Kaestner wins, Fielding Denied: What we can learn when analyzed together. 

On June 21, 2019, in North Carolina v. Kimberley Rice Kaestner 1992 Family Trust, Docket No. 18–457, the United States Supreme Court (SCOTUS) ruled that the residency of a beneficiary in a U.S. state alone was not sufficient nexus (connection) for a state to tax the undistributed net income of a trust. 

Many commentators have written about the case and its implications. However,  SCOTUS declining the writ of certiorari to Minnesota’s Fielding case right after deciding on Kaestner should not be overlooked.

Declining to Hear Fielding

By refusing to grant a writ of certiorari in Fielding, et al. v. Commissioner of Revenue, 916 N.W.2d 323 (Minn. 2018), the Minnesota Supreme Court’s decision in favor of Fielding remains. It is still unconstitutional to tax a trust solely based on grantor residency at the time the trust became irrevocable.

As applied to the Fielding trusts, the nexus between the state and the trust is not substantial enough to warrant state taxation. 

Two States Impact Our Entire Country

While some analysts believe the Kaestner decision was relatively narrow, the implications of both cases combined are broad, likely resulting in trust taxation changes in North Carolina and Minnesota. However, the implications extend to many other states limiting a state’s ability to tax undistributed income held within trusts.

It’s unlikely that SCOTUS will entertain another trust taxation case anytime soon. It’s now up to the state courts to interpret Kaestner and make the appropriate amendments to their laws.

North Carolina and Minnesota and states with similar tax laws have many estate planning opportunities even before states’ legislatures act.

But where will the lines be drawn? 

Comparing Kaestner and Fielding

First, let’s take a look at the facts in the two cases. Kaestner and Fielding have distinctly different fact patterns, as shown below.

  Kaestner Fielding
Residence of the Grantor New York Minnesota
Trustee Not a North Carolina resident Not Minnesota residents
Trust law New York Minnesota
Trustee physical presence None in North Carolina None in Minnesota
Beneficiaries North Carolina Three of the four beneficiaries lived outside of Minnesota
Trust Documents and records New York Colorado
Trust Established in New York Minnesota
Asset Custody Massachusetts Outside of Minnesota
Direct in-state investments None in North Carolina Included an MN S Corp
Physical Property None in North Carolina None in Minnesota
Pre-case Taxation: Only while a beneficiary was an N.C. resident If established as a resident trust, the trust would have been taxed in Minnesota for its entire existence

 

Broad or Narrow Implications? You Decide.

In Kaestner, the only connection to North Carolina is the beneficiary’s residence in the state. SCOTUS ruled that having a beneficiary in the state was not sufficient to tax the trust.

In the Fielding case, the Minnesota Supreme Court ruled that despite additional connections there was not sufficient nexus to permit Minnesota to tax the undistributed net income of a trust.

The United States Supreme Court’s decision in Kaestner was decided somewhat narrowly.

The Court relied on three key facts concerning the beneficiary in North Carolina:

“First, the beneficiaries did not receive any income from the Trust during the years in question. Second, they had no right to demand Trust income or otherwise control, possess, or enjoy the Trust assets in the tax years at issue. Third, they also could not count on necessarily receiving any specific amount of income from the Trust in the future.”

It is not entirely clear how SCOTUS might decide a case where the beneficiary received some distributions from a trust. It’s also unclear what a case decision would be if it had trust terms that permitted more control over the trust. It’s unknown whether the beneficiary would receive some or all of the corpus from the trust in the future.

The Kaestner decision does not address whether a beneficiary’s ability to assign a potential interest in the income from a trust would afford that beneficiary sufficient control or possession over the trust. It also does not address whether the beneficiaries were guarenteed to receive funds (or enjoyment of the property) in the future to justify North Carolina’s taxation based solely on the beneficiary’s in-state residence. 

Finally, SCOTUS did not consider the trust’s broader argument that the trustee’s contacts alone determine the state’s power over the trust.

In contrast, declining the Fielding writ and allowing the Minnesota Supreme Court decision to stand suggests that the location of the trustee (not the location of the grantor) is most relevant in determining the domicile of a trust.

Will Minnesota follow Michigan?

Bill Lunka, the founder of SALT Partners, a state and local tax consulting firm in Minneapolis, said:

 “Now that the U.S. Supreme Court has denied review of the Fielding case, it is a good time for trustees and their advisors to consider filing claims for refund for those trusts that had Minnesota residents at the time the trust became irrevocable. 

There may also be opportunities to file claims for refunds in North Carolina and other states provided that the beneficiaries are similarly situated to the beneficiaries in the Kaestner case. The combination of the Kaestner and Fielding decisions suggest that the location of the trustee will be most relevant in determining where a trust is domiciled.”

