Supreme Court Puts the Brakes on Aggressive Attempt by State to Tax Trust

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Supreme Court Puts the Brakes on Aggressive Attempt by State to Tax Trust

Jun 27, 2019

by Gregory S. Dowell

June 27, 2019

In a win for taxpayers against overly-aggressive efforts by states to tax any and all income, the US Supreme Court unanimously ruled that a state cannot tax a trust when the trust’s only connection to that state is because of the residency of a beneficiary. In this case (North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust), North Carolina attempted to tax a trust and relied on its statute that allows a trust to be taxed solely because it has a North Carolina beneficiary. Earlier in the litigation process, the North Carolina Supreme Court ruled that the statute was unconstitutional. Ultimately, the US Supreme Court ruled that because the trust lacked minimum contacts with the State of NC, taxing the trust in NC would be a violation of the Due Process Clause of the 14th Amendment.

In the case, the trust had no connection with NC, other than the fact that a beneficiary of the trust was a resident. NC assessed more than $1.3 million of taxes on income earned by the trust for tax years 2005 through 2008. During that same period, the beneficiary had no right to receive any distributions from the trust and, in fact, did not receive any distributions. The trustee has absolute determination as to whether any amounts were to be paid to the beneficiaries. The trustee paid the assessment under protest, and then filed suit in state court. The US Supreme Court, in agreeing with North Carolina courts that the assessment of tax violated due process, noted that the beneficiary “received no income from the trust in the relevant tax year, had no right to demand income from the trust in that year, and could not count on ever receiving income from the trust”. The US Supreme Court applied a 2-part test to determine if due process had been violated: 1) There must be some definite link or minimum connection between a state and the person, property, or transaction it seeks to tax, so as not to violate notions of fairness; 2) the income attributed to the state for tax purposes must be rationally related to values connected to the taxing state. The US Supreme Court said that the 2nd part of the test was not as relevant and focused on the first part. The Court determined 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”. 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”.

The North Carolina statute in question (N.C. Gen. Stat. Section 105-160.2) allows for the assessment of tax on any trust income that “is for the benefit of” a North Carolina resident. Very broadly, North Carolina has interpreted this to mean that it applies whether or not the beneficiary actually receives any income from the trust.

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by Gregory S. Dowell Updated May 16, 2023 Spring is the traditional kick-off to wedding season, and thoughts quickly turn to the wedding venue, gifts, the happy couple, and, of course, the guest list. Lurking somewhere in the shadows, behind even that strange uncle you barely know, is another guest that needs to be considered: The tax impact on the newlyweds. To start, newlyweds will have two options for filing their income taxes in the year of marriage: Filing status can either be married filing jointly, or married filing separately. In the vast majority of cases, a couple will benefit with a lower overall tax burden to the couple by choosing to file married filing jointly. One of the classic cases where a couple may consider filing separately is when one spouse has significant amounts of medical expenses for the year. 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To avoid any unpleasant income tax surprises, we always recommend that a newlywed couple take the time to make a projection of what their income will look like when combined as a couple, and determine what the tax bill will look like, at the Federal and State levels. After all, planning ahead, communicating with each other, discussing finances, and avoiding unpleasant surprises are some of the keys to a long marriage.