Supreme Court agrees to hear major estate case

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The U.S. Supreme Court has granted certiorari to, or agreed to hear, a case about whether the due process clause of the Constitution prohibits a state from taxing an out-of-state trust based on the in-state residence of the beneficiary.

While the question in the case, North Carolina Department of Revenue v. The Kimberley Rice Kaestner 1992 Family Trust, is relatively simple, the states are split on the issue, according to Reed Smith associates Megan Miller and Michael Lurie.

“It’s a really simple question with a really simple answer, but for some reason [state disagree] on the issue,” said Lurie. “North Carolina analyzed it as a straightforward minimum contact case, and decided that minimum contact was not present.”

In a 2016 decision in the Court of Appeals of North Carolina, the North Carolina Department of Revenue lost an appeal from a North Carolina Superior Court decision holding that the state did not demonstrate the minimum contacts necessary to satisfy the principles of due process required to tax an out-of-state trust. The decision affirmed the lower court’s grant of summary judgment in favor of the trust and upheld the order directing the Department of Revenue to refund the taxes and penalties paid by the trust.

The original trust was established by settlor Joseph Lee Rice III. Its situs, or location, was New York. The primary beneficiaries of the original trust were the settlor’s descendants, none of whom lived in North Carolina at the time of the trust’s creation. In 2002, the original trust was divided into three separate trusts: one for each of the settlor’s children, Kimberly Rice Kaestner, Daniel Rice, and Lee Rice. At that time in 2002, Kimberley Rice Kaestner, the beneficiary of the Kimberley Rice Kaestner Family Trust (the trust in the case) was a resident and domiciliary of North Carolina.

Tax returns were filed in North Carolina on behalf of the trust for tax years 2005-2008 for income accumulated by the trust but not distributed to a North Carolina beneficiary, In 2009, the trust filed a claim for a refund of taxes paid amounting to $1,303,172.

“The North Carolina court focused on whether the trust had a separate legal existence apart from the beneficiary,” said Miller. “The court held that it did. The fact that the beneficiary was in North Carolina did not provide sufficient contact for the state to tax the trust.”

Representatives of the trust asserted that the state DOR’s contention that a beneficiary’s domicile alone is sufficient to satisfy the minimum contacts requirement conflates what the law recognizes as separate legal entities – the trust and the beneficiary. The Court of Appeals of North Carolina agreed, and held that the connection between North Carolina and the trust was insufficient to satisfy the requirements of due process.

The decision will be a significant one whichever way the Supreme Court decides, according to Lurie. “If North Carolina wins, some states will be able to tax income they could not tax before. On the flip side, if the Supreme Court affirms the decision in favor of the taxpayer, taxpayers in states such as California will be entitled to a refund.”

A very small percentage of cases that petition for certiorari are successful, Lurie indicated. “The factors that made this case likely to be granted cert include the fact that multiple state courts are split on the issue. In addition, the court prefers to grant cert where the state lost in a state court on constitutional grounds. The reasoning behind that is that if the state loses on a constitutional issue in state court, it has no other option but to comply with the decision.”

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