To Tax or Not to Tax: State Income Tax on Trusts After North Carolina Department of Revenue v. the Kimberley Rice Kaestner 1992 Family Trust
| Publication year | 2020 |
| Pages | 0026 |
To Tax or Not to Tax: State Income Tax on Trusts After North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust
This article explains trust taxation, North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, planning tips and points to consider when drafting trusts.
BY BETH GILCHRIST
With the upcoming 2020 presidential election and the possible decrease in the federal estate tax exemption, Georgia attorneys should pay close attention to the changing trust laws to maximize the tax benefits for their clients and themselves. Currently, a Georgia resident can pass away with under $11,400,000 in countable assets and avoid paying an estate tax. (Georgia does not have an estate tax. $11,400,000 is the federal exemption, and people passing away with property in more than one state may have estate tax repercussions in those additional states.) Because this amount is the highest the estate tax has ever been, many Georgians have not had to do estate tax planning in recent years. However, this exemption is likely to decrease, and tax planning techniques, like trusts, will become more commonplace. An irrevocable trust is one planning tool, and a recent case warns attorneys to craft language carefully to avoid subjecting a trust to an income tax in more than one state, especially when the trust does not distribute income.
People with enough assets to have an estate tax problem typically name a corporate trustee. Although Georgia has average trust laws, a corporate trustee usually moves the trust corpus to another state with more favorable tax laws, like Tennessee. As a result, knowing what the U.S. Supreme Court permits and how Georgia treats taxation of trusts with non-resident fiduciaries is essential to drafting well-planned trust language and appropriately achieving a client's goals. This article explains trust taxation, North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust,[1] planning tips and points to consider when drafting trusts.
Trust income in the United States totals billions of dollars each year.[2] States have generally taxed trust income based on one or more of the following criteria: (1) the trust creator's residency;[3] (2) the beneficiary's residency;[4] or (3) the trustee's residency.[5] This variation has subjected some trusts to taxation in multiple states, while other trusts have operated tax-free (although the latter is harder to achieve). The U.S. Supreme Court clarified part of this issue in its recent case, North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust,[6] which related to undistributed trust income that resulted in the state's claim of $1.3 million in taxes.[7]
In Kaestner, a New York resident created a trust under New York law in 1992.[8] The initial Trustee resided in New York, but a Connecticut Trustee was later ap-pointed.[9] The beneficiaries of the trust were the Settlor's children,[10] and in 2006, the Trustee divided the trust into three separate trusts, one for each child.[11] In 1997, one of the beneficiaries, Kimberley Rice Kaestner (Rice), moved to North Carolina.[12] The trust for the benefit of Rice[13] provided that the Connecticut Trustee could distribute money to Rice "in such amounts and proportions" as the Trustee, in its "absolute discretion," decided "from time to time."[14] This discretionary distribution language was a decisive factor in the Court's decision, and from 2005 to 2008, the Trustee did not make any distributions. The state of North Carolina sought to tax the undistributed income from Rice's trust.[15]
The Court held that a state cannot tax undistributed trust income solely based on a beneficiary's in-state residency as applied to Kaestner's particular set of facts.[16] In arriving at its holding, the Court applied the Due Process Clause of the United States Constitution,[17] which creates ambiguity for how the Court's holding might apply to other situations. Under the Due Process Clause, the federal government provides limits for how states may structure their tax systems.[18] Primarily, a "minimum connection" must exist between the state and the asset being taxed.[19] Prior to Kaestner, states lacked a bright-line rule for how to define the minimum connection required for intangible assets, like those held in trust. After Kaestner, the test for the "minimum connection" needed for a trust beneficiary living in a particular state became whether that beneficiary has the right to "control, possess, or enjoy" the...
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