JD, LLM, Principal and Trusts and Estates National Practice Co-Leader
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Supreme Court Rules Against North Carolina’s Imposition of Tax
Update: Based on the notice released on July 2, 2019, from the North Carolina Department of Revenue (“Notice”), any North Carolina taxpayer who believes that Kaestner applies to their particular situation should contact their advisor to determine how best to proceed. The Notice identifies specific dates by which impacted taxpayers must take action. Specifically, a trust that has met certain statutory requirements and duly filed a Notice of Contingent Event before Kaestner was issued must request a refund on or before Dec. 21, 2019. All other taxpayers must either file an amended return or a claim for a refund within three years of the due date of the original return.
In North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, U.S., No. 18-457, the U.S. Supreme Court unanimously ruled against North Carolina’s imposition of tax as unconstitutional.
This decision has major implications beyond North Carolina. Twenty other states had joined North Carolina in losing the argument that a state could tax a trust based on the residence of the trust beneficiaries even if no income was actually distributed to the beneficiary.
In 1992, an irrevocable complex trust (the Trust) was settled by a New York resident with a New York trustee and New York beneficiaries. Under the terms of the Trust, when a beneficiary turned 40, the beneficiary could exercise a choice to take her share outright or allow it to continue in trust.
In 1997, a beneficiary of the Trust moved from New York to North Carolina. When she turned 40 in 2009, the beneficiary exercised her right to extend the trust for her own benefit and not receive an outright distribution.
Even though the Trust never had any North Carolina situs income and did not make any distributions to the North Carolina beneficiary, the state of North Carolina assessed income taxes of more than $1.3 million for the years 2005 through 2008 based solely on the primary beneficiary’s residence.
The North Carolina statute imposed income tax on “…the taxable income of the estate or trust that is for the benefit of a resident of this State, or for the benefit of a nonresident to the extent that the income (i) is derived from North Carolina sources and is attributable to the ownership of any interest in real or tangible personal property in this State; or (ii) is derived from a business, trade, profession, or occupation carried on in this State.”
In finding the North Carolina tax unconstitutional, the U.S. Supreme Court focused on the Fourteenth Amendment’s due process clause, concluding that North Carolina’s arguments were ”unconvincing” since:
1. “the beneficiaries did not receive income from the Trust during the years in question,”
2. the beneficiaries “had no right to demand Trust income or otherwise control, possess, or enjoy the Trust assets in the years at issue,” and
3. “(the beneficiaries) also could not count on necessarily receiving any specific amount of income from the Trust in the future.”
Kaestner magnifies the importance of state income tax planning for all non-grantor trusts, particularly those with beneficiaries who reside all across the United States. The Supreme Court specifically limited the reach of Kaestner to the particular facts of that case and terms of the state statute at issue. It is not entirely clear whether the decision would necessarily apply to all similarly situated trusts with beneficiaries residing in states other than North Carolina.
Nonetheless, Kaestner presents an opportunity for planning to save state income tax for both existing and new non-grantor trusts. The professionals of the CohnReznick Trusts and Estates National practice are available to analyze your trust instruments to determine whether adjustments are necessary or appropriate.
Joy Matak, Co-Leader, Trusts and Estates National Practice
862.245.5081
Lawrence M. Lipoff, Director, Trusts and Estates National Practice
646.601.7791
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Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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