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Supreme Court Rules in Favor of Beneficiaries in State Tax Case
Posted in Estate Planning
Supreme Court Rules in Favor of Beneficiaries in State Tax Case

Since our country’s inception in 1776, Americans have come to find that very few things in life are certain, with the exception of death and taxes.  In the world of trusts, these two certainties have historically gone hand-in-hand.  On Friday, June 21, 2019, however, the United States Supreme Court’s decision in North Carolina Dept. of Revenue v. Kimberly Rice Kaestner 1992 Family Trust laid such certainty to rest.

The issue in the case arose when North Carolina sought to tax the Kimberley Rice Kaestner 1992 Family Trust (the “Trust”).  Under the terms of the Trust, Kimberly Rice Kaestner and her three children (collectively, the “Beneficiaries”), had no right to control Trust assets.  In a footnote, the Court even went so far as to characterize the Beneficiaries’ interests as contingent, explaining that the trustee had sole discretion over Trust distributions to them.  Indeed, the Beneficiaries never received any income from the Trust.  Further, it was the Trustee, not the Beneficiaries, who made investment decisions with respect to the Trust property. 

The North Carolina courts held the tax law to be unconstitutional, reasoning that the State lacked the minimum contacts with the “object of its tax that the Constitution requires.”

Writing for a unanimous Court, Justice Sonia Sotomayor agreed, applying a ‘minimum contacts’ analysis to find the tax unconstitutional under the Due Process Clause of the Fourteenth Amendment.

Relying on the facts above, the Court reasoned that the Beneficiaries did not have the requisite relationship with the Trust assets at issue since they did not possess, control or enjoy such assets.  Consequently, North Carolina failed to meet its burden of proving the presence of ‘minimum contacts,’ as required under the Due Process Clause.  The Court went on to distinguish the position of a beneficiary from other parties to a trust.  A settlor, the court explained, often holds a power to dispose of the trust assets.  A trustee owns a legal interest in the trust property, whereas the trust beneficiaries maintain only an equitable interest in the trust property.  In both scenarios, there is an evident level of “practical control” over the trust property held by the parties, which is notably absent with respect to the beneficiaries.  The Court, relying on these distinctions, determined that the mere fact that a beneficiary is a resident of a particular state is not a sufficient premise on which that state may tax a trust. 

The Court’s determination that a state may not tax the beneficiary of a trust based solely on the fact that the beneficiary resides in that state is clear.  Less clear, however, is on what grounds a state may implement a tax on a beneficiary.  In Kaestner, the Court explicitly refused to answer that question, and the water is muddied by the disparate interests beneficiaries often hold.  As Justice Sotomayor pointed out, “in some cases, the relationship between beneficiaries and trust assets is so close as to be beyond separation,” but in others, “a beneficiary may only have a future interest [in trust assets].”  Unfortunately for many estate planning attorneys in search of guidance on this topic, such variation often lends itself to narrow holdings, which are dependent on the underlying facts and circumstances of the particular case.  Justice Alito expressly acknowledged the narrow character of the Kaestner holding in his concurrence, emphasizing that the Court’s opinion did not answer questions not presented by the facts of the case. 

Notwithstanding the Court’s narrow holding, Kaestner was not the first time the Court had occasion to address the issue of state taxation of trusts.  In Safe Deposit & Trust Co of Baltimore v. Virginia, the Court focused on the fact that no Virginia citizen had a right to control or possess the property of the underlying trust.  Based on this logic, the Court concluded that Virginia’s tax on the corpus of a trust could not be levied on its trustee.  Similarly, in Brooke v. Norfolk, the Court noted, among other things, the resident beneficiary’s lack of possession of the trust property, ultimately ruling that the state tax on the trust was unconstitutional.

As for the fate of the rest of the states, the Court did not go out of its way to address the issue.  In response to North Carolina’s argument that the Court’s holding would circumvent other states’ tax regimes, the Court pointed to the small minority of states that rely solely on beneficiary residency for trust taxation.  Specifically, it noted only 10 states with similar structures, but nevertheless distinguished them from the North Carolina scheme.  Ohio, for example, considers beneficiary residence in its tax scheme in combination with a number of other factors.  The Court reasoned that this totality of the circumstances approach is starkly contrasted with North Carolina’s broad beneficiary residence tax law. 

Through much of American history, the Court’s emphasis on federalism has lent itself to a high amount of state discretion when it comes to taxation of its citizens.  The Kaestner holding makes clear, however, that such discretion is not without limit.  For estate planners and their clients, this limit on state discretion means that the residence of a beneficiary is not as much of a tax trigger as it might have been before.

  • John S. Lueken

    John is Chair of the firm's Estate Planning Department. He also leads the firm's Senior Partner Committee, and is a member of the firm's Finance Committee. John, a former Certified Public Accountant, began his career in the tax ...



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