In a unanimous decision, the U.S. Supreme Court on June 21, 2019 reaffirmed that the Due Process Clause prevents a State from taxing accumulated but undistributed income of a trust based solely on the in-state residence of a contingent beneficiary of that trust, in the case of North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust. The Court’s opinion, written by Justice Sotomayor, built on the Court’s Due Process Clause precedents in tax cases including Quill Corp. and Wisconsin v. J.C. Penney Co., extending the logic of those precedents to the trust context.
The Due Process analysis in a trust beneficiary context focuses “on the extent of the in-state beneficiary’s right to control, possess, enjoy, or receive trust assets.” 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.” Carefully limiting its holding to the facts of the case, the Court expressed no opinion on trust taxation based on beneficiaries’ residence whose relationship to the trust differs from that presented in the case.
The governing principle is that when a State seeks to base its taxation of a trust’s income on the in-state residence of a trust beneficiary, the Due Process Clause requires a “pragmatic inquiry into what exactly the beneficiary controls or possesses and how that interest relates to the object of the State’s tax.” To conduct this inquiry, a court should analyze the relationship between the resident and the trust assets that the State seeks to tax; “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. Otherwise, the State’s relationship to the object of its tax is too attenuated to create the ‘minimum connection’ that the Constitution requires.” Since the beneficiaries of the Kaestner Trust received no income from the Trust, had no right to demand income from the Trust, and had no assurance that they would eventually receive a specific share of Trust income, the Court held that the beneficiaries’ residence could not “serve as the sole basis for North Carolina’s tax on trust income.”
A concurring opinion by Justice Alito, joined by the Chief Justice and Justice Gorsuch, emphasized that the Court’s 1920’s-era precedents of Safe Deposit & Trust Co. of Baltimore v. Virginia and Brooke v. Norfolk were still reliable guideposts because those cases turned on whether a resident trust beneficiary had control or possession of intangible assets in a trust or enjoyed use of the trust assets, similar to the analysis undertaken in the principal Kaestner opinion.
According to an amicus brief filed in the case by the American College of Trust & Estate Counsel, four states, North Carolina, Tennessee, Georgia, and California impose a tax on trusts with based on the residence of a beneficiary in the state. Of these states, only two, North Carolina and Tennessee, impose the tax based upon the residence of contingent beneficiaries.