The Court relied on its precedent that the Due Process Clause requires there to be a minimum connection between the state and the entity it seeks to tax in order for such tax to be imposed.
On June 21, 2019, the Supreme Court of the United States, in a unanimous decision, ruled that the mere presence of a trust beneficiary in a state, with no other link between the trust and that state, did not give the state the right to tax the undistributed income of the trust. The ruling in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust held that such a tax violated the Due Process Clause of the 14th Amendment to the U.S. Constitution.
The case involved a trust created by a New York resident, governed by New York law and under the control of a New York resident trustee. Under the applicable trust agreement, the trustee was granted absolute discretion to distribute trust income to the beneficiaries. The only connection to North Carolina was the fact that the beneficiaries resided there at the time the tax in question was imposed.
Under the North Carolina statute in question, the state was authorized to tax the income of any trust that was “for the benefit of” a state resident, whether or not such income was actually distributed to the resident beneficiaries. During the tax years in question, the trustee did not make any discretionary distributions to the trust’s beneficiaries. Nonetheless, North Carolina assessed a tax of more than $1.3 million on the undistributed income of the trust over a four-year period.
The Court relied on its precedent that the Due Process Clause requires there to be a minimum connection between the state and the entity it seeks to tax in order for such tax to be imposed. The minimum connection test is a flexible standard that requires the state to have certain minimum contacts and requires the taxation to be reasonable. In applying its minimum contacts jurisprudence to this case, the Court found that “the [beneficiaries’] in-state residence was too tenuous a link between the State and the Trust to support the tax.” The Court focused on the fact that no distributions were made to a North Carolina resident for the tax years in question, the beneficiaries had no right to request distributions, and the beneficiaries were not guaranteed to receive any income. Furthermore, the trustee was not located in North Carolina, the trust records were kept in New York, the custodians of the trust assets were located in Massachusetts, and no direct investments were made in North Carolina during the tax years in question.
The Court, however, was very careful to limit its decision to the particular North Carolina statute as applied to the facts of this case, and did not address the constitutionality of other states’ taxing mechanisms of trusts based on beneficiary residence. The Court’s holding in this case is a promising result for trust beneficiaries, even though its overall effect may be minimal, because the Court is ultimately still providing one more ruling scrutinizing a state’s taxation of a trust.