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North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust

United States Supreme Court

June 21, 2019

NORTH CAROLINA DEPARTMENT OF REVENUE, PETITIONER
v.
THE KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST

          Argued April 16, 2019

          ON WRIT OF CERTIORARI TO THE SUPREME COURT OF NORTH CAROLINA

         Joseph Lee Rice III formed a trust for the benefit of his children in his

home State of New York and appointed a fellow New York resident as the trustee. The trust agreement granted the trustee "absolute discretion" to distribute the trust's assets to the beneficiaries. In 1997, Rice's daughter, Kimberley Rice Kaestner, moved to North Carolina. The trustee later divided Rice's initial trust into three separate sub-trusts, and North Carolina sought to tax the Kimberley Rice Kaestner 1992 Family Trust (Trust)-formed for the benefit of Kaestner and her three children-under a law authorizing the State to tax any trust income that "is for the benefit of a state resident, N. C. Gen. Stat. Ann. §105-160.2. The State assessed a tax of more than $1.3 million for tax years 2005 through 2008. During that period, Kaestner had no right to, and did not receive, any distributions. Nor did the Trust have a physical presence, make any direct investments, or hold any real property in the State. The trustee paid the tax under protest and then sued the taxing authority in state court, arguing that the tax as applied to the Trust violates the Fourteenth Amendment's Due Process Clause. The state courts agreed, holding that the Kaestners' in-state residence was too tenuous a link between the State and the Trust to support the tax.

         Held: The presence of in-state beneficiaries alone does not empower

a State to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain to receive it. Pp. 5-16.
(a) The Due Process Clause limits States to imposing only taxes that "bea[r] fiscal relation to protection, opportunities and benefits given by the state." Wisconsin v. J. C. Penney Co., 311 U.S. 435, 444. Compliance with the Clause's demands "requires some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax," and that "the 'income attributed to the State for tax purposes ... be rationally related to "values connected with the taxing State, "'" Quill Corp. v. North Dakota, 504 U.S. 298, 306. That "minimum connection" inquiry is "flexible" and focuses on the reasonableness of the government's action. Id., at 307. Pp. 5-6.
(b) In the trust beneficiary context, the Court's due process analysis of state trust taxes focuses on the extent of the in-state beneficiary's right to control, possess, enjoy, or receive trust assets. Cases such as Safe Deposit & Trust Co. of Baltimore v. Virginia, 280 U.S. 83; Brooke v. Norfolk, 277 U.S. 27; and Maguire v. Trefry, 253 U.S. 12, reflect a common principle: When a State seeks to base its tax on the in-state residence of a trust beneficiary, the Due Process Clause demands a pragmatic inquiry into what exactly the beneficiary controls or possesses and how that interest relates to the object of the State's tax. Safe Deposit, 280 U.S., at 91. Similar analysis also appears in the context of taxes premised on the in-state residency of settlors and trustees. See, e.g., Curry v. McCanless, 307 U.S. 357. Pp. 6-10.
(c) Applying these principles here, the residence of the Trust beneficiaries in North Carolina alone does not supply the minimum connection necessary to sustain the State's tax. First, the beneficiaries did not receive any income from the Trust during the years in question. Second, they had no right to demand Trust income or otherwise control, possess, or enjoy the Trust assets in the tax years at issue. Third, they also could not count on necessarily receiving any specific amount of income from the Trust in the future. Pp. 10-13.
(d) The State's counterarguments are unconvincing. First the State argues that "a trust and its constituents" are always "inextricably intertwined," and thus, because trustee residence supports state taxation, so too must beneficiary residence. The State emphasizes that beneficiaries are essential to a trust and have an equitable interest in its assets. Although a beneficiary is central to the trust relationship, the wide variation in beneficiaries' interests counsels against adopting such a categorical rule. Second, the State argues that ruling in favor of the Trust will undermine numerous state taxation regimes. But only a small handful of States rely on beneficiary residency as a sole basis for trust taxation, and an even smaller number rely on the residency of beneficiaries regardless of whether the beneficiary is certain to receive trust assets. Finally, the State urges that adopting the Trust's position will lead to opportunistic gaming of state tax systems. There is no certainty, however, that such behavior will regularly come to pass, and in any event, mere speculation about negative consequences cannot conjure the "mini- mum connection" missing between the State and the object of its tax. Pp. 13-16.

371 N. C. 133, 814 S.E.2d 43, affirmed.

          SOTOMAYOR, J., delivered the opinion for a unanimous Court. ALITO, J., filed a concurring opinion, in which ROBERTS, C. J., and GORSUCH, J., joined.

          OPINION

          SOTOMAYOR JUSTICE.

