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Delaware Nonresident Trust Seeks SCOTUS Due Process Review of Ohio Income Tax Imposed on the Trust’s Capital Gains: Was It Proper to Apply General Jurisdiction Due Process Rules to a Non-Resident Rather Than Specific Jurisdiction Rule


Salt LawAmericans from all 50 states have increasingly begun to create trusts in states such as Delaware, which has long been considered to have personal trust laws that are perhaps the most favorable in the country. Among the reasons for this is that Delaware has adopted favorable tax rules for its resident trusts. And not just the wealthiest Americans do – or could – benefit from these trusts, as one in 11 U.S. households has a net worth of at least $1 million.   A recent Ohio Supreme Court decision has the potential to significantly foreclose these benefits.

On July 13, the T. Ryan Legg Irrevocable Trust, Reliance Trust Company of Delaware, a Delaware Limited Purpose Trust, petitioned the United States Supreme Court for a writ of certiorari to review the Ohio Supreme Court’s Opinion. T. Ryan Legg Irrevocable Trust v. Testa, 2016-Ohio-8418, 2016 WL 7449356 (Ohio 2016), petition for cert. filed, (U.S. July 13, 2017) (No. 17-84). The Ohio Court held that the Trust was a nonresident of Ohio and that the capital gain from the Trust’s sale of its 32.5% stake in S corporation stock was subject to Ohio income tax. The Ohio Court rejected the Trust’s arguments that taxing this gain was prohibited by due process, holding that due process was satisfied based solely on the grantor’s contacts with Ohio.

Left unchecked, the Ohio Court’s decision will erode due process jurisprudence, particularly in the income tax context, demanding both jurisdiction to subject the taxpayer to tax (requiring the trust to purposefully avail itself of the benefits of an economic market in Ohio), and jurisdiction to tax the transaction at issue (requiring proof of a unitary business between the trust and the Ohio corporation whose stock it sold). Given the widespread use of non-resident trusts as a tax planning vehicle – a practice at odds with the revenue needs of other states – the matter is ripe for Supreme Court review.

Question Presented to the U.S. Supreme Court

Following is the question presented to the U.S. Supreme Court:

A state’s coercive power to assert jurisdiction is subject to due process. Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. 915 (2011).  A state has general jurisdiction over its residents and may broadly subject them to its coercive power. By contrast, a state has only specific jurisdiction over nonresidents and cannot impose upon them an attenuated exercise of its coercive power.

Before a state may exercise one of its most coercive powers – the power to tax – over a nonresident, due process requires specific jurisdiction: some definite link, some minimum connection, between that state and both the person [Quill Corp. v. North Dakota, 504 U.S 298 (1992)] and transaction it seeks to tax [Allied-Signal v. Dir., Div. of Taxation, 504 U.S. 768 (1992)]. Yet, the Ohio Supreme Court held that Ohio could assert jurisdiction to tax over a nonresident and on a transaction with no identified or asserted connection to Ohio. The question presented is:

Did the Ohio Supreme Court err by applying the general jurisdiction due process rules applied in Curry v. McCanless, 307 U.S. 357 (1939) instead of the specific jurisdiction due process rules applied in Quill and Allied-Signal, to uphold Ohio’s imposition of income tax against a nonresident trust taxpayer on its sale of stock in an Ohio-based company based solely on the contacts between Ohio and the trust’s grantor (a different taxpayer), absent any contacts between the trust and Ohio, and absent a unitary business relationship between the trust and an in-state entity?

U.S. Supreme Court Review of the Petition Is Appropriate*

Ohio’s tax scheme seeks to impose income tax on a nonresident trust taxpayer’s gains from selling its holdings in an Ohio pass-through company, which is not in a unitary business with the nonresident trust. Instead, the purported due process nexus with Ohio is based solely on the contacts between Ohio and a different taxpayer, the nonresident trust’s grantor, evincing the absence of contacts between Ohio and the trust itself, which possessed full title and control over the stock following the transfer to the Trust.

