Jim Witt—Senior Attorney, National Legal Research Group
In Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, ___ N.C. App. ___, 789 S.E.2d 645, aff'd, ___ N.C. ___, 814 S.E.2d 43 (2018), cert. granted sub nom. North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust, No. 18-457, 2019 WL 166876 (U.S. Jan. 11, 2019) the court addressed the issue of whether North Carolina's taxation under North Carolina General Statutes § 105-160.2 of the income accumulated by the trust in question met the minimum contacts requirement of the Due Process Clause of the Fourteenth Amendment to the U.S. Constitution, where the trust's only connection with North Carolina was the residence and domicile of the beneficiary.
The Trust, the Kaestner 1992 Family Trust, was established by Joseph Lee Rice III, with William B. Matteson as trustee. The situs of the trust was New York. The primary beneficiaries of the trust were the settlor's descendants (none of whom lived in North Carolina at the time of the trust's creation). In 2002, the original trust was divided into three separate trusts: one for each of the settlor's children, with each trust named for a child. At that time, one of the children, Kimberley Rice Kaestner, the beneficiary of the plaintiff Kimberley Rice Kaestner 1992 Family Trust, was a resident and domiciliary of North Carolina. Neither the original trustee nor his successor was a resident of North Carolina. Tax returns were filed in North Carolina on behalf of the Kimberley Rice Kaestner 1992 Family Trust for tax years 2005-2008 for income accumulated by the Trust but not distributed to a North Carolina beneficiary. In 2009, representatives of the Trust filed a claim for a refund of taxes paid to the Department of Revenue (the “Department”) amounting to $1,303,172.00, for those same tax years.
The superior court dismissed the case on procedural grounds but denied the Department's motion to dismiss the Trust's constitutional claims. Both sides moved for summary judgment. The Department relied on and quoted from a Connecticut case, Chase Manhattan Bank v. Gavin, 249 Conn. 172, 733 A.2d 782, cert. denied, 528 U.S. 965 (1999):
"[J]ust as the state may tax the undistributed income of a trust based on the presence of the trustee in the state because it gives the trustee the protection and benefits of its laws; it may tax the same income based on the domicile of the sole noncontingent beneficiary because it gives her the same protections and benefits."
Kaestner, ___ N.C. App. at ___, 789 S.E.2d at 647 (Department's emphasis) (quoting Gavin, 249 Conn. at 204, 733 A.2d at 802 ). The superior court granted the Trust's motion for summary judgment and denied the Department's motion.
The North Carolina Court of Appeals affirmed, citing the unchallenged finding of fact that the Trust did not maintain a physical presence in North Carolina during the years in question: It never owned real property located in North Carolina and never directly had any North Carolina investments. Also, the principal place of the Trust's administration was not North Carolina and no Trust records were kept there.
The Department again relied on Gavin, and also cited a California case, McCulloch v. Franchise Tax Board, 61 Cal. 2d 186, 390 P.2d 412 (1964). In both of those cases, the state appellate court noted that in Greenough v. Tax Assessors, 331 U.S. 486 (1947), the U.S. Supreme Court upheld the taxation of trust income based on the domicile of the trustee. In both Gavin and McCulloch, the courts reasoned that, similar to the benefits and protections provided by a state to a trustee, the state of the beneficiary's domicile provided benefits and protections sufficient to satisfy the minimum contacts criteria of due process for taxation of the trust. The Trust argued that the Department's contention contradicted the point made by the U.S. Supreme Court in Anderson v. Wilson, 289 U.S. 20 (1933):
"[W]e do not forget that the trust is an abstraction, . . . [and] the law has seen fit to deal with this abstraction for income tax purposes as a separate existence, making its own return under the hand of the fiduciary and claiming and receiving its own appropriate deductions."
Kaestner, ___ N.C. App. at ___, 789 S.E.2d at 650 (quoting Anderson, 289 U.S. at 27). The court of appeals in Kaestner found the U.S. Supreme Court decision in Brooke v. Norfolk, 277 U.S. 27 (1928), controlling. In that case, the City of Norfolk and the State of Virginia assessed taxes on the corpus of a trust created by a Maryland resident. The petitioner, a beneficiary of the trust, who was a Virginia resident, argued that the direction in the trust to the Maryland trustee to pay the income of the trust to the petitioner for life did not satisfy the minimal contacts requirement. The Court adopted the petitioner's position. The court of appeals in Kaestner, stated:
The strong similarities between the facts in Brooke and the instant case cannot be ignored. While the trust in Brooke was a testamentary trust and the Trust here an inter vivos trust, both were created and governed by laws outside of the state assessing a tax upon the trust. The trustee for both trusts resided outside of the state seeking to tax the trust. The beneficiary of the trust who resided within the taxing state had no control over the trust during the period for which the tax was assessed. And, the trusts did not own property in the taxing state. In the instant case, the Trust's beneficiary did not receive a taxable distribution from the Trust during the years for which the Department has assessed a tax.
___ N.C. App. at ___, 789 S.E.2d at 650-51.
The court expressly declined to accept the holdings in the Connecticut case, Gavin, and the California case, McCulloch, as persuasive authority to the contrary. The Supreme Court of North Carolina agreed with the court of appeals that the Gavin and McCulloch cases were not persuasive, stating that
The Court in Gavin erroneously failed to consider that a trust has a legal existence apart from the beneficiary and that, consequently, for taxation to satisfy due process pursuant to Quill, the trust itself must have "some definite link, some minimum connection" with the taxing state by "purposefully avail[ing] itself of the benefits of an economic market" in that state. Quill, 504 U.S. [298,] 306-07, 112 S. Ct. [1904,] 1909-10 [(1992)]. . . .
. . . [W]e find McCulloch to be factually distinguished from the present case because the taxed entity in that case was both a beneficiary and a trustee of the trust and also resided in the taxing jurisdiction. Indeed, in holding that the taxes at issue did not violate due process, the Court in McCulloch particularly relied on the fact that the trustee was a domiciliary of the taxing jurisdiction.
Kaestner, ___ N.C. at ___, 814 S.E.2d at 49-50
The supreme court cited other cases in which the reasoning in Gavin and McCulloch was rejected. See Linn v. Dep't of Revenue, 2013 IL App (4th) 121055, 2 N.E.3d 1203, appeal dismissed, 22 N.E.3d 1165 (Ill. 2014); Fielding v. Comm'r of Revenue, No. 8911-R, 2017 WL 2484593 (Minn. T.C. filed May 31, 2017); Residuary Trust A v. Div. of Taxation, 27 N.J. Tax 68 (2013).