On June 21, 2019, the U.S. Supreme Court unanimously decided in favor of a taxpayer trust, finding that the state of North Carolina could not tax the trust merely because a trust beneficiary, who received no trust income or right to demand income, resided in North Carolina.
In North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, Joseph Rice formed a trust for the benefit of his children in his home state of New York and appointed a New York resident as trustee. The trustee had absolute discretion to make distributions to the beneficiaries. In 1997, one of Rice’s daughters, Kimberley, a beneficiary of the trust, moved to North Carolina. After the trust was divided into three separate trusts, one for each of Rice’s children, North Carolina sought to tax Kimberley’s trust under a North Carolina law authorizing the state to tax any trust income that “is for the benefit of” a resident of North Carolina. Kimberley had not received any distributions from the trust, could not demand any income from the trust, and no trust assets were located in North Carolina. More than $1.3 million in state income taxes was assessed against the trust. The trustee paid the tax under protest and then sued North Carolina in state court arguing that the tax violated the Due Process Clause.
The state courts agreed with the taxpayer, holding that in-state residence alone was insufficient to create sufficient contacts with the state of North Carolina to allow the trust to be taxed. The North Carolina Department of Revenue sought review by the U.S. Supreme Court. The U.S. Supreme Court eventually granted certiorari to decide whether the Due Process Clause prohibited states from taxing trusts based only on the in-state residency of trust beneficiaries.
In its analysis, the court stated that the due process analysis focuses on the extent of the in-state beneficiary’s “right to control, possess, enjoy, or receive trust assets.” 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 right to receive that property before the State can tax the asset.” Otherwise, the court stated, “the State’s relationship to the object of the tax is too attenuated to create the ‘minimum connection’ that the Constitution requires.” As a result, because the beneficiary did not receive any income from the trust, had no right to demand trust income or otherwise control or enjoy the trust assets, and because the beneficiary could not count on receiving any specific amount of income from the trust in the future, the court, affirming the decision of the lower court, held that the beneficiary’s residence alone could not serve as the sole basis for North Carolina to tax the trust income.
The full opinion may be found here.