Reed Smith Client Alerts

This morning, the United States Supreme Court issued its decision in North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust (“Kaestner”), holding that the Due Process Clause prohibits a state from taxing the income of a trust when the trust’s only connection with the state is a contingent beneficiary’s presence in the state.

Autoren: Michael I. Lurie Megan Q. Miller

Background

Kaestner involved the following facts:  The beneficiary of the trust at issue resided in North Carolina from 2005 to 2008.  During these years, the trust did not make any distributions to the North Carolina beneficiary, the trust was administered out of state, and the settlor resided out of state.  North Carolina asserted the power to tax the trust’s entire income, when the only contact between the trust and North Carolina was that a contingent beneficiary resided in North Carolina during the tax years at issue.  In this case, the beneficiary’s interest in the trust was contingent upon the trustee’s sole discretion to distribute trust property.   

The North Carolina courts ruled in favor of the trust and held that due process prevented North Carolina from taxing the trust.1 North Carolina petitioned the United States Supreme Court for a writ of certiorari, and on January 11, 2019, the United States Supreme Court granted cert.

A state cannot tax a trust based solely on the presence of an in-state contingent beneficiary 

On June 21, 2019, the Court unanimously affirmed the decision below.2 In the opinion, written by Justice Sotomayor, the Court held 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.”3

Consistent with nearly a century of precedent, the Court concluded that that due process “demands a pragmatic inquiry into what exactly the beneficiary controls or possesses and how that interest relates to the object of the State’s tax.”4    The court explained that in order to justify a state taxing a trust based on the presence of a beneficiary, the beneficiary must “have some degree of possession, control, or enjoyment of the trust property or a right to receive that property. . . .”5