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
The Court found that, under the facts of this case, the North Carolina beneficiary did not “have the requisite relationship” with the trust to justify North Carolina taxing the trust.6 Therefore, the Court held that due process prevented North Carolina from taxing the trust.
Justice Alito, joined by Chief Justice Roberts and Justice Gorsuch, penned a concurring opinion. In the concurrence, Justice Alito argued that this case was a straightforward application of precedent that prevented a state from taxing a trust based on the residency of a beneficiary. In a footnote, the concurrence indicated that it would not have made a difference whether the beneficiary in this case was non-contingent as opposed to contingent.
Analysis and potential impact
Kaestner’s holding is ostensibly narrow and limited to the facts of the case. The Court expressly and repeatedly declined to address the abstract question of “what degree of possession, control, or enjoyment would be sufficient to support taxation” of a trust based on the residency of a beneficiary.7 The Court also declined to determine whether “personal jurisdiction” and “tax jurisdiction” are coextensive—a question presented in the briefing and that could have provided useful guidance to the state tax world.
One important question that the Court left unanswered is whether a state can tax a trust based on the residency of a non-contingent beneficiary. Notably, California’s statutes require trusts to pay tax on this basis. The Court’s holding in Kaestner is limited to contingent beneficiaries because that was the fact pattern before the Court in this case. But as the Court recognized, there is “wide variation in beneficiaries’ interests,”8 so the “pragmatic inquiry” demanded by due process could reach the same result for some trusts with non-contingent beneficiaries. Additionally, at least three justices (Chief Justice Roberts and Justices Alito and Gorsuch) seem inclined to hold that a state can never tax a trust based on the residency of a beneficiary.9 Therefore, Kaestner may provide a basis for overruling, abrogating, or limiting state court precedent that allows taxation of trusts based on the residency of non-contingent beneficiaries.
As a constitutional decision, Kaestner is not limited to trusts with beneficiaries in North Carolina. Trusts that have been paying tax to any state based solely on the residency of a contingent beneficiary should be entitled to relief. Further, any trust that has been paying tax to any state—such as California—based on the residency of a non-contingent beneficiary may be entitled to relief as well and should explore its options.
- Kimberly Rice Kaestner 1992 Family Trust v. N.C. Dep’t of Revenue, No. 307PA15-2, (N.C. June 8, 2018).
- N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, No. 18-457, 588 U.S. ___ (2019).
- N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, No. 18-457, slip op. at 7 (2019).
- See id. at 9.
- See id. at 10.
- See id. at 10 n.8.
- See id.
- See N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, No. 18-457, slip op. at 14 (2019).
- See N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, No. 18-457, slip op. (2019) (Alito, J., concurring) (citing Brooke v. Norfolk, 277 U.S. 27, 28-29 (1928)) (interpreting Brooke to suggest that even where beneficiary has a right to income and receives income, does not alone justify taxing trust corpus).
Client Alert 2019-162
