Skip to Main Content
 

Supreme Court Rules Against North Carolina in Kaestner On State Income Taxation of Trusts: What Does This Mean for the District of Columbia, Virginia, and Maryland?

June 26, 2019

A landmark Supreme Court decision decided last week calls into question the constitutionality of local (District of Columbia, Maryland, and Virginia) fiduciary income tax regimes. Many trusts that have been treated as “resident trusts” – and thus subject to tax in the state on all of the trust’s undistributed income, wherever sourced – because of the residence of the settlor, now have fertile grounds to challenge the constitutionality of the local taxation regimes.

On June 21, the Supreme Court unanimously decided in favor of the taxpayer in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust. The Kaestner Trust challenged North Carolina’s law taxing undistributed trust income on the basis of the beneficiaries’ place of residence. The Supreme Court held that “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 ever to receive it.” Slip Op. at 7. While the Supreme Court was careful to limit the holding to its facts, the Court’s analysis calls into question many state statutes for taxing the income of trusts, including our local regimes.

None of our local jurisdictions purport to tax trusts as residents due to the residence of the beneficiaries. Instead, the District of Columbia, Maryland, and Virginia all subject trusts to taxation based on the residency of the settlor, although the particulars vary among jurisdictions.[1]

The Kaestner opinion does not specifically address taxation regimes based on the residence of the settlor. However, it does discuss such regimes in its analysis. The Court notes that “the Due Process Clause demands attention to the particular relationship between the [resident settlor] and the trust assets that the State seeks to tax.” Slip Op. at 10. The opinion notes that previous cases upholding the constitutionality of state taxation regimes based on the settlor’s residence had been decided on facts where the settlor’s relationship with the property included the “power to dispose of” or “revoke” the trust’s assets, such that they were “a potential source of wealth which was property in [the settlor’s] hands.” Slip Op. at 9.

The local taxation statutes are much broader than the facts in the cases cited by the Supreme Court: they would tax resident settlors’ trusts regardless of whether the settlor retained any control over the trusts (or, indeed, is even still living). These statutes may not pass constitutional muster in their current form, particularly as applied to trusts over which the settlor retains no control and that are not administered in the state claiming taxing authority. Several procedural options exist for challenging a state’s taxing authority.

The Kaestner opinion can be found here. Also of interest is Minnesota’s pending petition for certiorari before the Supreme Court in Bauerly v. Fielding. In the decision being challenged, the Minnesota Supreme Court held that Minnesota could not constitutionally tax a trust based on the residence of the settlor in that state; the State appealed. We anticipate that the Court will remand Fielding for reconsideration in light of its Kaestner decision. The status of the certiorari petition in Fielding can be found here.

If you have questions about how the Kaestner opinion affects the tax liability of a particular trust, please contact the authors of this alert or any member of Caplin & Drysdale, Chtd.’s Private Client Group.

Megan E. Wernke
202.862.5088
mwernke@capdale.com 
  Beth Shapiro Kaufman
202.862.5062
bkaufman@capdale.com 
 

[1] In addition, Maryland treats trusts “principally administered” in Maryland as resident trusts. Maryland-Tax General § 10-101(k)(1)(iii)(3). The constitutionality of this basis for taxation is not called into question by Kaestner. See Slip Op. at 6. Although Virginia has previously treated trusts “administered in the Commonwealth” as resident trusts, see Va. Code § 58.1-302, a new law effective July 1, 2019, removed this basis of taxation, see H.B. 2526. The District of Columbia’s only statutory basis for treating a trust as a resident trust is the residence of the settlor.

________________________________________________

About Caplin & Drysdale
Having celebrated our 50th Anniversary in 2014, Caplin & Drysdale continues to be a leading provider of legal services to corporations, individuals, and nonprofits throughout the United States and around the world. We are also privileged to serve as legal advisors to accounting firms, financial institutions, law firms, and other professional services organizations.

The firm's reputation over the years has earned us the trust and respect of clients, industry peers, and government agencies. Moreover, clients rely on our broad knowledge of the law and our keen insights into their business concerns and personal interests. Our lawyers' strong tactical and problem-solving skills -- combined with substantial experience handling a variety of complex, high stakes, matters in a boutique environment -- make us one the nation's most distinctive law firms.

With offices in New York City and Washington, D.C., Caplin & Drysdale's core practice areas include:
For more information, please visit us at www.caplindrysdale.com.
Washington, DC Office:
One Thomas Circle NW
Suite 1100
Washington, DC 20005
202.862.5000
New York, NY Office:
600 Lexington Avenue
21st Floor
New York, NY 10022
212.379.6000

___________________________

Disclaimer
This communication does not provide legal advice, nor does it create an attorney-client relationship with you or any other reader. If you require legal guidance in any specific situation, you should engage a qualified lawyer for that purpose. Prior results do not guarantee a similar outcome.

Attorney Advertising
It is possible that under the laws, rules, or regulations of certain jurisdictions, this may be construed as an advertisement or solicitation.
© 2019 Caplin & Drysdale, Chartered
All Rights Reserved.

Related Professionals

Related Practice Area(s)