[author: Jennifer Morrison, Senior Client Development Manager ]
The U.S. Supreme Court recently issued its decision in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Trust. The Court unanimously determined that the residency of in-state beneficiaries alone is an insufficient basis for a State’s taxation of trust income where (1) the beneficiary did not receive distributions of trust income, (2) the beneficiary had no right to distributions of trust income, and (3) it was uncertain if the beneficiary would ever receive trust distributions. The Court concluded that a State’s imposition of tax in such circumstances violated the Due Process Clause of the Fourteenth Amendment to the U.S. Constitution.
Justice Alito’s concurring opinion – joined by Chief Justice Roberts and Justice Gorsuch – took the position that the Court’s decision was merely derived from application of the Court’s existing precedent. Over ninety years ago, Justice Alito explained, the Court made clear in two decided cases that a state cannot tax trust assets unless the in-state beneficiary has “control, possession, [or] ability to use or enjoy the asset.” Justice Alito concurred with the majority opinion because “the Court’s discussion of the peculiarities of the trust [did] not change the governing standard” or the reasoning of the Court’s earlier decisions.
Justice Sotomayor, writing for the majority, applied a more liberal interpretation of the Due Process Clause. Although agreeing with the general proposition that a state is not permitted to tax trust assets absent a showing that the in-state beneficiary has “some degree of possession, control, or enjoyment of the trust property,” the majority based its decision on the specifics of the underlying trust instrument. In light of specific holding in the case, however, it appears that any variance between the majority and concurring opinions is merely a distinction without a difference.
Arguably the most interesting aspect of the Court’s decision in Kaestner Trust may be the questions that went unanswered by the Court. For example, the North Carolina trial court also held that the State’s tax violated the Commerce Clause of the U.S. Constitution. The lower court concluded that the New York trust lacked “substantial nexus” with North Carolina and that the tax was not “fairly related” to services provided by the State to the trust. However, because the appellate courts of North Carolina did not address the trial court’s Commerce Clause holding, the U.S. Supreme Court passed as well. Numerous other prickly issues also remain.
The majority explained that the Due Process Clause requires (1) that the State have “minimum contacts” with the object of the tax and (2) the income subject to tax must be rationally related to “values connected with the taxing State.” Since the Court held that the “minimum contacts” mandate was not met, there was no need to consider whether the tax bore any reasonable relationship to the benefits and protections provided by North Carolina.
Additional trust-specific issues remain unaddressed. Although the Court held that North Carolina’s tax could not be supported by the relationship between the Kaestner Trust in-state beneficiaries and the trust assets, the majority noted that it was not opining on the degree of possession, control, or enjoyment that would support a State tax. Moreover, the Court made clear its refusal to address situations where the in-state beneficiary had a right to assign a potential interest in trust income. The Court also chose to “reserve for another day” cases where the in-state beneficiary was certain to receive trust distributions in the future.
Perhaps the most interesting issue left unaddressed by the Court was relegated to a lengthy footnote in the majority opinion. Kaestner Trust, relying on Court’s holding in Hanson v. Denckla from 1958, argued that the trustee’s contacts alone control a State’s power to tax a nonresident trust. North Carolina countered that the Hanson decision is distinguishable because that case dealt with adjudicative jurisdiction rather than taxing jurisdiction. Despite providing a detailed account of the dueling positions on this issue, the Court chose not to weigh in given the distinct legal question to be decided.
The specific holding in Kaestner Trust is certainly unremarkable. That said, the Court carefully outlined several additional issues that may also implicate the Due Process Clause in future cases. Nothing to see here? We will see.