April 15, 2014
Link to [insert court] Opinion
The Supreme Court of
Missouri recently ruled that income from a “rabbi trust” used to finance a
corporation’s deferred compensation plan for executives is business income
subject to taxation and apportionment.[i] In 2007, MINACT, INC., a Mississippi
corporation that does business in multiple states, including Missouri,[ii]
claimed $667,773 as non-business income on its tax return, thereby exempting
that income from state taxation.[iii] However, when the Missouri Director of
Revenue refused to allow this claim, MINACT appealed to the Administrative
Hearing Commission. On appeal the Commission held that the income was not
business income as it failed to satisfy the transactional or functional tests
employed by Missouri courts in finding the existence of business income for
state taxation purposes.[iv] Subsequently, the Director of Revenue appealed
the Administrative Hearing Commission’s decision.[v] Ultimately, the Missouri Supreme Court ruled
in favor of the Director of Revenue, finding the income met the functional test
because it is used to attract and retain important employees.[vi] Thus, the Administrative Hearing
Commission’s decision was overturned and the case remanded.[vii]
I.
Facts and Holding
MINACT, INC. (MINACT) offers training and support programs to
government workers and agencies in multiple states, including Missouri.[i] In 1988, MINACT began a deferred compensation
plan allowing managers and executives to defer part of their earnings, with
MINACT providing “matching contributions” at their discretion of up to 3% of
the employee’s yearly income.[ii] The purpose of establishing this plan was to
attract and retain high quality corporate leaders.[iii]
Under 26
U.S.C. § 409, the plan is allowable as a
“non-qualified federal deferred compensation arrangement.”[iv] In this type of arrangement, the income from
the investments comprising the plan are considered part of MINACT’s federal
taxable income and the corporation’s contributions to the plan are not
deductible.[v] However, starting in 1994 MINACT established
a “rabbi trust” to fund the plan.[vi]
In its 2007 state income tax filing, MINACT, INC. reported
$667,773 as “non-business income, $455,395 of which was income from the rabbi
trust.”[vii] Non-business income is not subject to
apportionment and taxation in the various states where a corporation does
business – it is attributed to and subject to taxation in the corporation’s
home state only.[viii] However,
the Missouri Director of Revenue objected and “disallowed MINACT’s claim of
non-business income.”[ix]
Subsequently, MINACT filed a written protest, conceding only that
it should have allocated $212,378 as business income (subject to taxation),
while maintaining that, “all of the trust income was non-business income not
subject to apportionment and taxation.”[x]
On review, the Director found “the trust income was business income subject to
apportionment and taxation in Missouri.”[xi]
MINACT appealed the Director’s decision to the Administrative
Hearing Commission (AHC).[xii]
“The AHC determined that the trust income was non-business income because it
was “not attributable to the acquisition, management, and disposition of
property constituting an integral part of MINAT’s regular business,” as
required by section 32.200.”[xiii] The Director of Revenue sought judicial
review. Thus, the question of whether
the trust income is business income subject to apportionment and taxation in
Missouri reached the Missouri Supreme Court.[xiv]
The question decided was whether the trust’s earnings are subject
to state taxation and apportionment.[xv] The Missouri Supreme Court reversed the AHC’s
decision, holding that income from the “rabbi trust” was “business income.”[xvi] Therefore, MINACT has a duty to apportion
that income accordingly and it is subject to taxation in Missouri. Then, the case was remanded for a
determination of the amount owed.[xvii]
II.
Legal Background
“To qualify as a rabbi
trust, the employer must be the grantor of the trust and must report the
trust’s earnings as income on the employer’s federal income tax return.”[xviii] The issue in this case was whether the
trust’s earnings are also subject to state taxation and apportionment in Missouri.[xix]
Thus, the key legal question was whether
or not the trust’s earning satisfied either of the Missouri tests for
establishing business income.
