Trusts and Estates

Ca. Trs. & Estates Quarterly 2019, Volume 25, Issue 4

DOES KAESTNER HAVE ANY RELEVANCE FOR THE TAXATION OF TRUSTS IN CALIFORNIA?

By Paul N. Frimmer, Esq.*

In a unanimous decision, the United States Supreme Court in North Carolina Dept. of Revenue v. Kimberly Rice Kaestner 1992 Family Trust1 held that a state could not tax non-state source income of a trust if the trust’s only contact with the state was the residence of a beneficiary who did not receive any distributions in the tax years in question. The facts in Kaestner are quite simple, and sharply focus the issue.

The Kaestner trust was created by a New York resident and was governed by New York law. The trust was not a "grantor" trust and thus was a separate taxpayer under federal tax law. The trustee was never a North Carolina resident (for the years in question, the trustee was a Connecticut resident working in New York), and the assets of the trust were located in Massachusetts. The trustee had complete discretion over whether, and in what amounts and proportions, to make distributions to the beneficiaries. All of the income of the trust was from non-North Carolina sources. When the trust was created, none of the beneficiaries lived in North Carolina. However, several years later the beneficiaries of the trust moved to North Carolina. During the years covered by the case, no distributions were made to any beneficiaries.

North Carolina law provides that the undistributed income of an out-of-state trust is taxed by North Carolina if a beneficiary of the trust resides in that state. The trust challenged the constitutionality of the application of this law on these facts. The North Carolina courts held for the taxpayer, finding that the North Carolina taxing statute was in violation of the due process clause of the United States Constitution. They held that if the only connection of the trust with North Carolina is the residence of a trust beneficiary, that connection was not a constitutionally sufficient nexus to impose North Carolina’s income tax on the accumulated income of the trust.

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