United States Supreme Court to Consider Whether States May Tax Trusts Based on Residence of Beneficiary

Holland & Hart - Fiduciary Law Blog

The new limitation of the federal deduction for state income taxes to $10,000 has heightened interest in planning for state income taxes.  Thoughtful practitioners who assist clients in establishing non-grantor trusts should carefully consider trust situs, and the potential impact of state income taxes based on that situs. 

Currently, eleven states tax trust income based on the residence of the beneficiaries of the trust.  Many practitioners believe that this practice violates the Due Process Clause of the United States Constitution.  The United States Supreme Court recently granted certiorari to review this issue and the decision made by the North Carolina Supreme Court in North Carolina Department of Revenue, Petitioner v. The Kimberley Rice Kaestner 1992 Family Trust

In Kaestner, the North Carolina Supreme Court determined that the trust in that case “did not have sufficient minimum contacts with the State of North Carolina to satisfy due process requirements….”  Therefore, the Court held that North Carolina could not tax the trust solely based on the residence of the beneficiaries.

The trust at issue in Kaestner was not required to make distributions to its beneficiaries and did not actually make distributions to the beneficiaries residing in North Carolina during the years at issue.  The trustees were not located in North Carolina, the trust records were not kept in North Carolina and the trust’s financial advisors and assets were also outside of North Carolina. 

Given the facts in this case, the decision reached by the U.S. Supreme Court could potentially be quite narrow.  A decision that provides broader clarity on this issue would be beneficial to practitioners across the country.  Stay tuned for the outcome.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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