The U.S. Supreme Court recently heard oral arguments in a case, North Carolina Department of Revenue v. Kaestner 1992 Family Trust, Docket No. 18-457 (argued on April 16), in which a trust challenged a North Carolina law that taxes resident-beneficiaries on the income earned and retained by a nonresident trust. The trust prevailed at the trial level, appellate level and in the North Carolina Supreme Court, but the U.S. Supreme Court granted the North Carolina Department of Revenue’s petition for a writ of certiorari on the question of whether the due process clause of the Fourteenth Amendment prohibits states from taxing trusts based on trust beneficiaries’ in-state residency. The petitioner asserted that there was a split among the nine states that had considered taxation of trust income based on a beneficiary’s residence and that the split could only be resolved by the Supreme Court. While we await the court’s decision, this case presents an interesting mix of arguments regarding the proper analysis of the minimum contacts inquiry and a public policy appeal by the petitioner to “modernize” trust taxation along the lines of a recent court decision that eliminated the physical-presence requirement in the sales tax context.

General Trust Taxation Rubric

Taxation of income from trusts involves looking at federal law, state law, the language of the applicable trust, and the identity and location of the grantor, trustee, beneficiaries and assets held by the trust. In short, the analysis can be complex. Some states, looking to bring in additional revenue, have passed laws expanding the reach of their power to tax trust beneficiaries. One distinguishing feature of the North Carolina law is that it taxes beneficiaries who have not actually received taxable income from a trust.