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U.S. Supreme Court Ruling on State Trust Taxation of In-State Beneficiaries
On June 21, 2019, the U.S. Supreme Court heard North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust and delivered a unanimous opinion in favor of the Kimberly Rice Kaestner 1992 Family Trust. The ruling confirmed that the residence of a trust beneficiary is not by itself a sufficient factor to enable a state to tax the undistributed income of a trust where the beneficiaries have no right to demand that income.
Joseph Lee Rice III established a trust for the benefit of his three children. The trust was governed by New York State law and was administered by a New York trustee. The financial books and records and legal documents were all maintained in New York. At the time of the formation of the trust, neither the Settlor nor any of the beneficiaries lived in North Carolina. The trust agreement provided that trust distributions were based on the absolute discretion of the trustee and the trust would terminate when Kimberly Rice Kaestner attained the age of 40. In 1997, Ms. Kaestner moved to North Carolina and the trust was subsequently divided into three separate trusts, including the Kimberly Rice Kaestner 1992 Family Trust (Trust) formed for the benefit of Ms. Kaestner and her children. While living in North Carolina from 2005 through 2008, Ms. Kaestner did not receive any distributions from the trust, nor were any assets of the trust held or administered in North Carolina.
Under a law authorizing the State to tax any trust income that “is for the benefit of” a state resident, North Carolina assessed more than $1.3 million in tax on the income that had accumulated in the trust for the years 2005 through 2008. Later the Trustee paid the tax and filed a protest. It is important to reiterate that the Trust’s assets were not located in North Carolina. The case was initially heard by the North Carolina Business Court which decided that the statute allowing taxation of the trust income “that is for the benefit of a resident of this state” violated due process under the U.S. and North Carolina Constitutions. The case was subsequently tried in front of the State’s Court of Appeals, which affirmed the lower court’s decision.
The Basis of North Carolina’s Taxation
North Carolina taxes any trust that is for the benefit of a North Carolina resident (North Carolina statute § 105-160.2). The North Carolina Supreme Court interprets the statute to authorize North Carolina to tax a trust on the sole basis that the trust beneficiaries reside in the state.
During oral arguments the North Carolina Solicitor General, Matthew Sawchak contended that the beneficiary is an integral part of the trust and because of that; she should be subject to tax. He argued that during the entire period when the income is accumulating, the state is providing the beneficiary with protections and benefits that enable the trustee to not give distributions. Mr. Sawchak further argued that the current state law was valid as it had prevented abuses seen in other states that base the taxation of a trust on the situs of the trustee, and allows the trust to choose a trustee in a state that does not tax trusts.
The Supreme Court’s Decision
The Supreme Court ruled, “The presence of in-state beneficiaries alone does not empower a State to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain to receive it.”
The Court cited the following previous case precedents in their opinion:
International Shoe, 326 U. S., at 319. Ultimately, only those who derive “benefits and protection” from associating with a State should have obligations to the State in question.
Quill, 504 U. S., at 308. 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.’”
Impact of the Supreme Court Decision
In its ruling, the Supreme Court made it clear that its decision was specific to these specific facts. The ruling does not address state laws that consider the in-state residency of a beneficiary as one of a combination of factors, or that rely on the residency of noncontingent beneficiaries. In addition, the Court noted that it is important to examine the relationship between the resident beneficiary, trustee and the trust assets.
Potential Impact on Other States
The SCOTUS ruling was very narrow in scope and as such, will most likely only impact states that consider the beneficiary’s residence as the primary factor for taxing a trust.
Should we expect California to change its stance on taxation? While California law does take into consideration the residency of a beneficiary, it also considers other factors such as at non-contingent beneficiaries in determining taxation of income. Thus, the SCOTUS decision is not likely to directly impact California’s position.