         This case is about the limits of a State's power to tax a trust. North Carolina imposes a tax on any trust income that "is for the benefit of" a North Carolina resident. N. C. Gen. Stat. Ann. §105-160.2 (2017). The North Carolina courts interpret this law to mean that a trust owes income tax to North Carolina whenever the trust's beneficiaries live in the State, even if-as is the case here-those beneficiaries received no income from the trust in the relevant tax year, had no right to demand income from the trust in that year, and could not count on ever receiving income from the trust. The North Carolina courts held the tax to be unconstitutional when assessed in such a case because the State lacks the minimum connection with the object of its tax that the Constitution requires. We agree and affirm. As applied in these circumstances, the State's tax violates the Due Process Clause of the Fourteenth Amendment.

         I

         A

         In its simplest form, a trust is created when one person (a "settlor" or "grantor") transfers property to a third party (a "trustee") to administer for the benefit of another (a "beneficiary"). A. Hess, G. Bogert, & G. Bogert, Law of Trusts and Trustees §1, pp. 8-10 (3d ed. 2007). As traditionally understood, the arrangement that results is not a "distinct legal entity, but a 'fiduciary relationship' between multiple people." Americold Realty Trust v. ConAgra Foods, Inc., 577 U.S.__, __(2016) (slip op., at 5). The trust comprises the separate interests of the beneficiary, who has an "equitable interest" in the trust property, and the trustee, who has a "legal interest" in that property. Greenough v. Tax Assessors of Newport, 331 U.S. 486, 494 (1947). In some contexts, however, trusts can be treated as if the trust itself has "a separate existence" from its constituent parts. Id., at 493.[1]

         The trust that challenges North Carolina's tax had its first incarnation nearly 30 years ago, when New Yorker Joseph Lee Rice III formed a trust for the benefit of his children. Rice decided that the trust would be governed by the law of his home State, New York, and he appointed a fellow New York resident as the trustee.[2] The trust agreement provided that the trustee would have "absolute discretion" to distribute the trust's assets to the beneficiaries "in such amounts and proportions" as the trustee might "from time to time" decide. Art. I, §1.2(a), App. 46-47.

         When Rice created the trust, no trust beneficiary lived in North Carolina. That changed in 1997, when Rice's daughter, Kimberley Rice Kaestner, moved to the State. She and her minor children were residents of North Carolina from 2005 through 2008, the time period relevant for this case.

         A few years after Kaestner moved to North Carolina, the trustee divided Rice's initial trust into three subtrusts. One of these subtrusts-the Kimberley Rice Kaestner 1992 Family Trust (Kaestner Trust or Trust)-was formed for the benefit of Kaestner and her three children. The same agreement that controlled the original trust also governed the Kaestner Trust. Critically, this meant that the trustee had exclusive control over the allocation and timing of trust distributions.

         North Carolina explained in the state-court proceedings that the State's only connection to the Trust in the relevant tax years was the in-state residence of the Trust's beneficiaries. App. to Pet. for Cert. 54a. From 2005 through 2008, the trustee chose not to distribute any of the income that the Trust accumulated to Kaestner or her children, and the trustee's contacts with Kaestner were "infrequent."[3] 371 N. C. 133, 143, 814 S.E.2d 43, 50 (2018). The Trust was subject to New York law, Art. X, App. 69, the grantor was a New York resident, App. 44, and no trustee lived in North Carolina, 371 N. C, at 134, 814 S.E.2d, at 45. The trustee kept the Trust documents and records in New York, and the Trust asset custodians were located in Massachusetts. Ibid. The Trust also maintained no physical presence in North Carolina, made no direct investments in the State, and held no real property there. App. to Pet. for Cert. 52a-53a.

         The Trust agreement provided that the Kaestner Trust would terminate when Kaestner turned 40, after the time period relevant here. After consulting with Kaestner and in accordance with her wishes, however, the trustee rolled over the assets into a new trust instead of distributing them to her. This transfer took place after the relevant tax years. See N.Y.Est., Powers & Trusts Law Ann. §10- 6.6(b) (West 2002) (authorizing this action).

         B

         North Carolina taxes any trust income that "is for the benefit of" a North Carolina resident. N. C. Gen. Stat. Ann. §105-160.2. The North Carolina Supreme Court interprets the statute to authorize North Carolina to tax a trust on the sole basis that the trust beneficiaries reside in the State. 371 N. C, at 143-144, 814 S.E.2d, at 51.

         Applying this statute, the North Carolina Department of Revenue assessed a tax on the full proceeds that the Kaestner Trust accumulated for tax years 2005 through 2008 and required the trustee to pay it. See N. C. Gen. Stat. Ann. §105-160.2. The resulting tax bill amounted to more than $1.3 million. The trustee paid the tax under protest and then sued in state court, arguing that the tax as applied to the Kaestner Trust violates the Due Process Clause of the Fourteenth Amendment.

         The trial court decided that the Kaestners' residence in North Carolina was too tenuous a link between the State and the Trust to support the tax and held that the State's taxation of the Trust violated the Due Process Clause. App. to Pet. for Cert. 62a.[4] The North Carolina Court of Appeals affirmed, as did the North Carolina Supreme Court. A majority of the State Supreme Court reasoned that the Kaestner Trust and its beneficiaries "have legally separate, taxable existences" and thus that the contacts between the Kaestner family ...


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