U.S. Supreme Court Gives Taxpayer a Win in Trust Tax Case

Mr. Rice formed a trust for the benefit of his children in his home state, New York, and appointed a New York resident as the trustee. Under the terms of the trust the trustee has “absolute discretion” to distribute the trust’s assets to the beneficiaries.

In 1997, Rice’s daughter, Kaestner, moved to North Carolina. North Carolina assessed a tax of $1.3 million for tax years 2005-2008 on the Kaestner Trust under a law authorizing the state to tax any trust income that “is for the benefit of” a state resident.

During the period in question, Kaestner had no right to and did not receive, any distributions from the trust. The Trust had no physical presence, make any direct investments, or hold any real property in North Carolina. The trustee paid the tax under protest and then sued, citing the Due Process Clause of the United States Constitution.

In a 9-0 decision the United States Supreme Court ruled in favor of the trustee.

Key point: 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 may never receive it.

The Due Process Clause limits the states to imposing only taxes that “bear fiscal relation to protection, opportunities and benefits given by the state.”

When a state seeks to base its tax on the in-state residence of a trust beneficiary, due process demands a pragmatic inquiry into what the beneficiary controls or possesses and how that interest relates to the object of the tax. The residence of the beneficiaries in North Carolina alone does not supply the minimum connection necessary to sustain the tax.

Robert Adler, Esq. is an attorney who focuses his practice on wills, trusts and estates. He can be reached at 212-843-4059 or 646-946-8327.