Supreme Court Review of Trust Nexus Tax Case May Affect Many States

In an important state tax nexus case (North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, Dkt. 18-457), the U.S. Supreme Court agreed to review whether Due Process allows North Carolina to tax the income of out-of-state trusts based only on beneficiaries who are residents in the state.

But the Supreme Court’s action will likely have an impact well beyond North Carolina, as a number of other states also have nexus provisions allowing them to impose tax based on a trust’s in-state beneficiaries.

Further, if the Supreme Court finds North Carolina’s imposition of tax to be permissible in this case, other states may amend their laws to impose tax on out-of-state trusts in a similar way.

In its petition to the Supreme Court, North Carolina highlighted the significance of the issue, noting that income flowing through trusts (more than $120 billion) is a vital source of tax revenue for the states.

North Carolina Supreme Court’s Decision on Due Process

The Kaestner Trust case involves a New York trust whose only contact with North Carolina was its resident beneficiaries. North Carolina imposed tax on the trust’s undistributed income held for the benefit of the beneficiaries.

The North Carolina Supreme Court issued a decision concluding that the law violated the trust’s Due Process rights because the trust did not have sufficient minimum contacts with the state.

Split Among State Court Decisions

State courts have reached different conclusions about whether Due Process prohibits trust taxation under these circumstances.

According to North Carolina’s petition, there are four states where courts have concluded (or suggested) that a beneficiary’s residency can support the imposition of tax on the trust’s income:

  • California
  • Connecticut
  • Illinois
  • Missouri

On the other hand, court decisions in several states, including Minnesota, New Jersey, and New York (as well as North Carolina), have indicated that such taxation violates Due Process.

In the Minnesota case (Bauerly v. Fielding, Dkt. 18-664), the state has also asked for review by the U.S. Supreme Court.

By Brian Plunkett, J.D.

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All stories by: CCHTaxGroup