For well over a century, this Court has acknowledged that “[n]o principle [has been] better settled than that the power of a state, even its power of taxation, in respect to property, is limited to such as is within its jurisdiction.” New York, L.E. & W.R. Co. v. Pennsylvania, 153 U.S. 628, 646 (1894). And in the context of trust taxation, as here, this Court long ago held that a Virginia citizen’s irrevocable transfer of corporate stocks and bonds to a Maryland trust could not, consistent with due process, be taxed by Virginia. Safe Deposit Trust Co. of Baltimore v. Commonwealth of Virginia, 280 U.S. 83, 92 (1929). This Court has since had occasion to confirm and refine these due process rules in the face of ever more voracious state tax schemes. None of those cases authorize the trust income tax scheme at issue here.

In the face of the Trust’s constitutional challenge to Ohio’s tax scheme, the Ohio Supreme Court did not cite, much less distinguish, Allied-Signal. Instead, reflective of the tax scheme’s dubious legal underpinning, the Ohio Court relied upon this Court’s 5-4 opinion in Curry v. McCanless, decided in 1939, which held that both Tennessee, the decedent’s residence, and Alabama, where the trustee resided, each had the right to collect inheritance taxes on an estate probated in each state, administered by executors in each state, where the trust instrument permitted the decedent to receive income from the trust during her life, and to dispose of it at death. Thus, Tennessee could impose its inheritance tax on the Tennessee resident decedent’s equitable title in the intangibles, while Alabama could impose its inheritance tax on the Alabama trust’s legal title in the intangibles.

But Curry does not open the door for states like Ohio to tax nonresident trust taxpayers which possess the right to dispose of the trust’s assets. Rather, here, as in Safe Deposit – specific jurisdiction to tax, i.e., the nonresident taxpayer trust’s requisite minimum contacts, cannot be premised upon (or aggregated with) a different taxpayer’s contacts with the taxing state.

In relying upon Curry, and in eschewing Allied-Signal, the Ohio Court simply applied the wrong rule (improperly applying general jurisdiction rules to a nonresident, rather than the pertinent specific jurisdiction rules), rendering an opinion wholly incompatible with this Court’s controlling decisions. If left undisturbed, it will, similar to California’s tax scheme at issue in Hunt-Wesson, Inc. v. Franchise Tax Bd. of Cal., 528 U.S. 458 (2000), provide a vehicle for states to evade due process restraints on the jurisdictional reach of state laws, and particularly state tax laws.

Reasons for Granting the Writ*

The Ohio Supreme Court’s decision warrants review by this Court for three compelling reasons. First, the decision below cannot be read in accord with this Court’s controlling due process precedent as to the requirements for and application of general and specific jurisdiction. Those cases demand that for a state to assert specific jurisdiction over a nonresident person, there must be a minimum connection between the taxing state and both the taxpayer and the transaction the state seeks to tax. Yet the decision below neither identifies nor asserts any connection between Ohio and the Trust and its sale of . . . stock, instead predicating its holding on Ohio’s connections to Legg alone. This cannot be squared with Fourteenth Amendment due process requirements.

Second, the decision below is an outlier among other state courts of last resort. Other state courts have long held that connections between a grantor and the state are not enough of a connection for a state to tax the trust. In fact, Ohio’s decision appears to be the first of its kind. This Court should review whether Ohio’s reading of the Due Process Clause is correct when it is in opposition to what other state courts have held for years. Moreover, Ohio’s decision conflicts with its own precedent in a case it decided mere months before this one.

Third, this case has broad real-world significance. It is commonplace for individuals to create trusts in states like Delaware as a tax-efficient estate planning measure. The Ohio Court’s decision effectively holds that Ohio residents, and states that follow Ohio’s lead, will no longer receive Due Process Clause protection when creating out-of-state trusts. This starkly contrasts with residents of other states whose courts have correctly chosen to treat out-of-state trust taxpayers consistent with due process.

To read entire Cert Petition click this link.

The authors’ law firm represents the taxpayer. Mark A. Loyd is counsel of record.  BGD’s Appellate Co-Chair, Brent Baughman, and Bailey Roese are also counsel to the taxpayer.

* Reproduced from the taxpayer’s Petition for Certiorari.

July 31, 2017

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