Case No. 18-457 | N.C.
Preview by Sean Lowry, Online Editor*
In Kaestner, the question presented to the Court is whether the due process clause prohibits states from taxing trusts based on a beneficiary’s in-state residency.
North Carolina law provides that the Department of Revenue (the “Department”) may tax trust income “that is for the benefit of a resident of this State.” N.C. Gen. Stat. § 105-160.2. Under this statute, the Department assessed taxes on the Kimberley Rice Kaestner Family Trust (the “Family Trust”) from 2005 to 2008, and the Family Trust paid approximately $1.28 million in taxes under protest before filing the suit. The only connection between North Carolina and the Family Trust is that Ms. Kaestner, sole beneficiary of the Family Trust, resided in the state from 2005 to 2008. The original trust in question was created in New York, the trustee (trust administrator) was a resident of Connecticut, and the assets underlying the trust are located in Massachusetts. During these years, the Family Trust did not make any distributions to Ms. Kaestner.
Three levels of North Carolina state courts ruled against the Department, with the North Carolina Supreme Court holding, 6–1, that the use of North Carolina Statute § 105-160.2 was unconstitutional under the due process clauses of the U.S. and North Carolina constitutions where taxation of a trust is based solely on the fact that the beneficiary resided in North Carolina. See Kimberley Rice Kaestner 1992 Family Trust v. N.C. Dep’t of Revenue, 814 S.E.2d 43 (N.C. 2018). Here, the Family Trust lacked sufficient connection with North Carolina for due process purposes.
Respondents, representing the State of North Carolina, claim in their petition for certiorari that there is a split among state courts as to whether a trust and its beneficiary are legally separate, for the purposes of due process clause analysis. Petition for a Writ of Certiorari at 9, N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, No. 18-457 (U.S. filed Oct. 9, 2018). North Carolina requests that the Court “modernize” its trust taxation jurisprudence to eliminate formal distinctions that have prevented states from taxing trusts based primarily on the beneficiary’s contacts with the jurisdiction.
In contrast, counsel for the Family Trust argues that the trustee had absolute discretion over the trust and Ms. Rice was not guaranteed to receive a distribution during her residency in North Carolina. In support, the Family Trust points to precedent in Safe Deposit & Trust Co. of Baltimore v. Virginia, 280 U.S. 83 (1929) (holding that a nonresident trust could not be taxed solely based on the residency of a beneficiary), and Hanson v. Denckla, 357 U.S. 235 (1958) (holding that a state lacked jurisdiction over a nonresident trust because the trustee did not “purposefully avail” itself of the state’s laws).
At stake for states are concerns of federalism and their taxing power, and, perhaps more importantly, how that power is divided among the states to tax billions of dollars of income annually reported by trusts. Several states, like North Carolina, tax undistributed income when a trust beneficiary lives in the state and have had such laws on the books for decades.
Interestingly, the amicus briefs show that Kaestner has split legal academics. Separate briefs were filed in support of North Carolina by law professors specializing in trust and tax law. One professor specializing in conflict of laws argues that North Carolina does not have a right to tax the Family Trust. Another brief filed by constitutional law scholars argues that the case should be remanded under the dormant commerce clause, rather than the due process clause.
*Sean Lowry is a 2LE (Class of 2021) and Analyst in Public Finance at the Congressional Research Service (CRS). The views expressed are those of the author and are not necessarily those of the Library of Congress or CRS.