Mr. Lunka further noted, “It is possible that Minnesota will follow, at least for now, Michigan’s lead on using administrative, rather than legislative, tools to change trust taxation. Given the current environment in the Minnesota Legislature where the Democrats control the House of Representatives (and the governor’s office), and the Republicans control the Senate, it may not be easy for the Minnesota Department of Revenue to get legislation passed to change the definition of a resident trust. 

Because Fielding found that the Minnesota definition of resident trust was unconstitutional only as applied to the Fielding trusts, the definition currently in Minnesota law still stands because the Minnesota Supreme Court did rule that the definition facially violated the Due Process Clause. 

Therefore, the Minnesota Department of Revenue can continue to apply the definition of a resident trust in Minnesota for other taxpayers. Of course, the Department is likely to continue to receive claims for refund for those trust that irrevocable while the grantor was a Minnesota resident, and they will review those on a case-by-case basis until legislation can be passed, or then issue guidance.”

The Current Trust Climate According to Michael Redden of Redden Law

Trusts are becoming more like corporations and the implications of that, such as taxes, must be considered. Michael Redden of Redden Law provides the following insight:

“Trusts are going to be treated more like corporations now. Corporations, though fictional, are treated like people and have their own rights. The trust and estates in our country have not been discussed in this context much until recently. For corporations, there are many wide implications. The most obvious implication for trusts is for taxation. 

Here, the U.S. Supreme Court has recognized that trusts have the same rights as individuals. A state must be able to get personal jurisdiction over an individual to tax that person or exercise any power over them. The same is now true for a trust. I predict that we will continue to explore how the personhood of trusts affect other policies in the future. This is especially true since dynastic trust planning is becoming more and more common.

The U.S. Supreme Court, in Kaestner, alluded to the Fielding case when it limited its opinion. The Court likely sees that there are many more circumstances that might need review. By limiting the opinion, the Court likely expects to hear more about these situations. The Minnesota law is different than North Carolina’s. 

By focusing so much on the grantor, it creates many more factual situations that are not as clear cut at Kaestner. In short, it is prone to more grey areas. I agree that the Court should have declined to hear the case. The Minnesota Supreme Court used the same line of analysis when it decided Fielding. The result is one that the Court would likely have upheld.

For now, all taxpayers and their advisors and lawyers should consider how a trust that is sitused in Nevada, South Dakota, or another taxpayer-friendly jurisdiction might help. The worst case scenario is that you will pay taxes at the same rate that you pay now. The best case is that you might end up with a much lower tax burden in the future. It is also very attractive since these same jurisdictions also have special trusts for asset protection.”

 

Estate Planning Strategies Practitioners Should Consider

Those filing refunds for applicable trusts with Minnesota grantors or North Carolina beneficiaries should consult their advisors. It’s important to discuss whether a case could be due refunds for relevant tax years.

It will be interesting to see if taxpayers in other states will use these precedents to challenge their statutes.

Decanting Trusts

For existing trusts, practitioners should look for decanting opportunities to states like Nevada, that have no income tax. Note that Nevada trust laws may provide additional benefits for asset protection and dynasty provisions as well.

Create Your Own Facts

Residents in states outside of Minnesota and North Carolina will benefit from careful planning by structuring around the rulings in Kaestner and Fielding.

Rulings in both cases focus on two key factors: the importance of the trustee’s domicile and not having physical property in the trust.

Develop Flexibility

You can build flexibility, including trust protectors, into a trust structure, even if the facts or laws will change in the future. However, practitioners should be careful. It’s possible to give too much power to an in-state trust protector and create a nexus to state taxation.

Carefully Select Trustees

Pick your trustee carefully! A trustee’s connections to your state can tip the scales in the eyes of the revenue authorities.

Practitioners should consider out-of-state trust companies as part of their process. It’s crucial to be mindful of out-of-state companies that have a significant presence in your state too.

Connections to the state may be scrutinized by state taxation authorities to meet “minimum connection” standards and tax the trust.

SCOTUS may take on another case in the future, which would clarify what connections with a state are necessary before a state can tax a trust. Until then, it’s best to be careful.

Employ Discretionary Trusts

The Kaestner decision was very explicit in favoring discretionary trusts. Practitioners should include a spendthrift clause, which prevents a beneficiary from assigning their interest, in their trust documents.

Conclusion

While Minnesota and North Carolina will need to redo trust taxation codes to comply with the two rulings, there are implications and opportunities in most states. We anticipate a lively dialogue in Minnesota and North Carolina governments to create respective new trust taxation structures.

Will other state tax codes be challenged by new precedents set in Kaestner and Fielding? Our guess is yes. It’s also likely that many states will experience a large volume of refund claims filed in light of the Kaestner decision.

While those challenges and discussions are occurring, we would encourage practitioners to evaluate their existing trust structures carefully. The imminent advantages (beyond the current benefits) of utilizing out-of-state trust structures are likely ideal for many clients. 

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