Minnesota and North Carolina appeal to the Supreme Court in Trust Taxation Cases

The United States Supreme Court will review two petitions for a writ of certiorari from the states of North Carolina and Minnesota. Both states lost cases in their respective State Supreme Courts where the state laws were deemed in violation of the United States Constitution under Due Process Clause. Both states have appealed to the U.S. Supreme court for review.

A Breakdown of the Original Cases

Case 1: North Carolina

The Case: North Carolina Department of Revenue, Petitioner v. The Kimberly Rice Kaestner 1992 Family Trust Current North Carolina Practice: North Carolina taxes trusts based on beneficiary residency. The Original Conclusion: “The North Carolina Supreme Court concluded that a trust and its beneficiaries are legally separate – in other words, that beneficiaries are outsiders to a trust. On that basis, that majority (of the NC Supreme Court) expressly disregarded the trust beneficiaries’ in-state residency and other contacts with North Carolina. That analysis led the majority to conclude that the trust at issue lacked a constitutionally sufficient connection with the state.”

Click here to view the case filings.

Case 2: Minnesota

The Case: Cynthia Bauerly, Commissioner, Minnesota Department of Revenue, Petitioner v. William Fielding, Trustee of the Reid and Ann MacDonald Irrevocable GST Trust for Maria V. Macdonald, et al. Current Minnesota Practice: Minnesota taxes trusts based on the residency of the grantor when the trust becomes irrevocable. The Original Conclusion: “The grantor’s connections to Minnesota are not relevant to the relationship between the trust’s income that Minnesota seeks to tax and the protection and benefits Minnesota provided to the trusts’ activities that generated that income. The relevant connections are Minnesota’s connection to the trustee, not the connection to the grantor who established the trust years earlier. A trust is its own legal entity, with a legal existence that is separate from the grantor or the beneficiary. Nor did the court find the grantor’s decision to use a Minnesota law firm to draft the trust documents to be relevant. Thus, the grantor Reid MacDonald is not the taxpayer, the trusts are.”

Click here to view the case filings.

What Are the States Asking For?

Both states believe they have the right to tax the trusts under due process clause, given legal abstractions of trusts. The Minnesota Supreme Court concluded that the trust is separate from the Grantor, but the connections between Grantor and the state of Minnesota were not sufficient to tax the trust. Similarly, the North Carolina Supreme Court ruled that a beneficiary and a trust are legally separate and the connection between the beneficiary and the state of North Carolina are not enough to tax the trust.

The question presented by the State of Minnesota: Does the Due Process Clause prohibit states from imposing income taxes on statutory “resident trusts” which have significant additional contacts with the state, but are administered by an out-of-state trustee? The question presented by the State of North Carolina: Does the Due Process Clause prohibit states from taxing trusts based on trust beneficiaries’ in-state residency?

A Constitutional Reminder: The Due Process Clause of the Fourteenth Amendment provides that [n]o state shall…deprive any person of life, liberty, or property, without due process of law.” U.S. Const. Amend. XIV § 1.)

What Lower Courts Had to Say in Regard to Their Decisions

From Minnesota Writ: “This Court has not spoken on the issue in decades, and its precedents point in opposite directions. As a consequence, state appellate courts are deeply divided on the correct answer. Some state appellate courts have held that a state may impose an income tax on a trust even when the trustee resides out-of-state, so long as the grantor resided in-state when the trust became irrevocable. Other courts have required, on top of grantor residence, that the trust have some additional contacts with the state during the tax year. One other state high court has held that a state may tax a trust as a resident if a beneficiary of the trust resided in the state during the tax year.”

From North Carolina Writ:

“This case asks whether the Due Process Clause prohibits states from taxing trusts based on trust beneficiaries’ in-state residency—a question on which nine state courts have split. Because of the Tax Injunction Act, this federal constitutional question is usually litigated in state courts. State courts are divided in their answers to this question, however, because they lack modern guidance from this Court.”

“With that decision, North Carolina joined the ranks of eight other states that have reached conflicting decisions on the question presented here. Five states have concluded that the Due Process Clause forbids states from taxing trusts based on trust beneficiaries’ in-state residency. Four states have concluded the opposite.”

The United States Supreme Court has not ruled on trust taxation since 1947 (Greenough v. Newport 331 U.S. 486 (1947)) and states say that since state courts are split regarding their rulings of trust taxation that a review by the Supreme Court is needed.

Where Concluding States Land

Four state courts have concluded that the Due Process Clause allows states to tax trusts based on trust beneficiaries’ in-state residency:

  • California in McCulloch v. Franchise Tax Board, 390 P.2d 412 (Cal. 1964)
  • Missouri in Westfall v. Director of Revenue, 812 S.W.2d 513 (Mo. 1991)
  • Connecticut in Chase Manhattan Bank v. Gavin, 733 A.2d 782, 802 (Conn. 1999)
  • Illinois in Linn v. Department of Revenue, 2 N.E. 3d 1203, 1209 (Ill. App. Ct. 2013) – but note that Linn ultimately held that the state could not tax a trust merely because the trust’s settlor had been an Illinois resident.

 

Five states ruled against taxation of trusts:

  • New York in Mercantile-Safe Deposit & Trust Co. v. Murphy, 203 N.E.2d 490, 491 (N.Y. 1964)
  • New Jersey in Potter v. Taxation Division Director, 5 N.J. Tax 399, 405 (N.J. Tax Ct. 1983)
  • Michigan in Blue v. Department of Treasury, 462 N.W.2d 762, 764 (Mich. Ct. App. 1990)
  • North Carolina in this current case: North Carolina Department of Revenue, Petitioner v. The Kimberly Rice Kaestner 1992 Family Trust
  • Minnesota in this current case: Cynthia Bauerly, Commissioner, Minnesota Department of Revenue, Petitioner v. William Fielding, Trustee of the Reid and Ann MacDonald Irrevocable GST Trust for Maria V. Macdonald, et al. Note that Minnesota rejected both the residency of Grantor and Beneficiary.)

What is the Impact of the Recent Wayfair Case?

In South Dakota v. Wayfair the United States Supreme Court ruled that states may impose sales tax even if the seller does not have a physical presence in the state.

This case could have an impact on future Supreme Court decisions regarding taxation. Although South Dakota’s decision is not an exact template for other states, it could influence how they craft their laws.

Timing

In the North Carolina case, the writ was filed on October 9th, 2018. The taxpayer filed their brief in opposition on November 30th.

The Minnesota case writ was filed on November 15th and docketed on November 21st. The taxpayers have until December 21st to file their response.

Will the Supreme Court Take Both Cases, or One?

Some Potential Outcomes: Ruling for the states – A ruling for the states would have a significant negative impact on out-of-state trust planning and could potentially send grantors to offshore jurisdictions.

Ruling for taxpayers – This will have a significant impact on the 22 states that still impose taxes on trusts and could potentially be a clear law-of-the-land in which all states would need to amend their tax code to comply.

Both cases declined – This is an implicit win for the taxpayers, and would lead to further haggling at the state level, both in courts as well as legislation.

Because Minnesota’s Fielding case includes both grantor and beneficiary issues, the Supreme Court hearing this case would set more comprehensive precedents regarding the taxation of trusts. With the North Carolina Kaestner case, the only issue at hand is the beneficiary’s residence.

There are still a lot of questions and unknowns about the impact of the court’s decisions and a lot of speculation. Either way, there are sure to be some interesting changes ahead.

Who said trust laws had to be boring?

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