Under Missouri law, there are “two tests to determine whether
income is business or non-business.”[xx]
First, the “transactional test” is met
when the income earned is the result of a type of business transaction the
taxpayer participates in regularly.[xxi] Second, the “functional test” is met when the
income earned is “attributable to an activity – namely the acquisition,
management, and disposition of property – that constitutes an integral part of
the taxpayer’s regular business.”[xxii] Here, the Missouri Supreme Court found that
the transactional test was not met because “MINACT’s business is the management
of Job Corps Centers pursuant to its contract with the federal government, not
investing in and administering the trust.”[xxiii]
However, the court found that the functional test was met as “MINACT
admitted that it established the Plan and funds the rabbi trust in order to
attract and retain key employees.”[xxiv] Because this is a judicially recognized
“important business purpose,” the court concluded that the income derived from
the rabbi trust does qualify as business income.[xxv]
During the course of litigation, MINACT had raised two points
arguing against the conclusion reached by the Missouri Supreme Court: (1) “the
due process and commerce clauses of the U.S. Constitution prohibit Missouri
from taxing the trust’s income because the trust is located in Mississippi;”
and (2) “the trust income cannot satisfy the functional test for business
income because it has no authority to control or manage the trust because the
trust is administered by a third party trustee.”[xxvi]
Per the court’s reasoning, MINACT’s first point failed because
MINACT established the fund to attract and retain talent to “sustain its
current business operation.”[xxvii]
Further, the court reasoned that, “If . . . one state can tax all business
profits derived in another state, constitutional limits on interstate business
taxation are rendered largely illusory.”[xxviii]
MINACT’s second point was also unsuccessful because none of the
case law MINACT cited was binding precedent and the trust was clearly
established to further a business purpose, not an altruistic or non-business
one.[xxix]
III.
Comment
This was a concise opinion with sound reasoning. All judges concurred in the holding.
However, the question of the decision’s impact on MINACT, INC. and
similarly situated corporations in other states remains. If the income derived
from the rabbi trust is subject to apportionment and taxation in Missouri, it
follows that the Directors of Revenue in other states could also challenge
MINACT’s tax filings, if they have not already done so.
- Liz Lafoe
[i] Minact, Inc., About Minact, http://www.minact.com/aboutUs.htm.
[ii]
Id.
[iii] Id.
[iv] Id; 26 U.S.C. § 409(A) (West)
[v] Id.
[vi] No. SC93162 (Mo. Apr. 15, 2014)
available at http://www.courts.mo.gov/file.jsp?id=72256. The West
reporter citation is MINACT, INC. v. Dir. of Revenue, ___ S.W.3d ___ (Mo.
2014).
[vii] Id.
[viii] Id.
[ix] Id.
[x] Id.
[xi] Id.
[xii] Id.
[xiii] Id.
[xiv] Id.
[xv] Id.
[xvi] Id.
[xvii] Id.
[xviii] Id.
[xix] Id.
[xx] Id at 5.
[xxi] Id.
[xxii] Id (citing ABB C-E Nuclear Power
Inc. v. Director of Revenue, 215 S.W.3d 85, 87 (Mo. 2007)).
[xxiii] Id.
[xxiv] Id.
[xxv] Id. at 5 (citing Hoechst
Celanese Corp. v. Franchise Tax Board, 25 Cal. 4th 508 (2001); Estate of True
v. C.I.R., 2001 WL 761280 (U.S. Tax Ct. 2001)).
[xxvi] Id.
[xxvii] Id.
[xxviii] Id.
[xxix] Id.
[v] Id.
[vi] Id at 2.
[vii] Id at 4.
[viii] Minact, Inc., About Minact, http://www.minact.com/aboutUs.htm.
[ix]
Id.
[x] Id.
[xi] Id; 26 U.S.C. § 409(A) (West)
[xii] Id.
[xiii] No. SC93162 (Mo. Apr. 15, 2014)
available at http://www.courts.mo.gov/file.jsp?id=72256. The West
reporter citation is MINACT, INC. v. Dir. of Revenue, ___ S.W.3d ___ (Mo.
2014).
[xiv] Id.
[xv] Id.
[xvi] Id.
[xvii] Id.
[xviii] Id.
[xix] Id.
[xx] Id.
[xxi] Id.
[xxii] Id.
[xxiii] Id.
[xxiv] Id.
[xxv] Id.
[xxvi] Id.
[xxvii] Id at 5.
[xxviii] Id.
[xxix] Id (citing ABB C-E Nuclear Power
Inc. v. Director of Revenue, 215 S.W.3d 85, 87 (Mo. 2007)).
[xxx] Id.
[xxxi] Id.
[xxxii] Id. at 5 (citing Hoechst
Celanese Corp. v. Franchise Tax Board, 25 Cal. 4th 508 (2001); Estate of True
v. C.I.R., 2001 WL 761280 (U.S. Tax Ct. 2001)).
[xxxiii] Id.
[xxxiv] Id.
[xxxv] Id.
[xxxvi] Id.
