Source: https://www.uclalawreview.org/the-supreme-court-due-process-and-state-income-taxation-of-trusts/
Timestamp: 2019-04-20 06:47:45+00:00

Document:
Generally speaking, an irrevocable trust is taxed only once—as an entity. That is, unless the grantor has retained certain powers over the trust property, the trust is treated for income tax purposes as an entity separate from the person who created it.11 The trustee will pay tax on any income the trust earns (or accrues) and retains.12 To the extent that the trustee distributes trust income out to a beneficiary, the beneficiary will pay tax on that income and the trustee will not.13 Unique challenges arise in taxing an irrevocable trust when the trust has significant relationships with multiple jurisdictions, when the trust has any beneficiary with a contingent interest, or when the trust has multiple beneficiaries in different jurisdictions. For example, if a trust with a trustee domiciled in State X has mandatory income beneficiaries located in State Y, it may be that the trust is subject to income taxation in both State X and State Y.
Part I of this Article explains the factual background and procedural posture of the Kaestner Trust case and frames the constitutional questions that are before the Court.18 Part II examines how and why due process applies in the state income taxation context, with a particular focus on how the familiar concepts of general and specific jurisdiction apply uneasily to donative trusts. Part III articulates the reasons that the Court should hold that a state has no constitutional authority to impose a tax on trust income where the trust’s only connection with the forum state is the residence of a contingent beneficiary.
At the time of trust creation, both Mr. Rice and the initial trustee were residents of and domiciled in New York.21 On the basis of the residence of the trustee, the trust was subject to income taxation in the state of New York.22 At that time, no descendants of Mr. Rice were domiciled in or maintained a residence in North Carolina.23 Some years later, in 1995, Mr. Rice moved to Florida.24 In 1997, Kimberley Rice Kaestner, Mr. Rice’s daughter and a beneficiary of one of the separate share trusts, moved to North Carolina.25 She and her children continuously resided in North Carolina throughout the tax years in question, 2005 to 2008.
North Carolina imposes an income tax on any trust for the benefit of a North Carolina resident (as well as residents outside of North Carolina if certain other conditions are met).29 North Carolina makes no distinction between beneficiaries who actually receive trust income and beneficiaries who merely might (but do not in fact) receive trust income.30 In other words, according to North Carolina, the fact that a contingent income beneficiary resides in-state is sufficient for the trust to become subject to state income tax, regardless of whether the discretionary income beneficiary receives any distribution of income from a trust that otherwise has no connection with North Carolina.
Still not deterred, the North Carolina Department of Revenue appealed its case to the North Carolina Supreme Court.54 The state’s highest court affirmed the lower courts’ grant and affirmation of summary judgment for the trustee, finding that North Carolina did not have minimum contacts with the trust.55 The North Carolina Department of Revenue then petitioned the Supreme Court of the United States for a writ of certiorari.56 North Carolina cited a split between four state courts that have held that in-state residence of a trust beneficiary is a sufficient basis on which a state may impose income tax on a trust, and five state courts that have held that such taxes violate the Due Process Clause.57 The Supreme Court granted the petition.58 The Court will hear oral arguments on April 16, 2019.59 A decision is likely by the end of June, 2019.
The same issue—determining a corporation’s presence in a jurisdiction—spurred the development of the Court’s due process jurisprudence in the personal jurisdiction area, beginning with the foundational case of International Shoe Co. v. Washington.82 The Court in Quill, in a portion of the decision undisturbed by Wayfair, recognized that International Shoe and its progeny are relevant to the state tax inquiry because the inquiries into state tax and personal jurisdiction due process are “comparable.”83 In determining that a corporation could be subject to personal jurisdiction in a foreign state by virtue of its contacts with that state, the Court in International Shoe articulated the due process standard commonly known as the “minimum contacts test.”84 To satisfy due process, the corporation must have minimum contacts with the state such that the maintenance of the suit does not offend “traditional notions of fair play and substantial justice.”85 By parity of reasoning, the same “minimum contacts” should extend to the state taxation arena as well.
In cases involving state taxation of trusts, the principal challenge comes from the fact that a trust is not a traditional legal person; it is neither a human being nor a corporation. It is an arrangement for holding property that splits legal title and equitable title.92 The Supreme Court itself has stated that a donative trust is “not a thing that can be haled into court; legal proceedings involving a trust [are] brought by or against the trustees in their own name.”93 A trust does not exist in corporeal form; there can be no personal jurisdiction over a trustee (the legal owner of trust property) unless the trustee is present in the jurisdiction.94 For that reason, if a state seeks to impose tax on the basis of the residence of a contingent beneficiary who may never receive trust assets, the question is whether the state has the requisite contacts required under due process to tax the trust.
