The Supreme Court, in a unanimous decision, held that the presence of beneficiaries of a trust in a state does not alone give a state the power to tax the trust's income. The court found that the imposition of the tax violated the Due Process Clause of the 14th Amendment because the trust lacked the necessary minimum contacts with the state to sustain the tax.
Facts: A New York trust had beneficiaries who resided in North Carolina but otherwise had no connections to North Carolina, and the trustee had absolute discretion over distributions to the beneficiaries. For the years in question, 2005 through 2008, the beneficiaries received no income from the trust, had no right to demand income from the trust in that year, and could not count on ever receiving income from the trust. Nonetheless, North Carolina, under N.C. Gen. Stat. §105-160.2, which allows a trust to be taxed solely because it has a North Carolina beneficiary, assessed a tax of more than $1.3 million on income earned by assets in the trust for tax years 2005 through 2008.
The trustee paid the tax under protest and then filed suit in state court, arguing that the tax violated the 14th Amendment's Due Process Clause. The North Carolina Supreme Court held that the statute was unconstitutional, finding that the beneficiaries' residence in North Carolina was too tenuous a link between the state and the trust to support the tax (Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Dep't of Rev., 814 S.E.2d 43 (N.C. 2018), aff'g 789 S.E.2d 645 (N.C. Ct. App. 2016), aff'g 12 CVS 8740 (N.C. Sup. Ct., Wake Cty. 4/23/15)).
Issues: N.C. Gen. Stat. Section 105-160.2 taxes any trust income that "is for the benefit of" a North Carolina resident. North Carolina has interpreted the phrase "for the benefit of" to include beneficiaries regardless of whether they actually receive income from a trust (slip op. at 15).
To determine whether the imposition of tax in that situation violates due process, the Court applied a two-step analysis, derived from its decision in Quill Corp. v. North Dakota, 504 U.S. 298, 306 (1992). Under the first step of the analysis, there must be "some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax." Under the second step, the income attributed to the state for tax purposes must be rationally related to values connected to the taxing state (slip op. at 6).
Citing International Shoe Co. v. Washington, 326 U.S. 310 (1945), the Court explained that for a state to have the power to tax an entity, that entity must have certain minimum contacts with the state, so that the tax does not violate notions of "fair play and substantial justice." The Court explained that a trust can have many types of contact with a state that could reach the level of minimum contacts necessary to assert a tax, including a trustee's residing in the state or an in-state beneficiary's receiving a distribution of income.
The Court concluded, however, that those circumstances were not present in this case, where in-state beneficiaries did not receive a distribution. Instead, the Court said, "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 before the State can tax the asset" (slip op. at 10).
Holding: Therefore, the Court held, "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" (slip op. at 7). The Court emphasized that its holding was limited to these specific facts.
As the Court explained in a footnote to the case, because the tax did not meet the minimum-connections requirement of the first step of the due process analysis, the Court did not address the second requirement that the tax be rationally related to values connected to the taxing state.
- North Carolina Dep't of Rev. v. Kimberley Rice Kaestner 1992 Family Trust, No. 18-457 (U.S. 6/21/19)
— By Sally P. Schreiber, J.D., a JofA senior editor.