On Friday, June 21st, the U.S. Supreme Court ruled in favor of the Kimberley Rice Kaestner 1992 Family Trust and held that states cannot tax trust income that hasn’t been distributed to beneficiaries if the sole connection to the state is a resident beneficiary.
In the decision, Justice Sonia Sotomayor wrote “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 ever receive it.”
So, what does this mean?
Nexus, or sufficient presence to be subject to tax, for a trust can be established in several ways and the rules vary from state to state. For instance, states may look to the residency of the grantor at the time the trust was created, where the trustee is located, where the administration of the trust occurs, or if the trust owns property in the state. In the case of the Kaestner Trust, North Carolina looked to the residency of the beneficiary.
From 2005 to 2008, North Carolina assessed more than $1.3 million in tax on the Kaestner Trust’s income. NC took the position that it could tax all the income of the Kaestner Trust solely because the beneficiary, Kimberley Rice Kaestner, resided in NC, even though she was not entitled to nor did she receive distributions from the Trust.
In addition to Kimberley Kaestner not receiving distributions, the Trust’s grantor was a New York resident when the trust was created, the initial trustee was located in NY, and the successor trustee was located in Connecticut. Accordingly, all administration of the Trust took place outside of NC. The only “connection” to NC was Kimberley Kaestner’s residing there, which the Court ruled to be insufficient to establish nexus.
The Kaestner Trust case is not an anomaly. There have been several cases in recent years related to state tax nexus which have made it important to review the tax situs of some trusts. It may be possible to change a trust’s tax situs to a lower tax jurisdiction due to the death of the trust grantor, a change in the domicile of the grantor or the trustee, or due to a change in state source income such as the trust no longer owning income-producing property in a certain state.
The facts and circumstances for each trust are very different and should be reviewed carefully in connection with the law of each relevant state. Reach out to the The Tax Warriors® at Drucker & Scaccetti if you think you have a trust whose tax situs should be reviewed. We’d be happy to assist in state tax planning for your trust.
**Interestingly, on the flip side of the physical presence argument, the Kaestner decision came exactly one year after the Court’s landmark Wayfair decision in which it ruled that physical presence was not necessary to establish nexus and require out-of-state sellers to collect sales tax.