Supreme Court Decides Trust Taxation Case

A June ruling by the U.S. Supreme Court on a trust case in North Carolina will be used as guidance on the taxation of trusts and beneficiaries in the interstate context for years, largely because the Supreme Court decides so few cases. 

Here are the details.

The case is North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust.  On June 21, the Supreme Court held that the law authorizing the State of North Carolina to tax any trust income that “is for the benefit of” a state resident violated the Fourteenth Amendment's Due Process Clause.

In the Kaestner case, North Carolina taxed a New York trust because a future beneficiary lived in North Carolina even though the beneficiary had no right to income from the trust and did not receive any income in the tax years in question. The trustee paid the roughly $1.3 million tax bill under protest and filed suit. 

North Carolina’s tax code allows taxation on any trust income that “is for the benefit of” a state resident. The trial court, appeals court and Supreme Court of North Carolina ruled in favor of Kaestner, saying the contacts between Kaestner and the state did not rise to the required level needed for just taxation. 

The Supreme Court of the United States agreed, saying “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 ruling went on to say, “When a tax is premised on the instate 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 before the State can tax the asset.”  In the Kaestner case, the trust was a discretionary trust, and the beneficiary could not compel distributions and did not receive any distributions; there was no guarantee that any beneficiary would ever receive a distribution.

The Supreme Court found that because the in-state beneficiary did not have possession or control over the trust property, nor a right to receive any trust property, the required minimum contacts were not established and North Carolina’s tax on the trust was a violation of Due Process.

While the Supreme Court was very clear that this was a narrow ruling and only applied to the facts presented to them, the ruling means that in states that tax trusts solely on the basis of an in-state beneficiary, the taxation laws can now be challenged and overturned if the facts are similar to those in the Kaestner case.

Some tax professionals may choose to file an amended return or file a claim for refund. 

While this case may seem like it has little to do with the taxes and plans of the average citizen, the Supreme Court decides so few cases that lawyers, courts and agencies will look to this case for guidance on the taxation of trusts and beneficiaries in the interstate context for years.

At Estate & Elder Law Services we spend time and money reviewing cases and trends in the law to serve our clients so you can be assured you are receiving the best service and advice possible.