Supreme Court Rules Against North Carolina In Trust Tax Case

On June 21, 2019, the U.S. Supreme Court decided North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, holding that the Due Process Clause does not allow a state to tax a trust’s income where the state’s only contact with the trust is the residence of a trust beneficiary who received no income from the trust in the relevant tax year, had no right to demand income from the trust in that year, and had no guarantee of receiving income from the trust.

Joseph Rice, a New York resident, formed a trust for the benefit of his children. The trust was governed by New York law, and the trustee was a New York resident. The trust’s asset custodians were in Massachusetts. The trust agreement gave the trustee “absolute discretion” whether to distribute income to the children, and which children should receive it and when.

One of Rice’s children, Kimberley Rice Kaestner, later moved to North Carolina. A few years later, the trustee divided the initial trust into three subtrusts, one of which was formed for the benefit of Kaestner and her children. All three subtrusts were governed by the same trust agreement that governed the original trust. And the trustee continued to have exclusive control over distributions from the three subtrusts. While Kaestner lived in North Carolina, the trust maintained no physical presence there, made no direct investments there, and held no real property there. North Carolina’s only connection to the trust was that one of its original beneficiaries lived there.

North Carolina taxes any trust income that “is for the benefit of” a resident of the State. Accordingly, the State taxed all of the proceeds that Kaestner’s trust had accumulated over several years, even though Kimberley received no distributions during those years. The trustee sued for a refund, arguing that the tax violated the Due Process Clause because North Carolina lacked a sufficient connection with the trust to allow the state to tax the trust. The North Carolina courts agreed an ordered a full refund.

The Supreme Court affirmed. The Court noted that, under the Due Process Clause, “a State has the power to impose a tax only when the taxed entity has certain minimum contacts with the State such that the tax does not offend traditional notions of fair play and substantial justice,” and that “only those who derive benefits and protection from associating with a State should have obligations to the State." Therefore, a state may tax a trust’s income if it is actually distributed an in-state resident, or if the trustee is an in-state resident, or (probably) if the trust is administered within the state. But “when a tax is premised on the in-state residence of a beneficiary, the Constitution requires that the resident have some degree of possession, control, or enjoyment of the trust property or a right to receive that property." Because Kimberley had none of those rights during the relevant tax years, her residence in North Carolina did not provide the minimum contacts needed for the State to tax the trust’s income.

Brooke Swier Schloss
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Family Law and Estate Planning attorney helping families across South Dakota plan and protect their loved ones