McNeil v. Commonwealth

• Decision Date: 24 May 2013
• Citation: 67 A.3d 185
• Parties: ROBERT L. McNEIL, JR. TRUST for Nancy M. McNEIL, et al., Petitioner v. COMMONWEALTH of Pennsylvania, Respondent Levine R L JRV MCN Levine, a/k/a Robert L. McNeil, Jr. Trust for Mary Victoria McNeil, et al., Petitioners v. Commonwealth of Pennsylvania, Respondent.
• Court: Pennsylvania Commonwealth Court

67 A.3d 185

ROBERT L. McNEIL, JR. TRUST for Nancy M. McNEIL, et al., Petitioner

v.COMMONWEALTH of Pennsylvania, Respondent

Levine R L JRV MCN Levine, a/k/a Robert L. McNeil, Jr. Trust for Mary Victoria McNeil, et al., Petitioners

v.Commonwealth of Pennsylvania, Respondent.

Commonwealth Court of Pennsylvania.

Argued March 13, 2013.

Decided May 24, 2013.

Joseph Lipari and Mark E. Wilensky, New York, NY, and Stewart M. Weintraub, West Conshohocken, for petitioners.

Kevin A. Moury, Senior Deputy Attorney General, Harrisburg, for respondent.

BEFORE: PELLEGRINI, President Judge, and McGINLEY, Judge, and LEADBETTER, Judge, and COHN JUBELIRER, Judge, and SIMPSON, Judge, and LEAVITT, Judge, and BROBSON, Judge.

OPINION BY Judge COHN JUBELIRER.

In 2007, the Department of Revenue (Department) assessed Pennsylvania IncomeTax (PIT) and interest on all of the income of two inter vivos trusts, which are located in, administered in, and governed by the laws of Delaware and which had no Pennsylvania income or assets in 2007. The Department imposed the PIT because the trusts' settlor, Robert L. McNeil, Jr. (Settlor), resided in Pennsylvania when he established the trusts in 1959 and the trusts' discretionary beneficiaries are Pennsylvania residents. On appeal, the Robert L. McNeil, Jr. Trust for Nancy M. McNeil (NMM Trust) and the Levine R L JRV MCN Levine, a/k/a Robert L. McNeil, Jr. Trust for Mary Victoria McNeil (MVM Trust) (collectively, the Trusts), argue that this tax is contrary to the Department's interpretation of the Tax Reform Code of 1971 ¹ (Tax Code) and violates the Uniformity Clause of the Pennsylvania Constitution ² and/or the Commerce,³ Due Process,⁴ and Equal Protection ⁵ Clauses of the United States (U.S.) Constitution. Because we conclude that the imposition of PIT here violates the Commerce Clause of the U.S. Constitution, we reverse.

I. Factual History

The parties stipulated to the following facts. On January 2, 1959, Settlor, a Pennsylvania resident, executed the Trusts' Agreements and, by January 3, 1959, all of the Trusts' trustees had executed those Agreements. (Stipulation of Facts (Stip.) ¶¶ 14–16, 51–53.) The Trusts' Agreements provide that the Trusts are Delaware trusts that are to be governed, administered, and construed under the laws of Delaware, (Stip.¶¶ 17, 54), and named the Wilmington Trust Company (WTC), located in Wilmington, Delaware, as the sole administrative trustee; WTC was the administrative trustee in 2007 (Stip. ¶¶ 19–21, 56–57; NMM Trust Agreement at 4; MVM Trust Agreement at 4). WTC had no offices, conducted no trust affairs, and did not act as administrative trustee for the Trusts in Pennsylvania in 2007. (Stip.¶¶ 23–24, 58.) All of the Trusts' books and records are maintained in WTC's Wilmington, Delaware office. (Stip.¶ 22.) In 2007, the Trusts' three general trustees resided outside of Pennsylvania and did not conduct trust affairs or act as general trustees for the Trusts in Pennsylvania. (Stip.¶¶ 25–30, 59–60.)

None of the Trusts' assets or interests in 2007 were located in Pennsylvania, and the Trusts had no income from Pennsylvania sources. (Stip.¶¶ 31–34, 39–40, 61–65, 70–71.) All of the Trust's discretionary beneficiaries ⁶ were residents of Pennsylvaniain 2007. (Stip.¶¶ 36, 66–67.) NMM Trust made no distributions to the discretionary beneficiaries in 2007. (Stip.¶ 38.) The trustees of the MVM Trust were not required to make any distributions of income or principal during 2007, but did make a distribution of $1,400,000.00 to one of its discretionary beneficiaries. (Stip.¶¶ 68–69.)

As fiduciary of the NMM Trust, WTC reported that the NMM Trust had no taxable income from Pennsylvania sources and had a net Pennsylvania taxable income of zero. (Stip.¶¶ 41–42.) As fiduciary of the MVM Trust, WTC reported that the MVM Trust had taxable income from Pennsylvania sources in the amount of $1,349,817.00; however, no portion of that $1,349,817.00 was, in fact, derived from Pennsylvania sources. (Stip.¶¶ 72–74.) The MVM Trust reported the taxable income because the tax preparation software required it to report taxable income from Pennsylvania sources in order to report the distribution of $1,400,000.00. (Stip.¶ 75.) The MVM Trust claimed a deduction in the amount of $1,349,817.00 with respect to the distribution and reported its net Pennsylvania taxable income of zero. (Stip.¶ 76.)

