A state cannot tax trust income solely based on an in-state residency of a beneficiary

On June 21, 2019, the U.S. Supreme Court issued its unanimous opinion for North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust. The Court held that the Due Process Clause of the U.S. Constitution bars a state from taxing undistributed trust income when a trust’s sole connection to the state is the presence of in-state beneficiaries. The North Carolina statute imposes tax on any trust income that is for the benefit of a North Carolina resident. The state’s Department of Revenue relied on this law to tax the income from a trust solely because the beneficiaries were residents of the state. Facts were (1) the trust was formed and administered outside of the state, (ii) the trustee resided outside of the state, (iii) the trust made no direct investment in the state, and (iv) the trust did not distribute any funds to the beneficiaries of the state.

Is this rule a new opportunity for state income tax planning? It likely may be. If a trust strategically delays distribution of its funds to a beneficiary who currently resides in a state with income tax until the beneficiary relocates to a state where no state income tax is imposed, the beneficiary may legitimately avoid state income tax on its trust income. The Court’s opinion in Kaestner is narrow. In order to rely on the Kaestner position, all conditions must meet. Please consult an attorney before embracing a new state income tax planning.