Paul L. Caron
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Saturday, June 22, 2019

Unanimous Supreme Court: State Cannot Tax Out-Of-State Beneficiary On Undistributed Trust Income

Supreme Court (2018)North Carolina Dept. of Revenue v. Kimberley, No. 18–457 (June 21, 2019):

Joseph Lee Rice III formed a trust for the benefit of his children in his home State of New York and appointed a fellow New York resident as the trustee. The trust agreement granted the trustee “absolute discretion” to distribute the trust’s assets to the beneficiaries. In 1997, Rice’s daughter, Kimberley Rice Kaestner, moved to North Carolina. The trustee later divided Rice’s initial trust into three separate subtrusts, and North Carolina sought to tax the Kimberley Rice Kaestner 1992 Family Trust (Trust)—formed for the benefit of Kaestner and her three children—under a law authorizing the State to tax any trust income that “is for the benefit of” a state resident, N. C. Gen. Stat. Ann. §105–160.2. The State assessed a tax of more than $1.3 million for tax years 2005 through 2008. During that period, Kaestner had no right to, and did not receive, any distributions. Nor did the Trust have a physical presence, make any direct investments, or hold any real property in the State. The trustee paid the tax under protest and then sued the taxing authority in state court, arguing that the tax as applied to the Trust violates the Fourteenth Amendment ’s Due Process Clause. The state courts agreed, holding that the Kaestners’ in-state residence was too tenuous a link between the State and the Trust to support the tax.

Held: 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 to receive it. Pp. 5–16.

(a) The Due Process Clause limits States to imposing only taxes that “bea[r] fiscal relation to protection, opportunities and benefits given by the state.” Wisconsin v. J. C. Penney Co., 311 U. S. 435, 444. Compliance with the Clause’s demands “requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax,” and that “the ‘income attributed to the State for tax purposes . . . be rationally related to “values connected with the taxing State,” ’ ” Quill Corp v. North Dakota, 504 U. S. 298, 306. That “minimum connection” inquiry is “flexible” and focuses on the reasonableness of the government’s action. Id., at 307. Pp. 5–6.

(b) In the trust beneficiary context, the Court’s due process analysis of state trust taxes focuses on the extent of the in-state beneficiary’s right to control, possess, enjoy, or receive trust assets. Cases such as Safe Deposit & Trust Co. of Baltimore v. Virginia, 280 U. S. 83; Brooke v. Norfolk, 277 U. S. 27; and Maguire v. Trefry, 253 U. S. 12, reflect a common principle: When a State seeks to base its tax on the in-state residence of a trust beneficiary, the Due Process Clause demands a pragmatic inquiry into what exactly the beneficiary controls or possesses and how that interest relates to the object of the State’s tax. Safe Deposit, 280 U. S., at 91. Similar analysis also appears in the context of taxes premised on the in-state residency of settlors and trustees. See, e.g., Curry v. McCanless, 307 U. S. 357. Pp. 6–10.

(c) Applying these principles here, the residence of the Trust beneficiaries in North Carolina alone does not supply the minimum connection necessary to sustain the State’s tax. First, the beneficiaries did not receive any income from the Trust during the years in question. Second, they had no right to demand Trust income or otherwise control, possess, or enjoy the Trust assets in the tax years at issue. Third, they also could not count on necessarily receiving any specific amount of income from the Trust in the future. Pp. 10–13.

(d) The State’s counterarguments are unconvincing. First the State argues that “a trust and its constituents” are always “inextricably intertwined,” and thus, because trustee residence supports state taxation, so too must beneficiary residence. The State emphasizes that beneficiaries are essential to a trust and have an equitable interest in its assets. Although a beneficiary is central to the trust relationship, the wide variation in beneficiaries’ interests counsels against adopting such a categorical rule. Second, the State argues that ruling in favor of the Trust will undermine numerous state taxation regimes. But only a small handful of States rely on beneficiary residency as a sole basis for trust taxation, and an even smaller number rely on the residency of beneficiaries regardless of whether the beneficiary is certain to receive trust assets. Finally, the State urges that adopting the Trust’s position will lead to opportunistic gaming of state tax systems. There is no certainty, however, that such behavior will regularly come to pass, and in any event, mere speculation about negative consequences cannot conjure the “minimum connection” missing between the State and the object of its tax. Pp. 13–16. ...

Sotomayor, , delivered the opinion for a unanimous Court. Alito, J., filed a concurring opinion, in which Roberts, C. J., and Gorsuch, J., joined.

Bloomberg Law, SCOTUS Rules in Favor of Trust in Tax Case
Forbes, Supreme Court Rules Against North Carolina In Trust Tax Case

Bridget J. Crawford (Pace) & Michelle S. Simon (Pace), The Supreme Court, Due Process and State Income Taxation of Trusts, 67 UCLA L. Rev. Discourse 2 (2019):

What are the constitutional limits on a state’s power to tax a trust with no connection to the state, other than the accident that a beneficiary lives there? The Supreme Court of the United States will take up this question this term in the context of North Carolina v. Kimberley Rice Kaestner 1992 Family Trust. The case involves North Carolina’s income taxation of a trust with a contingent beneficiary, meaning someone who is eligible, but not certain, to receive a distribution or benefit from the trust, who resides in that State. Part I of this Essay explains the background of Kaestner Trust and frames the constitutional questions that will be before the Court at oral arguments on April 16, 2019. Part II examines how and why due process applies in the state income taxation context, with a particular emphasis on how familiar concepts of general and specific jurisdiction apply uneasily to donative trusts. Part III articulates the reasons that the Court should hold that a State has no constitutional authority to impose a tax on trust income where the trust’s only connection with the forum State is the residence of a contingent beneficiary. Kaestner Trust is the most important due process case involving trusts that the Court has decided in over sixty years; it bears directly on the fundamental meaning of due process.

https://taxprof.typepad.com/taxprof_blog/2019/06/unanimous-supreme-court-state-cannot-tax-out-of-state-beneficiary-on-undistributed-trust-income.html

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Comments

This case is puzzling to me. The Court unanimously affirms the decision below essentially on the basis that it is mandated by existing precedents, and offers virtually no guidance. Why did they ever take this case? It is certiorari jurisdiction, so they did not need to take it. Did the court take the case to show that sometimes they can all agree? Just a mystery.

Posted by: Victor Thuronyi | Jun 23, 2019 2:57:58 AM

Wow. I love it. I don't follow the Supremes that much, but when was the last unanimous decision?

Posted by: Dale Spradling | Jun 23, 2019 5:19:13 AM

@ Dale, actually 25 of 64 decisions thus far this term have been unanimous, about forty pct.
@ Victor, agreed. The decision is limited to a small subset of the established facts, which tended to show rather close cooperation between the beneficiary and the trustee to accomplish exactly this result. The case will likely have essentially zero precedential value, except as it resurrects Brooke and Safe Deposit, which Alito and Gorsuch both clearly want to hold onto.
https://www.plannedgiftdesign.com/uploads/2/4/6/6/24661337/volume_two_number_nine.pdf

Posted by: Russ Willis | Jun 26, 2019 3:44:33 PM

@ Victor, agreed, the court should have dismissed cert as improvidently granted. The scope of this opinion is so narrow as to be nearly meaningless, but now we have reaffirmation of a couple of questionable precedents.

@ Dale, actually in the current term we have about forty pct. of decisions unanimous.

Posted by: Russ Willis | Jun 28, 2019 8:15:41 PM