm, Red Wing City Hall, 315 W. Fourth St. The Red Wing City Council has a special meeting planned for after its taxation hearing to consider budget and levy resolutions.

oWanamingo: Dec. 8, 7 pm, Wanamingo City Hall Council Chambers, 401 Main St.

oZumbrota: Dec. 4, 6 pm, Zumbrota City Hall Council Chambers, 175 West Ave.

oNo meetings required in Bellechester, Dennison

School districts

oCannon Falls ISD 252: Dec. 15, 6 pm, Cannon Falls High School, 820 E. Minnesota St., Cannon Falls

oFaribault ISD 656: Dec. 15, 6:30 pm, Faribault City Hall, 208 First Ave. NW

oGoodhue ISD 253: Dec. 17, 7 pm, Goodhue School, 510 Third Ave., Goodhue

oHastings ISD 200: Dec. 10, 6:30 pm, District Office Board Room, 1000 11th St. W., Hastings

oKenyon-Wanamingo ISD 2172: Dec. 15, 6:30 pm K-W Middle-High School, 400 Sixth St., Kenyon

oLake City ISD 813: Dec. 15, 6 pm, Lincoln High School, 300 S. Garden St., Lake City

oNorthfield ISD 659: Dec. 8, 7 pm, Northfield High School, 1400 Division St. S., Northfield

oPine Island ISD 255: Dec. 4, 6 pm, Pine Island High School, 223 First Ave. SE, Pine Island

oRandolph ISD 195: Dec. 15, 7 pm, Randolph School, 29110 Davisson Ave., Randolph

oRed Wing ISD 256: Dec. 1, 6 pm, Red Wing High School, 2451 Eagle Ridge, Red Wing

oTriton ISD 2125: Dec. 15, 6:01 pm, Triton High School, 813 West Highway St., Dodge Center

oZumbrota-Mazeppa ISD 2805: Dec. 15, 6:30 pm, High School, 705 Mill St., Zumbrota