SCOTUS smacks down North Carolina trust tax attempt

In hyper-partisan Washington, D.C., where polarization appears in just about every sentence written about the nation’s capital, and Supreme Court votes are very often 5-4 squeakers, the court delivered to North Carolina a unanimous taxation smackdown.

Tarheel State representatives in oral arguments in April tried to sell to the court that the state was on solid legal footing to tax a trust solely because the beneficiary is a North Carolina resident, even if that person hadn’t received a cent from the trust - and might never see any money.

The high court wasn’t buying.

On June 21, 2019 the Supreme Court ruling in North Carolina Dep't of Rev. v. Kimberley Rice Kaestner 1992 Family Trust, said that the state’s position violated the 14th Amendment to the U.S. Constitution’s Due Process Clause.

The trustee is based in New York, with no connection to North Carolina. The issue was over income earned by the trust from 2005 to 2008. The figure wasn’t inconsiderable: the assessed tax alone came to $1.3 million.

However, the beneficiaries in North Carolina had received no disbursements from the trust. Furthermore, they had no right, as the court pointed out, to demand trust disbursements: “But by reserving sole discretion to the trustee, the Trust agreement still deprived Kaestner and her children of any entitlement to demand distributions or to direct the use of the Trust assets in their favor in the years in question.”

Had they received payments from the trust the income would have been taxable under North Carolina’s state income tax. But North Carolina wanted more, and didn’t want to wait.

Instead, North Carolina said that as long as the trust had a (someday potential) beneficiary who lived within the state, the state was legally entitled to tax the trust’s income though the trust had nothing to do with, in, or about, North Carolina other than the beneficiary’s residency.

The court’s opinion, which upheld a ruling by the North Carolina Supreme Court, included within its reasons a description of a novel premise the state developed as a rationale for its taxation decision: “The State is concerned that a beneficiary in Kaestner’s position will delay taking distributions until she moves to a State with a lower level of taxation, thereby paying less tax on the funds she ultimately receives.”

Translation: the beneficiary, if they ever did receive trust disbursements, might try to legally limit their tax liability by exercising their right to move to a place they found more hospitable, tax-wise; therefore, North Carolina figured it should get its piece of the pie before it was even cooked.

The Supreme Court’s decision opens the door around the country for trusts and their beneficiaries that have been dealt with similarly by a state government. However, as is true in most court cases, there are narrow aspects to the ruling that may give similar – yet not exact – situations a different outcome.

The court’s unanimous decision does send a clear message that in such due process cases, states need to come with more than fanciful taxation theories designed to award them that to which they have no right.

Read the Supreme Court's ruling here


I have questions about Tax Reform and would like to speak to a CPA.

Tagged Tax