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Assets of an Out-of-State Trust Included in Resident’s Taxable Estate

Sept. 22, 2021, 8:01 AM

The Oregon Supreme Court ruled this past summer that the assets of an out-of-state trust are included in a resident’s taxable estate.

The decision is interesting because it seems to enlarge the circumstances under which such inclusion is required, extending the U.S. Supreme Court’s recent Kaestner decision beyond what the text of that case may indicate.

At the time of her death, Helene Evans was a lifetime beneficiary of a trust that had been created upon the death of her husband, Donald Gillam. After Evans died in 2015, a dispute arose over whether Oregon could enforce its statutory requirement that the value of the assets held in the trust must be included in Evans’s taxable estate (Estate of Evans v. Dept. of Revenue, No. S067899 (Ore. 7/9/21)).

Under federal estate tax law, there can be no marital deduction for property passing from the decedent to his spouse when what is passed to the spouse is a mere “terminable interest” in the property, which would include an income interest in property held in a trust that terminates upon the spouse’s death. Federal tax code Section 2056(b)(7) provides an exception to this rule when the property is qualified terminal interest property (QTIP), which is defined as a terminable interest passing to a decedent’s spouse if:

  1. the surviving spouse is entitled to all the income from the property for life,
  2. no person can have a power to direct any part of the property to any person other than the surviving spouse, and
  3. the decedent’s executor has made an election to designate the property as QTIP.

Any property deducted from the decedent’s estate as QTIP must, upon the surviving spouse’s death, be included in, and taxed as part of, the spouse’s estate. Oregon law provides that, for purposes of Oregon taxes, a resident decedent’s taxable estate is the same as his or her federal taxable estate.

Gillam died in 2012. Upon Gillam’s death, his executor transferred the intangible property to the trust. The trustee was required to pay all of the net income from the trust to Evans, as well as such amounts from the principal as the trustee deemed necessary for Evans’s health, education, maintenance or support in her accustomed manner of living during her lifetime. Gillam’s executors elected to designate the trust property as QTIP and the property, therefore, was excluded from Gillam’s estate.

When Evans died in Oregon in 2015, her estate filed an Oregon estate tax return that included the value of the assets that were held in the trust. Later, the estate sought to revise the return and requested a refund of the tax that had been paid on those trust assets. The estate argued that imposing Oregon’s estate tax on the assets of the trust violated the Due Process Clause of the Fourteenth Amendment. The Oregon Department of Revenue denied the refund.

Enjoyment of Trust Property Is Sufficient

With respect to a state’s authority to impose tax, the Oregon Supreme Court said the essential due process issue was whether the tax “bears fiscal relation to protection, opportunities and benefits given by the state, i.e., whether the state has given anything for which it can ask return.” The court noted that the U.S. Supreme Court has formulated the issue in terms of a two-part test of which only the first part was applicable regarding the Evans estate. The relevant part of the test requires a minimum connection between a state and the person, property, or transaction it seeks to tax. Only those who derive “benefits and protection” from associating with a state should have obligations to the state in question.

A state may tax interests in tangible property located within its borders. A state may also tax interests in intangible property if the taxpayer has in some sense enjoyed the benefits and protections that the state offers. With respect to intangible property that exists outside of the taxing state, the benefits and protections that are relevant are those that the state offers to persons or entities within the state who own or have similarly substantial interests in the property.

“In other words, whether a state has the necessary minimum connection to intangible property that is connected to the state only through an in-state resident depends on the nature of that in-state resident’s interest in the intangible property. If the resident’s interest in the intangible property is sufficiently substantial, such that it is a source of actual or wealth to...the resident, then his or her enjoyment of the benefits and protections offered by the state...is a sufficient justification for the state to impose its tax on that property,” the court said.

In North Carolina Dept. of Rev. v. The Kimberly Rice Kaestner 1992 Family Trust, the U.S. Supreme Court said that: “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.” Kaestner, the Oregon court noted, does not explore what might qualify as “some degree.”

The estate contended that the U.S. Supreme Court decisions all supported its contention that a decedent who was the income beneficiary of an out-of-state trust must have had some actual control over the assets of the trust before the decedent’s home state may impose its estate tax on those assets. Because Evans had no ability to control how the trust assets were invested, managed, or even distributed upon her death, Oregon could not rely on her in-state residency to establish the required minimum connection to those assets.

According to the department, a state may include the assets of an out-of-state trust in a decedent’s estate when the decedent had either complete or more limited control respecting the disposition of trust assets, but the cases did not establish that due process requires such control. The department contended that the cases did not speak of the circumstance here, in which the decedent had a large degree of enjoyment of the trust property.

The court agreed with the department. “The demands of due process also could be satisfied by a showing that a resident decedent had some degree of possession or enjoyment of, or right to receive, the trust property.

Evans had sufficient “enjoyment” of the trust principal to satisfy Kaestner’s requirement of “some degree of possession, control, or enjoyment” of the trust assets, the court said. While “Evans could not claim a right to the whole of the trust principal or any particular portion thereof, she had a potential right to receive distributions of principal, to the extent that trust income was insufficient to satisfy her needs.”

Even under the settlement in which Evans ceded her rights with respect to the trust principal, she received a substantial one-time payment that consisted of part of the principal. “Evans could and did access the trust principal for her own use and benefit.” Evans thereby had a substantial measure of “enjoyment” of the trust principal, the court said.

Therefore, the court concluded, Oregon could rely on Evans’s status as an Oregon resident to impose its taxes on that trust principal without violating the Due Process Clause. Evans satisfied Kaestner’s requirement that she had sufficient “possession, control or enjoyment” of the trust assets to permit Oregon to include the assets in Evans’s taxable estate. The court went on to reject the estate’s additional argument that—even if Oregon had the required minimum connection to the assets—its taxation of the assets was nonetheless unfair.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.

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