July 8, 2019
North Carolina Department of Revenue v. Kaestner 1992 Family Trust, 588 U.S. ___ (2019) (Sotomayor, J.).
Response by Alan B. Morrison
Geo. Wash. L. Rev. On the Docket (Oct. Term 2018)
Slip Opinion | SCOTUSblog
North Carolina Department of Revenue v. Kaestner 1992 Family Trust:
No Tax Due, But No Path for the Next Cases
Every state needs revenue, and so the North Carolina legislature decided to impose a tax on certain income of trusts whose only connection with North Carolina was that the beneficiary of the trust is a North Carolina resident. When it sought to collect $1.3 million from a trust created by New York resident Joseph Rice in 1992 for his family, it relied on the fact that his beneficiary-daughter lived in North Carolina during the period in question, leading to the Supreme Court’s June 21st decision in North Carolina Department of Revenue v. Kaestner 1992 Family Trust,1 in which the Court unanimously ruled against the State.
As the opinion of Justice Sotomayor writing for herself and five other Justices makes clear on a number of occasions, the facts of this case made it very hard for the State to prevail, in particular the facts that no North Carolina beneficiary received a dollar of income from the trust during this time period, nor was any beneficiary in the state entitled to receive any money. It was entirely up to the trustee, who lived in Connecticut, whether to give any beneficiary any money, then or at any time in the future, from the trust which was being administered in New York. Given the lack of any connection between the trust income that North Carolina sought to tax, and any benefit that the state conferred that would entitle the state to impose that tax, the majority said no to the tax. The concurring opinion of Justice Alito, in which the Chief Justice and Justice Gorsuch joined, agreed with the conclusion, but seemed to be willing to rule against North Carolina based on the lack of distributed trust income alone.
The parties and the lower courts did battle over the application of the Due Process Clause, focusing largely on the cases involving personal jurisdiction over out-of-state defendants. But the Court relied instead on its tax cases from the pre–International Shoe era,2 none of which involved income from out-of-state trusts, but instead involved taxes based on trust assets or the assets of trustees in a variety of circumstances. Finding no case with as few connections to the taxing jurisdiction as this one, the Court said this was too much and North Carolina could not impose this tax.
While the situation in Kaestner is not common, the Court was also asked to hear another taxation of undistributed trust income case from Minnesota, which was held by the Court pending the resolution of Kaestner.3 In that case, the person who created the trust (known as the “settlor”) was a Minnesota resident as were most of the beneficiaries. The trust was organized in Minnesota and administered in Minnesota. Its principal asset was a Minnesota business owned by the settlor, which was sold and produced the income that Minnesota sought to tax. Like Kaestner, the trust did not distribute the income, which everyone in both cases agreed could be taxed by the state of residence of each person who received the income. The Minnesota trust made one change in its operations just before the business was sold: it changed trustees and the replacement lived in Texas. And this move really mattered, according to the Minnesota court, because it concluded that only the state of residence of a trustee may tax undistributed income, and Texas has no income tax. The State asked the Supreme Court to review that holding, which is in most respects the opposite pattern of Kaestner, but in its final order list, the Court denied review.
Because of the narrow ruling in Kaestner, it seems quite likely that the decision will be the beginning of renewed efforts by states to tax undistributed trust income. The Court was careful not to opine on other situations, but New York tax officials will surely read this decision and are likely to conclude that it has significant connections to the Kaestner trusts and therefore has a claim to taxing undistributed trust income. There is New York law to the contrary,4 but aggressive tax collectors would not be deterred from making the effort, especially because of the large sums involved.
The main result of Kaestner is likely to be a large number of lawsuits, focusing on different aspects of the operation of trusts, because different states seek to impose taxes on this income based on different connections with the state. These include the residence of the decedent for testamentary trusts, the state of residence of the settlor of an inter vivos trust, and where the trust is being administered.5 Other states may choose to focus on the location of the trust’s assets, which might make sense when assets are tangible, such as real or personal property, or perhaps even stocks and bonds when they are evidenced by actual certificates, but not when they are computer entries that can be accessed from anywhere there is Wi-Fi. In theory, states could tax this income if the trustee lived (or worked) in the state, but that approach will not produce any income as long as there are states like Florida, Texas, and Washington that do not have any income tax at all. On top of these complications are those cases in which the trustee distributes some, but not all the income, either because the trust precludes greater distribution or because the trustee decides to accumulate more in order to earn more in the future and have more available for the next generation. And while Kaestner did not permit taxation based on residence alone, it did not rule out the residence of one or more beneficiaries as a basis for taxing trust income when other factors were also present.
One problem that was not present in Kaestner was double taxation because no other state sought to tax the same income, but that problem is likely to arise in future situations. In light of decisions such as Comptroller v. Wynne,6 the Court will almost certainly preclude that result, but it will still have to figure out which of the states is allowed to keep the tax and which has to settle for giving a credit for taxes paid elsewhere.
Kaestner relied on the lack of connections between North Carolina and the income being taxed, not quite the minimal contacts test from International Shoe, but a close cousin. As the amicus brief which I filed with Professors Allan Erbsen (Minnesota) and Darien Shanske (UC Davis) pointed out, there are not likely to be any clear lines using that approach especially given the multiple possible combinations of arguably relevant connections to the trust. That kind of uncertainty may be tolerable when the issue is whether a particular party can be sued in a given state over single matter, but trusts are ongoing and they may (or may not) have to pay taxes each year and they need to know what their obligations are, even before taking into account the inevitable moves made by beneficiaries and perhaps others involved in the trust. Moreover, while some elements of existing trusts are fixed, those contemplating creating new trusts, in their wills or otherwise, need to know the ground rules so that they can plan accordingly. As we argued in our brief, using the Dormant Commerce Clause, as the Court finally did in Quill Corp. v. North Dakota,7 to deal with interstate sales and uses taxes, is far more preferable than the Due Process Clause, because it is more likely to produce consistent and predictable results, aside from being the constitutional provision used by the Court to sort out conflicts involving state taxation issues. Whether the Court will recognize this is one of the big issues that will be the focus of coming litigation.
Alan B. Morrison is the Lerner Family Associate Dean for Public Interest & Public Service Law, George Washington University Law School. He teaches civil procedure and constitutional law. He was one of three law professors who filed an amicus brief in this case as discussed in this essay.
- No. 18-457 (U.S. June 21, 2019).
- Int’l Shoe Co. v. Washington, 326 U.S. 310 (1945).
- Fielding v. Comm’r of Revenue, 916 N.W.2d 323 (Minn. 2018), cert. denied sub nom. Bauerly v. Fielding, No. 18-664 (U.S. June 28, 2019).
- Mercantile-Safe Deposit & Trust Co. v. Murphy, 242 N.Y.S.2d 26 (App. Div. 1963), aff’d, 203 N.E.2d 490 (N.Y. 1964).
- North Carolina chose not to seek to tax trust income based on the trust administration, perhaps because it has a large number of banks and imposing such a tax would not be good for their business, especially if other states did not seek to tax the trust income on that basis.
- 135 S.Ct. 1787 (2015).
- 504 U.S. 298 (1992), overruled by South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018).
Recommended Citation
Alan B. Morrison, Response, North Carolina Department of Revenue v. Kaestner 1992 Family Trust: No Tax Due, But No Path for the Next Cases, Geo. Wash. L. Rev. On the Docket (July 8, 2019), https://www.gwlr.org/north-carolina-department-of-revenue-v-kaestner-1992-family-trust-no-tax-due-but-no-path-for-the-next-cases/.
