The United States Supreme Court rarely addresses trusts and estates issues. The purview of the states, issues arising in intergenerational wealth transfers, are generally outside federal jurisdiction. To reach the U.S. Supreme Court, trusts and estates cases typically involve federal preemption or the constitutionality of a state’s law; the latter has brought the most recent trusts and estates case before the Court.
On April 16, 2019, oral arguments were heard in the case North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust (Kaestner). The issue in Kaestner is the constitutionality of North Carolina General Statute Section 105-160.2, which subjects a trust to North Carolina income tax if a trust beneficiary resides in North Carolina. The North Carolina Supreme Court ruled that the statute was unconstitutional as applied to the trust in question because the trust does not have a sufficient nexus to the State. The Kaestner Family Trust was created in New York. Its initial trustee resided in New York, and its successor trustee resided in Connecticut. The trust’s only connection with North Carolina during the tax years at issue was the trust’s North Carolina-domiciled beneficiaries. North Carolina taxed the trust’s income each year, regardless of whether distributions were made to any of the beneficiaries.
Upon granting certiorari for North Carolina’s appeal, the U.S. Supreme Court noted that nine states are split on this issue: Four state courts allow the state to tax trust income based on resident beneficiaries, while five state courts have held that taxing beneficiaries on non-resident trust income violates due process. North Carolina, Georgia, Tennessee, and California are the only states that use the residency of a beneficiary to establish the nexus required to impose a tax on a non-resident trust, based on the theory that a trust’s beneficiaries are the true owners of the trust’s property. This theory, however, was questioned by the justices on oral argument. Among the questions asked by the justices: Is it certain the beneficiary will receive a distribution from the trust while still a resident of North Carolina? Are the beneficiaries certain to receive distributions at all?
Estate planners and taxpayers alike anxiously await a disposition in Kaestner. Estate planners should be prepared to address the taxation of trusts and their beneficiaries in light of the Supreme Court’s holding. Do you anticipate the Court will uphold the North Carolina law?