Republic Bancorp Co. v. Beard, 2–17–0350

2018 IL App (2d) 170350

107 N.E.3d 423

REPUBLIC BANCORP COMPANY, Plaintiff–Appellant,

v.Constance BEARD, in her Official Capacity as Director of Revenue; Michael W. Frerichs, in his Official Capacity as Treasurer; and The Department of Revenue, Defendants–Appellees.

No. 2–17–0350

Appellate Court of Illinois, Second District.

Opinion filed June 8, 2018

Michael J. Wynne, Jennifer C. Waryjas, and Douglas A. Wick, of Jones Day, of Chicago, for appellant.

Lisa Madigan, Attorney General, of Chicago (David L. Franklin, Solicitor General, and Evan Siegel, Assistant Attorney General, of counsel), for appellees.

JUSTICE BIRKETT delivered the judgment of the court, with opinion.

¶ 1 In tax years 2012, 2013, and 2014, plaintiff, Republic Bancorp Company, asserted a tax deduction that, upon auditing, was disallowed by defendant the Department of Revenue (Department). The Department thereafter assessed plaintiff the taxes, penalties, and interest accruing from the disallowed deduction. Plaintiff paid the assessment under protest and filed in the circuit court of Du Page County a declaratory-judgment action against defendants, Constance Beard in her official capacity as Director of the Department, Michael W. Frerichs in his official capacity as Treasurer, and the Department, seeking a declaration that it was entitled to the claimed deduction (count I) or, alternatively, that it had a good-faith basis for claiming the deduction that should serve to abate the assessed penalties (count II), and seeking the issuance of an injunction prohibiting the Department from transferring plaintiff's protest payment to the State's general fund and, ultimately, praying for a return of the protest payment upon plaintiff's success in this action (count III). The parties filed cross-motions for summary judgment. The trial court granted defendants' motion for summary judgment and denied plaintiff's motion for summary judgment, and plaintiff appealed, arguing that the trial court's interpretation of the relevant provisions was incorrect. We affirm.

¶ 2 I. BACKGROUND

¶ 3 We summarize the pertinent facts appearing in the record. Plaintiff is a subchapter S corporation for both federal and state income tax purposes. A subchapter S corporation is treated as a pass-through entity that does not pay tax; instead, the income of a subchapter S corporation is attributed directly to its owners. 26 U.S.C. § 1361 (2012) ; 35 ILCS 5/205(c) (West 2016). It is also a family-operated bank, headquartered in Oak Brook, and serving the Chicago area since 1964. Plaintiff's shareholders consist of seven grantor trusts. A grantor trust is a trust where the grantor has retained certain powers that result in the grantor, and not the trust, being treated as the owner of the assets for tax purposes. 26 U.S.C. §§ 671 – 678 (2012) ; 35 ILCS 5/205(e) (West 2016).

¶ 4 In July 2016, after auditing plaintiff, the Department sent notices of deficiency for the tax years ending in December 2012, 2013, and 2014. According to the Department, plaintiff had claimed an improper subtraction modification pursuant to section 203(b)(2)(S) of the Illinois Income Tax Act (Act) ( 35 ILCS 5/203(b)(2)(S) (West 2016) ) for the amounts that plaintiff had distributed to its shareholders—all of which were grantor trusts. The Department computed the tax deficiency to be $642,294, the penalties to be $128,458.80, and the interest to be $40,667.60, for a total assessed amount of $811,420.40. In September 2016, plaintiff paid to the Treasurer the total amount owing under protest, pursuant to the State Officers and Employees Money Disposition Act (Money Disposition Act) ( 30 ILCS 230/1 et seq. (West 2016) ).

¶ 5 On September 16, 2016, plaintiff filed its complaint against defendants. On September 30, the trial court entered an agreed order granting plaintiff's motion for an injunction to prevent defendants from cashing its protest tax deficiency payment. On January 17, 2017, the parties filed cross-motions for summary judgment.

¶ 6 The record does not contain a transcript of any hearing on the cross-motions for summary judgment, only the motions and related written submissions in support and opposition. On April 19, 2017, the trial court denied plaintiff's motion for summary judgment and granted defendants' motion for summary judgment:

"This matter came before the Court for hearing on Cross Motions for Summary Judgment. It appears to be a case of first impression, involving the relationship between the Personal Property Replacement Income Tax (‘Replacement Tax’) [ ( 35 ILCS 5/201 et seq. (West 2016) ) ], and grantor trusts.

