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Last summer the Supreme Court of North Carolina handed a victory to a taxpayer challenging the state’s ability to impose its income tax on an “out-of-state” trust. In Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Dept. of Revenue, the court ruled that the state could not impose its income tax on trust income merely because it had a resident beneficiary. The settlor of the trust in question was located in New York, the trustee was a Connecticut resident, and the trust held assets in the form of financial instruments located in Massachusetts. The beneficiary did not receive any distributions from the trust during the tax years at issue.

The North Carolina Department of Revenue imposed the tax under the authority of a state law that levies the income tax on trust income earned “for the benefit of a resident of this State.” The court case ensued after the trust paid the tax for tax years 2005 through 2008 and later filed a refund claim on the basis that the state statute is unconstitutional for violating due process. In other words, the trust argued that it did not have a sufficient connection with North Carolina for the state to impose the income tax based solely upon the resident beneficiary.

Taxpayer Wins at Supreme Court of North Carolina

The court ultimately ruled in the trust’s favor because it found that that the in-state presence of a resident beneficiary alone does not establish jurisdiction to tax. The court stressed that the trust is an entity separate from individual beneficiaries and further distinguished cases in Connecticut and California that reached contrary results under similar facts. In dissent, Justice Samuel Ervin argued that the trust did subject itself to North Carolina’s taxing power consistent with the due process clause because it purposely availed itself to the state through the beneficiary. Justice Ervin noted that the beneficiary was a North Carolina resident when the trust was created for her benefit and that the trustee communicated with her in the state, in reliance upon benefits, protections, and opportunities that the state provided.

Similar Issues in Other State Courts

The Kaestner Trust case comes on the heels of cases in Minnesota and Ohio that we reported on in back in August. In July 2018, the Supreme Court of Minnesota ruled that a trust did not establish nexus with the state of Minnesota despite holding shares of an in-state company, having an in-state beneficiary, and applying Minnesota law to govern disputes arising under the terms of the trust. By contrast, the Supreme Court of Ohio upheld an Ohio tax imposed on a trust with shares of an in-state company and having Ohio residents as the trust grantor and beneficiaries. With reliance on only the in-state beneficiary to establish nexus, North Carolina has taken a more aggressive position than the courts reviewed in Minnesota and Ohio.

State of North Carolina Petitions High Court

Against this legal landscape, the North Carolina Department of Revenue petitioned the U.S. Supreme Court on Oct. 9, 2018 to review its case. In what could be an important consideration, the Supreme Court of North Carolina decided its case in early June with reliance on Quill Corp. v. North Dakota, just days before the U.S. Supreme Court handed down its seminal sales and use tax case in South Dakota v. Wayfair. We will keep you posted as the U.S. Supreme Court contemplates whether or not to accept the Kaestner Trust case.

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