BHBM Tax Law Alert 6/25/2019
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In-State Income Beneficiary Insufficient for States to Tax Trust Income
Recently, the Supreme Court unanimously ruled in N.C. Dep’t of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust
that a trust cannot be taxed based solely on where the trust beneficiaries reside. Specifically, a state may not tax undistributed trust income when the in-state beneficiary has no right to demand income and uncertainty exists as to whether the beneficiary will receive the income.
In this case, North Carolina taxed a trust on income it accumulated even though the income was neither generated in North Carolina nor distributed to the beneficiaries, who were North Carolina residents. Outside of the beneficiary relationship, the trust had no connection to North Carolina. The trust (i) was created in New York by a New York resident, (ii) is governed by New York law and (iii) has its records kept in New York. Moreover, at no time was a trustee a resident of North Carolina.
The North Carolina Supreme Court held that the income tax imposed on the out-of-state trust violated due process. The due process clause provides that an entity must have at least a minimal connection with the state seeking to tax such entity. In upholding the North Carolina Supreme Court’s decision, the Supreme Court determined that a beneficiary’s residence in a state alone is not sufficient to establish a minimal connection with the state for the trust to be taxed in that state.
There are a myriad of states that currently tax a trust based on the residence of the trust beneficiaries, e.g., California, Georgia, Montana, North Dakota, Tennessee.
It is important to note that these states may still be able, under this ruling, to tax a trust based on its in-state beneficiary if the beneficiary has sufficient rights to control, possess, enjoy or receive trust assets.
If you would like to discuss in more detail the state-level taxation of trusts and planning opportunities available for trusts, please contact us at (504) 569-2900.