The requirements for due process would appear to be met in the case of a trust with a trustee resident or domiciled (as in the case of a human being) or conducting business (as in the case of a bank or trust company) in a particular state. In Hanson v. Denckla,95 a resident of Pennsylvania had established a trust in Delaware, naming a Delaware bank as trustee. The trust grantor then moved to Florida. Shortly before her death, she changed the beneficiaries of the trust from her children to her grandchildren. Upon grantor’s death, the remainder of the trust passed to her grandchildren, the designated beneficiaries. The grantor’s children brought an action in Florida, alleging that the change of beneficiaries was ineffective, and that the children were the real beneficiaries of the trust. The Supreme Court of Florida held that it had property jurisdiction over the trust and that the change indeed had been ineffective. Yet before the Florida court rendered judgment, the grandchildren commenced an action in Delaware, seeking to have themselves declared as the beneficiaries of the trust, which the court granted. In determining which state—Florida or Delaware—properly had jurisdiction over the trust, the Supreme Court of the United States held that the trust did not have sufficient contacts with Florida, and so Florida courts could exercise no jurisdiction over the trust. The Court explained that the trustee, a trust company, “has no office in Florida, and transacts no business there. None of the trust assets has ever been held or administered in Florida, and the record discloses no solicitation of business in that state, either in person or by mail.”96 As the Court suggests in Hanson v. Denkla, the requirements of due process might be met if the trustee conducts substantial administrative activity in the jurisdiction, or maintains trust assets in the jurisdiction.97 All of these situations are examples of the trust’s having sufficient activity within the state, properly becoming subject to personal jurisdiction (and thus income taxation under the same analysis).
In the case of a trust that specifically invokes the laws of a particular jurisdiction in naming its situs, the trust properly would be subject to personal jurisdiction in the forum state (in addition to possibly being subject to taxation in the jurisdiction where it conducts substantial activity). While the contacts between the trust and the forum are isolated in the latter case, the cause of action, or ability to tax, arises out of those contacts. Due process would be satisfied because the interests of the forum state are very strong when its laws govern the trust. But the mere residence of potential—not actual—trust beneficiaries in the state, without additional forms of contact, likely does not rise to the level of activity that would trigger personal jurisdiction and thus income tax liability. The contacts between the trust and the forum state would be too tenuous to be of a quality and nature that it would be fair and reasonable for the trust assets to be taxed by that state. Taxation would hinge on the possibility that a trustee might make a discretionary decision to make a distribution from the trust, when the beneficiary has no control over this decision.
In light of the minimum contacts requirements of International Shoe,98 the Supreme Court likely will rule in Kaestner Trust that a state’s taxation of a trust based solely on a contingent income beneficiary’s residence in that state violates the Due Process Clause.99 A discretionary beneficiary’s interest is too speculative to give rise to the minimum contacts that are required under the reasoning and spirit of International Shoe.100 Allowing taxation based on the residence of a contingent beneficiary would eviscerate any common-sense understanding of “minimum contacts;” it would allow a state to tax on the basis of what might occur, not on the facts as they are. There would be seemingly no logical limit to the reach of such a tax system.
Justice Harry Blackmun famously said that he knew he was “in the doghouse” with the Chief Justice if he received an assignment to write the opinion in a tax case.107 But Kaestner Trust is no dog of a case. It broadly implicates basic principles of due process. There are many reasons to allow each state to implement its own tax (and strong arguments in favor of a more uniform approach),108 but it would be fundamentally unfair to require a trust to pay income tax to a jurisdiction solely on the basis of the residence of a discretionary trust beneficiary who does not actually receive any trust distributions. Once the beneficiary receives trust income, it is reasonable in all respects to subject that income to taxation. The Court’s decision in Kaestner Trust will have lasting impact on the future of due process jurisprudence.
. Mark Twain, Following the Equator: A Journey Around the World 156 (1897) (epigraph to Chapter 15). Pudd’nhead Wilson is a fictional lawyer in a small town who produces a calendar with idiosyncratic quotations; local townspeople consider him a simpleton, or “pudd’nhead.” See Mark Twain, Pudd’nhead Wilson and Those Extraordinary Twins (1894).
. See, e.g., Klay Kruczek & Eric Sundberg, A Pairing Strategy for Tic-Tac-Toe on the Integer Lattice With Numerous Directions, 15 Electronic J. Combinatorics 1 (2008).
. See, e.g., Snap, Crackle & Pop, Kellogg’s Rice Krispies, https://www.ricekrispies. com/en_US/snap-crackle-pop.html [https://perma.cc/B4DP-FC8R] (dating first appearance of the cereal advertising slogan to 1929).
