In a case deciding the “limits of a State’s power to tax a trust,” a unanimous Supreme Court rules that North Carolina wrongly taxed the undistributed income held in a New York trust for beneficiaries residing in North Carolina. North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust (U.S., No. 18-457, June 21, 2019).
The Kimberley Rice Kaestner 1992 Family Trust was one of three sub-trusts created from a larger trust established in New York in 1992 by Joseph Lee Rice III, a resident of New York, for his three children, all residents of New York at the time. The original trustee, also a resident of New York, was given “absolute discretion” to distribute the trust’s assets “in such amounts and proportion” as he might decide. In 1997, Mr. Rice’s daughter Kimberley Rice Kaestner moved with her children to North Carolina and, a few years later, the trustee divided the original trust into the three separate sub-trusts, all controlled by the original trust agreement.
For the tax years 2005 through 2008, the North Carolina Department of Revenue relied on N.C. Gen. Stat. Ann § 105-160.2, which authorizes the state to tax any trust income that “is for the benefit of” a state resident, and taxed the undistributed income in the trust. Under protest, the trustee paid the more than $1.3 million in taxes for those years, then sued the state, arguing that its taxation of the trust violated the Due Process Clause of the Fourteenth Amendment because the state lacked the requisite minimum contacts with the trust.
A North Carolina trial court determined that the state’s taxation of the trust violated the Due Process Clause because Ms. Kaestner’s residence in North Carolina was too tenuous a link between the state and the trust. The state appeals court and the Supreme Court of North Carolina affirmed.
On appeal to the U.S. Supreme Court, North Carolina argued that a trust and its constituents are “inextricably intertwined” such that the beneficiary’s residence supports state taxation; that ruling in favor of the trust would “undermine numerous state taxation regimes”; and that ruling in favor of the trust would lead to “opportunistic gaming of state tax systems.”
The United States Supreme Court unanimously affirms the judgment of the Supreme Court of North Carolina. Justice Sotomayor, delivering the opinion for the Court, writes that when a state taxes a trust based on the 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. . . .” The Court finds that the different forms of beneficiary interests that may exist counsels against North Carolina’s broad proposition that beneficiary residence alone is enough to support taxation. The Court rejects the state’s claim that ruling for the trust would undermine numerous state taxation statutes, distinguishing North Carolina’s law from all other states, and its speculation that large-scale gaming of state tax laws would result. Based on the facts of the case before it, the Court holds that “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 ever to receive it.” Justice Alito filed a concurring opinion.