Estate planning could get trickier depending on how the U.S. Supreme Court rules in a case involving taxation of trust income based on where beneficiaries live.
The high court is scheduled to hear arguments April 16 in N.C. Dep’t of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust. It will consider the link a state must have with a trust in order to tax it—the due process clause says that an entity must have at least a minimal connection with the state seeking to tax it.
There is potentially a significant amount of money at stake: The U.S. sees $120 billion in income from trusts each year.
If the high court finds that there is a connection to the state needed to tax the trust, it would put pressure on estates to track down any out-of-state beneficiaries, practitioners said. The ruling could have broad implications: many trusts have beneficiaries in states other than where the trust was created.
“The trustees would have to follow the beneficiaries all around the country and figure out where they are and start withholding in those jurisdictions,” said Steven Wlodychak, a principal with Ernst & Young LLP’s indirect tax practice in Washington.
North Carolina taxed the Kimberley Rice Kaestner 1992 Family Trust for income that the trust earned from 2005 to 2008.
Kaestner’s father originally created a family trust in New York in 1992, where he lived at the time. It was later split into three separate trusts, one for each of his children. During the tax years at issue, North Carolina had taxed the trustee of the trust on income it accumulated, even though the income wasn’t generated in North Carolina or distributed to Kaestner or her children.
The trust had paid in total more than $1.3 million in taxes to North Carolina, but sued for a refund and argued that the state didn’t have the necessary jurisdiction under the due process clause.
The North Carolina Supreme Court’s 2018 decision held that the income tax imposed on the out-of-state trust violated due process.
Matthew W. Sawchak represented the state Department of Revenue. David A. O’Neil, a partner at Debevoise & Plimpton LLP in Washington, represented the trust.
North Carolina argues that Kaestner’s residency there establishes the trust’s “minimum connection” with the state, and that the due process clause doesn’t bar it from taxing a trust when its beneficiaries live there.
The state said that the trust can’t satisfy the two-step test that the Supreme Court set out in Quill Corp. v. North Dakota. Under this test, the trust has to show that there isn’t a minimum connection and that the income earned from the trust isn’t related to “values connected with” the taxing state.
The trust argued that residency alone isn’t enough to meet the minimum connection standard.
The high court considered a similar issue in 2018 with South Dakota v. Wayfair. In that case, the court tossed out Quill’s physical presence standard that limited the ability of states to tax remote sales.
Why It Matters
The outcome of the case could extend beyond North Carolina.
“There are a number of other states that tax a trust based on the residence of the beneficiary, and those states’ laws may then be questioned as a result of the Supreme Court’s decision,” said Stuart Kohn, partner at Levenfeld Pearlstein LLC in Chicago.
The Supreme Court’s ruling could help determine the importance of residency in determining whether to tax a trust’s income, said James F. Hogan, managing director at Andersen Tax LLC.
“Depending on the outcome, those states may have to rethink the relevance of a beneficiary’s residence when taxing a trust,” Hogan said.
The case is N.C. Dep’t of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, U.S., No. 18-457, oral argument scheduled 4/16/19.