North Carolina Department of Revenue, Petitioner v. The Kimberley Rice Kaestner 1992 Family Trust, 814 S.E.2d 43 (N.C. 2018)
U.S. Supreme Court Grants Petition for Writ of Certiorari in Trust-Level State Income Tax Case
On October 9, 2018, the North Carolina Department of Revenue (“NC DOR”) filed a Petition for Writ of Certiorari to the U.S. Supreme Court, appealing the decision of the North Carolina Supreme Court in North Carolina Department of Revenue, Petitioner v. The Kimberley Rice Kaestner 1992 Family Trust, 814 S.E.2d 43 (N.C. 2018) (“Kaestner”). The NC DOR asked whether the existence of a resident beneficiary of a non-grantor trust can trigger a trust-level state income tax within the state of the beneficiary’s residence. On January 11, 2019, the U.S. Supreme Court granted the NC DOR’s Petition.
In Kaestner, the trust at issue was created by a New York resident grantor and was governed by New York law. The trustee was a resident of Connecticut. All books and records were kept, and all tax returns and accountings were prepared, in New York. No beneficiary resided in North Carolina until years after the trust’s creation. All of the trust’s assets consisted of financial investments that were kept in Boston. The trust gave the trustee full discretion and no distributions had been made. The North Carolina resident beneficiary received accountings and legal advice from the trustee and his firm and travelled to New York to discuss investment opportunities for the trust. North Carolina taxed the trust on its accumulated income. The trust paid the tax but sought a refund. After the NC DOR denied its refund request, the trust filed a complaint alleging that the North Carolina tax violated the due process clause of the 14th Amendment and the Commerce Clause of the U.S. Constitution. The Business Court held that taxation of the trust was unconstitutional and ordered that the trust be refunded with interest. The NC DOR appealed the Business Court’s decision to the North Carolina Court of Appeals, which affirmed the Business Court’s decision, but the NC DOR appealed again.
The North Carolina Supreme Court ultimately determined that the trust at issue did not have sufficient minimum contacts with North Carolina to satisfy due process requirements. Minimum contacts require “the taxed entity [to] ‘purposefully avail itself of the benefits of an economic market in the taxing state’…”. Kaestner, 814 S.E.2d at 48. Simply put, a taxed entity’s minimum contacts cannot be established by a third party’s minimum contacts with the taxing state, and, here, mere contact with a North Carolina beneficiary does not constitute purposeful availment of North Carolina’s benefits and protections.
To date, the U.S. Supreme Court has been silent on whether a trust-level state income tax based solely on the residence of its beneficiaries comports with due process. The Petition states, “[t]here is now a direct split spanning nine states. Four state courts have held that the due process clause allows states to tax trusts based on trust beneficiaries’ in-state residency. Five state courts, including two state supreme courts …have concluded that due process forbids these taxes.” The due process clause should not have different meanings in different states.
Practitioners should keep a keen eye out for the U.S. Supreme Court’s decision. Any U.S. Supreme Court decision will assuredly have a substantial impact on planning to minimize trust-level state income tax.