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N.C. tax dispute heads to U.S. Supreme Court

N.C. tax dispute heads to U.S. Supreme Court

Lawyers across the country are waiting to see how the U.S. Supreme Court will rule on an issue at the intersection of tax law and trusts and estates, thanks to a dispute over the reach of North Carolina’s tax laws.


The justices on Jan. 11 agreed to answer whether the Due Process Clause of the U.S. Constitution prohibits states from taxing a trust located in another state based on the in-state residency of a beneficiary.

The dispute involves the Kimberly Rice Kaestner Trust, created in 1992 in New York and governed by the laws of that state. The trustee resided in Connecticut, and in 2005, the beneficiary moved to North Carolina. For the next several years, the trust paid tax on undistributed income earned by the trust pursuant to Section 105-160.2 of the North Carolina code, which says that income tax on an estate or trust “is computed on the amount of the taxable income of the estate or trust that is for the benefit of a resident of this State.”

In 2008, the trust requested a refund for the roughly $1.3 million paid in taxes, which was denied. The trust then sued the North Carolina Department of Revenue, arguing that the statute at issue is unconstitutional as applied, in violation of the Due Process Clause.

Judge Gregory McGuire of the North Carolina Business Court granted summary judgment in favor of the trust, a ruling affirmed by both the state’s Court of Appeals and its Supreme Court.

“For North Carolina’s taxation of a foreign trust to satisfy due process, the trust must have some minimum contacts with the State of North Carolina such that the trust enjoys the benefits and protections of the state,” the North Carolina Supreme Court wrote. “When, as here, the income of a foreign trust is subject to taxation solely based on its beneficiaries’ availing themselves of the benefits of our economy and the protections afforded by our laws, due process is violated.”

The North Carolina Department of Revenue filed a writ of certiorari to the U.S. Supreme Court, seeking clarification on the “important and unresolved constitutional issue” that has arisen in eight other states across the country and implicates billions – yes, with a “b” – of tax dollars for the government.

“This is a huge case,” Professor Gerry W. Beyer of Texas Tech University School of Law said. “It could be one of the landmark rulings in the tax and trust area in a long time.”

To tax or not to tax?

Several factors likely operated together for the justices to agree to hear the case. First, North Carolina is not alone in its legal battle over the taxing of foreign trusts. Eight other state courts have weighed in on similar statutes with an almost equal split: four have found sufficient minimum contacts for the state to tax the undistributed income of a foreign trust while five, including North Carolina, have reached the opposite result.

In addition to the split among state courts, Tom Myrick of Moore & Van Allen in Charlotte – who has represented the trust for over seven years – said that a 2018 Supreme Court decision may have signaled the justices’ interest in updating tax law for the 21st century. In South Dakota v. Wayfair, Inc., the Court reversed precedent that prevented states from collecting sales tax from internet retailers that do not have a physical presence in the state.

“It could be that the Court wants to draw a similar line in the sand in the context of trusts as to what satisfies minimum contacts by a trust with a particular state giving rise to tax jurisdiction,” Myrick said.

The trust will stick with its heretofore winning argument before the high court, he added: that the trust is separate and distinct from its beneficiaries. The Kaestner trust was administered in New York, the trustee resided in Connecticut, and although the beneficiary resided in North Carolina for the tax years at issue, the trust itself derived no benefits from the state, Myrick argued.

Should the justices reverse the North Carolina Supreme Court, “it would open up a can of worms and give a green light to all the states that are in need of additional revenues to pass creative tax laws designed to reach out beyond their borders,” Myrick cautioned.

Attorneys for the North Carolina Department of Revenue declined to comment on the case.

But in the agency’s cert petition, it rejected the “formalistic theory” that a trust is distinct from its beneficiaries, as “the fundamental nature of a trust [is] … that [it] exists solely for the benefit of the beneficiary, who holds ‘an actual property interest in the subject matter of the trust.’”

“The Due Process Clause should not have different meanings across nine states, especially when billions of dollars in state-tax revenue hang in the balance,” the Department wrote. “Without guidance from this Court, the split at issue here will continue to worsen, with serious consequences for the states.”

Regardless of the outcome, the Supreme Court’s grant of cert is particularly welcome news for trusts and estates attorneys, Beyer noted, as having a definitive ruling on the issue will allow for easier planning. “A lot of people want to set up trusts in states that don’t have income tax and not worry about where the beneficiary lives,” he explained. “That can get difficult if the beneficiary moves. So this decision will make a big difference.”

Oral argument will be heard in the coming months with a decision expected from the justices by the end of the term in June.


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