II. Procedural History

On June 23, 2009 and May 21, 2010 the Department issued Notices of Assessments for the 2007 Tax Year (TY) in the amounts of $232,164.00 and $276,263.00, including underpayment, interest, and penalties against the NMM Trust and MVM Trust, respectively, based on all of the Trusts' 2007 reported income. (NMM Trust Notice of Assessment, Ex. 6; MVM Trust Notice of Assessment, Ex. 10.) The Trusts filed Petitions for Reassessment with the Board of Appeals, which denied reassessment. (NMM Board of Appeals Decision, Ex. 7; MVM Board of Appeals Decision, Ex. 11.) The Trusts then appealed to the Board of Finance and Revenue (Board), arguing that they were non-resident trusts with no taxable income, no assets, and no trustees in Pennsylvania. Rather, the Trusts argued that they were Delaware resident trusts administered in Delaware and that the imposition of PIT violates the Due Process and Commerce Clauses of the U.S. Constitution. (Board NMM Op. at 2, Ex. 8; Board MVM Op. at 2, Ex. 12.) In its appeal, the MVM Trust also relied on Department Ruling No. PIT–01–040 (Ruling 01–040), to support its argument that it was a non-resident trust and asserted that, in addition to the Due Process and Commerce Clauses of the U.S. Constitution, imposing the PIT also violated the Uniformity Clause of the Pennsylvania Constitution and the Equal Protection Clause of the U.S. Constitution. (Board MVM Op. at 2, Ex. 12.) In addition to reassessment, the Trusts requested that the Board abate the assessed penalties and interest.

The Board did not rule on the Trusts' constitutional claims and held that, pursuant to Sections 301(s) (defining resident trusts) and 302(a) (indicating that all resident trusts are subject to a tax) of the Tax Code ⁷ and the Department's regulations, the Trusts were resident trusts because Settlor was a Pennsylvania resident when he created the Trusts and, as such, are subject to PIT. (Board NMM Op. at 4–5, Ex. 8; Board MVM Op. at 5–6, Ex. 12.) With regard to Ruling 01–040, the Board noted that such rulings were not binding on the Department or the Board and that, even if Ruling 01–040 applied, it could only be relied upon for five years, a period that expired on July 27, 2006. The Board did strike the underpayment and estimated underpayment of penalties, but upheld the imposition of interest. (Board NMM Op. at 6, Ex. 8; Board MVM Op. at 6, Ex. 12.) The Trusts petitioned this Court for review, and our Court consolidated the Trusts' appeals.⁸

III. Taxing Trusts in Pennsylvania

We begin by reviewing the relevant statutory and regulatory provisions that apply to the taxation of trusts in Pennsylvania. Section 302(a) of the Tax Code provides that: “Every resident ... trust shall be subject to, and shall pay for the privilege of receiving ... income ... a tax upon each dollar of income received by that resident during that resident's taxable year ....” 72 P.S. § 7302(a). Section 301(s)(2) defines “resident trust” as including “[a]ny trust created by ... a person who at the time of such creation ... was a resident.” 72 P.S. § 7301(s)(2). The Department's regulations explain:

The single controlling factor in determining if a trust is a resident trust for purposes of this article shall be whether the decedent, the person creating the trust or the person transferring the property was a resident individual or person at the time of death, creation of the trust or the transfer of the property. The residence of the fiduciary and the beneficiaries of the trust shall be immaterial. A resident trust shall be one of the following:

(i) A trust created by the will of an individual who at the time of his death was a resident individual.

(ii) A trust created by a person who at the time of the creation was a resident.

61 Pa.Code § 101.1. Section 305 of the Tax Code,⁹ states:

The income of a beneficiary of [a] ... trust in respect of such ... trust shall consist of that part of the income or gains received by the ... trust for its taxable year ending within or with the beneficiary's taxable year which, under the governing instrument and applicable State law, is required to be distributed currently or is in fact paid or credited to said beneficiary. The income or gains of the ... trust, if any, taxable to such ... trust shall consist of the income or gains received by it which has not been distributed or credited to its beneficiaries.

72 P.S. § 7305. Section 314 of the Tax Code ¹⁰ provides, in relevant part, a credit “against the tax otherwise due under this article for the amount of any income tax ... on him ... by another state with respect to income which is also subject to tax under this article,” but such credit “shall not exceed the proportion of the tax otherwise due under this article that the amount of the taxpayer's income subject to tax by the other jurisdiction bears to his entire taxable income.” 72 P.S. § 7314. With these principles in mind, we turn to the issues presently before this Court.

IV. Trusts' Challenges to the PIT

a. Ruling 01–040

The Trusts first argue that imposing the PIT on all of the Trusts' income is arbitrary, capricious, and contrary to Ruling 01–040, in which the Department opined that a resident testamentary trust, with no Pennsylvania income or administration, may change its situs to outside Pennsylvania if it obtains an Orphan's Court order approving that change, thereby avoiding the imposition of the PIT. The Trusts assert that the Department should not treat an inter vivos trust whose situs is outside Pennsylvania pursuant to the trust instrument ¹¹ differently...