Prior to the enactment of the 1970 Constitution, local taxing bodies were allowed to impose ad valorem taxes on personal property of corporations, partnerships and other business entities. The 1970 Constitution abolished those taxes. The Replacement Tax was enacted to compensate local districts for the loss of revenue. The Replacement Tax is assessed on specified entities in addition to state income tax at rates set by the legislature. At issue is whether [plaintiff's] shareholders are among those specified entities subject to the Replacement Tax.

[Plaintiff] is a Subchapter S corporation (‘Sub S Corp’) for the purpose of taxation under the federal Internal Revenue Code ( [ 26 U.S.C. § 1 et seq. (2012) ] ) and the [Act]. The shares of [plaintiff] are held by family members in grantor trusts in which the family member retains powers over the trust corpus to the extent that income to the trust is attributable to the family member and not to the trust itself for tax purposes. For federal and state income tax purposes, the income of [plaintiff] is attributed to the family members themselves, whether they hold their shares individually or as grantors of grantor trusts.

The issue before the Court is essentially whether the grantor trusts are subject to Replacement Taxes in addition to the state income tax paid by the grantors. [Plaintiff] contends that the grantor trusts are subject to the Replacement tax [sic ] because they are excluded from the class of trusts which are relieved of the burden of paying the Replacement Tax. [Defendants] contend that in its returns for 2012, 2013 and 2014 [plaintiff] improperly deducted income distributable to trusts which were [not] subject to (i.e. , required to pay) Replacement Tax because they were relieved of that liability by the terms of [section 205(e) of the Act ( 35 ILCS 5/205(e) (West 2016) ) ].

[Defendants point] out that grantor trusts are not specifically defined in the [Act], necessitating reference to the [Internal Revenue Code] for definition. Under the [Internal Revenue Code], grantor trusts are disregarded for tax purposes, and all income is attributed to the individual grantor. Under [the Department's] regulations, grantor trusts are likewise not treated as a trust for income tax purposes.

If the grantor trusts ARE subject to Replacement tax [sic ], then the grantor trusts are liable for payment of Replacement Tax. However, under both the [Internal Revenue Code] and the [Act], grantor trusts are disregarded entities and are not required to pay taxes. The tax liability flows to the grantor as an individual. However, individuals are excluded from the class of entities required to pay Replacement tax [sic ]. In contrast, if grantor trusts are NOT required to pay Replacement Tax, then [plaintiff] erroneously deducted the Replacement Tax liability.

The issue of grantor tax liability was addressed by the Illinois Supreme Court in Hanley v. Kusper , [61 Ill. 2d 452, 337 N.E.2d 1 (1975) ]. The Supreme Court [sic ] ‘again rejected the claim that all personal property held in trust for natural persons is exempt from taxation’. The Court [sic ] then drew a distinction between trusts ‘intended to be exempted from taxation * * * in which the natural person who owns the property is prevented by law from dealing with it as a natural person.’ It then goes on to say that ‘[t]hese situations, in our opinion, are distinguishable from voluntary fiduciary relationships created to accomplish results that could not be achieved so long as the property is owned by a natural person.’

However, the Illinois legislature appears to have remedied the situation addressed in the Hanley case. The [Act] in effect in 2011 states * * *:

‘(e) Certain Trusts. A common trust fund described in section 584 of the Internal Revenue Code, and any other trust to the extent that the grantor is treated as the owner thereof under sections 671 through 678 of the Internal Revenue Code shall not be subject to the tax imposed by this Act.’ [ 35 ILCS 5/205(e) (West 2016).]

While an argument can be made that this section refers only to the imposition of income tax, the Replacement tax [sic ] is also covered in another section of ‘this act’. The [Act] must be read as a whole, in a manner that does not render one section meaningless.

As pointed out above, the interpretation urged by [plaintiff] would lead to an absurd result. The trusts would be subject to (i.e. , required to pay) Replacement Tax under one section of the [Act] but would be relieved of that burden by another section which imputes income to the individual grantor, who would not be required to pay the Replacement Tax. The entire [Act] must be read in a manner that would not lead to such a result.

IT IS THEREFORE ORDERED that the Motion for Summary Judgment of [plaintiff] is denied. The Motion for Summary Judgment of [defendants] is granted. The Court finds that Plaintiff is liable for taxes for the years in question on the sums it improperly deducted for Replacement Tax, plus applicable interest and penalties.

This is a final and appealable order, with no just reason to delay appeal or enforcement."

¶ 7 Plaintiff timely appeals.

¶ 8 II. ANALYSIS

¶ 9 On appeal, plaintiff argues that the trial court misread section 205(e) of the Act ( 35 ILCS 5/205(e) (West 2016) ) as exempting grantor trusts from the replacement tax and that it misinterpreted the phrase...