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‘Kaestner’ Ruling May Have Only Narrow Impact on Estate Planning

June 24, 2019, 7:09 PM

The Supreme Court’s ruling in a North Carolina tax case was so fact-bound that it may have only a limited impact on estate planning and trust taxation, some tax professionals said.

The case centered around North Carolina’s taxation of the Kimberley Rice Kaestner 1992 Family Trust for over $1.3 million on income between 2005 and 2008 from the trust, which was created in New York and from which there hadn’t been any distributions.

The high court said June 21 that North Carolina couldn’t do it, because the trust’s only connection to the state—the fact that beneficiaries Kaestner and her three children lived there—wasn’t enough of a connection.

“I will say it is about as narrow a decision as one could imagine,” said Alan B. Morrison, a law professor at the George Washington University Law School. Justice Sonia Sotomayor went out of her way to emphasize she wasn’t deciding “anything else about beneficiary taxation,” he said.

Writing for a unanimous court, Sotomayor said the beneficiary’s place of residence wasn’t enough, at least by itself, when the trustee in Connecticut had full discretion over the trust’s assets and didn’t give the beneficiaries any distributions during those years.

Narrow Language

The court’s decision placed a limit on a state’s taxing abilities over trusts: If a state’s only connection is the beneficiary’s place of residence, and if the beneficiary both doesn’t have the right to demand income from the trust and may never get any, the state can’t impose tax payments on income the trust generates.

But the opinion suggests the court wasn’t ready to go beyond those circumstances in restricting state taxing authorities, at least for now.

North Carolina is “one of a small handful” of states that only look to a beneficiary’s residency before taxing a trust, Sotomayor said. And it is “one of an even smaller number,” she added, that will rely on this residency “regardless of whether the beneficiary is certain to receive trust assets.”

According to Sotomayor, that is all the court was addressing.

“Today’s decision does not address state laws that consider the in-state residency of a beneficiary as one of a combination of factors,” she said. “We express no opinion on the validity of such taxes.”

Michael H. Barker, a partner at McGuireWoods in Richmond, Va., who focuses on tax and estate planning, described the opinion as going “out of its way” to assert its limited scope. “The opinion makes clear that it’s only applying to trusts where the beneficiary is not receiving distributions, has no right to receive distributions, and may never get them,” he said.

Barker suggested practitioners may want to be cautious about predicting what the opinion might mean for other cases.

“All this opinion does is give us rules in North Carolina,” he said.

A Minnesota Case

Given the narrowness of the court’s opinion, what the justices do with a pending Minnesota case could be especially telling.

In Bauerly v. Fielding, Minnesota tried to tax the income of multiple trusts created by the same grantor. William Fielding, a trustee, sued.

The case involves some significant differences from Kaestner. These include that the original grantor was a Minnesota resident, that the trusts at issue were created in Minnesota, that the trusts held stock in a Minnesota S corporation, and that the trust documents provide for Minnesota law to govern questions of law regarding the documents. In addition, as in Kaestner, one beneficiary was a Minnesota resident during the tax year at issue.

The trusts argue they should win because the trustees weren’t Minnesota residents, the trusts weren’t administered in Minnesota, some of the trusts’ income was derived from investments with no direct connection to Minnesota, and three of the four beneficiaries resided outside Minnesota.

The Minnesota Department of Revenue is asking the U.S. Supreme Court to overturn the state Supreme Court’s conclusion that there weren’t enough connections between the trust income and the state to make the tax constitutional.

The high court hasn’t said yet whether it will accept the case.

To contact the reporter on this story: Aysha Bagchi in Washington at abagchi@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Kathy Larsen at klarsen@bloombergtax.com