. See, e.g., Robert Gardner & Robert Davidson, Hypothesis Testing Using the Films of the Three Stooges, 32 Teaching Stat. 49 (2010).
. See, e.g., Florence Warren Brown & Neva L. Boyd, Old English and American Games for School and Playground 44 (1915).
. See, e.g., Robert H. Sitkoff & Jesse Dukeminier, Wills, Trusts, and Estates 385 (10th ed. 2017).
. See Unif. Trust Code § 107 (Unif. Law Comm’n 2000) (providing that a trust’s governing law is “the law of the jurisdiction designated in the terms unless the designation of that jurisdiction’s law is contrary to a strong public policy of the jurisdiction having the most significant relationship to the matter at issue”).
. This is the approach taken by New York, for example. See N.Y. Tax Law § 605(b)(3)(D) (McKinney 2018) (imposing no tax on a trust if no trustees are domiciled in that state, the trust has no source income from New York, and no trust property is located in the state).
. This is the approach taken by North Carolina, Tennessee, Georgia, and California. See generally Richard W. Nenno, Bases of State Income Taxation of Nongrantor Trusts (2019).
. This is the approach taken by Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. See generally id.
. But see 26 U.S.C. §§ 676, 677 (2012) (providing that where grantor of inter vivos trust retains certain rights over trust property, such as the right to substitute trust property, all items of trust income be treated as belonging to the grantor).
. Jerome R. Hellerstein, Walter Hellerstein & John A. Swain, State Taxation ¶ 20.09 (3d ed. 2018).
. Curry v. McCanless, 307 U.S. 357, 372 (1939) (permitting both Alabama and Tennessee to impose tax on testamentary transfer of intangible property under will of Tennessee domiciliary passing to trustee located in Alabama).
. N.C. Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Tr., 139 S. Ct. 915 (2019) (mem.).
. Supreme Court of the United States October Term 2019, [Monthly Argument Calendar] for the Session Beginning April 15, 2019, https://www.supremecourt.gov/oral_arguments /argument _calendars/MonthlyArgumentCalApril2019.pdf [https://perma.cc/253D-UZCY] [hereinafter Monthly Argument Calendar].
. The last significant trust case involving state due process claims was Hanson v. Denckla. Hanson v. Denckla, 357 U.S. 235 (1958) (holding that Florida, the state of the decedent’s domicile, had no jurisdiction over Delaware trustees of a testamentary trust).
. Complaint ¶¶ 11–12, 14, 17, Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 2015 WL 1880607 (N.C. Super. Ct. Apr. 23, 2015) [hereinafter Complaint] (No. 12-CVS-8740), 2012 WL 12282023, aff’d, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Complaint, supra note 19, ¶ 15.
. Id. See also N.Y. Tax Law § 605(b)(3)(D) (McKinney 2018) (imposing income tax based on residence of trustee in New York).
. Complaint, supra note 19, ¶ 12.
. Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 2015 WL 1880607, at *2 (N.C. Super. Ct. Apr. 23, 2015) (No. 12-CVS-8740), aff’d, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Complaint, supra note 19, ¶ 23.
. Kaestner, 2015 WL 1880607, at *2.
. N.C. Gen. Stat. Ann. § 105-160.2 (West 2017) (imposing tax on taxable income of estates and trusts where beneficiary is North Carolina resident or, in the case of a nonresident beneficiary, if trust income derives from North Carolina sources).
. See id. (imposing tax on taxable income of estates and trusts based on beneficiary’s residence in-state).
. Complaint, supra note 19, ¶ 22.
. Id. ¶¶ 24–25; Kaestner, 2015 WL 1880607, at *1.
. Complaint, supra note 19, ¶¶ 5–6. See U.S. Const. amend. XIV, § 1.
. Quill Corp. v. North Dakota, 504 U.S. 298 (1992) (limiting conditions in which states may impose tax on interstate commerce).
. Kimberley Rice Kaestner 1992 Family Tr. v. N. Carolina Dep’t of Revenue, 2015 WL 1880607, at *4 (N.C. Super. Ct. Apr. 23, 2015) (No. 12-CVS-8740), aff’d, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Complaint, supra note 19, ¶¶ 37–38, 43.
. Id. ¶¶ 5–6. See U.S. Const. art. I, § 8, cl. 3 (reserving to Congress the sole power to regulate commerce among the states).
. See, e.g., Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977).
. Complaint, supra note 19, ¶ 43.
. Id. ¶ 42. The trustee also asserted related violation of the North Carolina State Constitution. Id. ¶¶ 46–49.
. Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 2015 WL 1880607, at *12 (N.C. Super. Ct. Apr. 23, 2015) (No. 12-CVS-8740), aff’d, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Id. at *9. See also Quill Corp. v. North Dakota, 504 U.S. 298 (1992) (limiting conditions in which states may impose tax on interstate commerce).
. Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 2015 WL 1880607, at *9 (N.C. Super. Ct. Apr. 23, 2015) (No. 12-CVS-8740), aff’d, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. Petition for Writ of Certiorari, N.C. Dep’t of Revenue v. Kimberley Rice Kaestner 1992 Family Tr., 2018 WL 4942045 at *9 (2018) (No. 18-457) (noting a conflict between, on the one hand, courts in the four states of California, Missouri, Connecticut, and Illinois that permit taxation of trusts based on a contingent beneficiary’s in-state residency, and, on the other hand, courts in the five states of New York, New Jersey, Michigan, Minnesota, and North Carolina that prohibit states from taxing trusts based on a contingent beneficiary’s in-state residence).
. N.C. Dep’t of Revenue v. Kimberley Rice Kaestner 1992 Family Tr., 139 S. Ct. 915 (2019) (mem.).
. Monthly Argument Calendar, supra note 16.
. See supra notes 8–10 and accompanying text.
. See supra note 53 and accompanying text.
. See, e.g., Kimberley Rice Kaestner 1992 Family Tr. v. N.C. Dep’t of Revenue, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff’d, 814 S.E.2d 43 (N.C. 2018), cert. granted, 139 S. Ct. 915 (2019) (mem.).
. South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018).
. See Quill Corp. v. North Dakota, 504 U.S. 298 (1992). The Wayfair Court upheld the South Dakota law against a Commerce Clause challenge and overruled Quill in part. Wayfair, 138 S. Ct. at 2080. In Wayfair, the Court ruled that laws imposing state sales tax on nonresident sellers with zero physical presence in the jurisdiction are valid under the Commerce Clause “so long as [they] (1) appl[y] to an activity with a substantial nexus with the taxing State, (2) [are] fairly apportioned, (3) do not discriminate against interstate commerce, and (4) [are] fairly related to the services the State provides.” Id. at 2091 (citing Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977)).
. Quill, 504 U.S. at 304.
. Id. at 305–06 (citing Int’l Harvester Co. v. Dep’t of Treasury, 322 U.S. 340, 353).
. Kaestner, 2015 WL 1880607, at *9.
. Safe Deposit & Tr. Co. v. Virginia, 280 U.S. 83 (1929).
. South Dakota v. Wayfair, Inc., 138 S. Ct. 2080, 2093 (2018) (“When considering whether a State may levy a tax, Due Process and Commerce Clause standards may not be identical or coterminous, but there are significant parallels.”).
. Id. (citing Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977)).
. See Quill, 504 U.S. 298.
. Quill, 504 U.S. at 307–08.
. Int’l Shoe, 326 U.S. at 316.
. Id. The Court in Quill stated “[b]uilding on the seminal case of International Shoe . . . we have framed the relevant inquiry as whether a defendant had minimum contacts with the jurisdiction ‘such that the maintenance of the suit does not offend ‘traditional notions of fair play and substantial justice’’” 504 U.S. at 307 (citations omitted).
. See generally Helicopteros Nacionales de Colombia, S.A. v. Hall, 466 U.S. 408 (1984) (finding no general jurisdiction and holding that specific jurisdiction violates due process).
. See generally Daimler AG v. Bauman, 571 U.S. 117 (2014).
. Int’l Shoe, 326 U.S. at 318.
. See Gray v. Am. Radiator & Standard Sanitary Corp., 176 N.E. 2d 761 (1961) (referring to Illinois legislature’s drafting of the first specific jurisdiction statute). Following the decision in International Shoe, states began to enact “long-arm” or specific jurisdiction statutes. See, e.g., id. Generally, an individual or corporation could be amenable to personal jurisdiction in that state if the cause of action arises out of that individual’s or corporation’s contact with the forum state. See also World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 286 (1980) (describing the due process limitations of specific jurisdiction).
. Int’l Shoe, 326 U.S. at 316–19.
. Id. Since the decision in International Shoe, the Supreme Court has tried to refine and clarify the standard for determining whether due process is satisfied. See generally McGee v. Int’l Life Ins. Co., 355 U.S. 220 (1957); Hanson v. Denckla, 357 U.S. 235 (1958); Shaffer v. Heitner, 433 U.S. 186 (1977); World-Wide Volkswagen Corp. v. Woodson, 444 U.S. 298 (1980); Burger King Corp. v. Rudzewicz, 471 U.S. 462 (1985); Asahi Metal Indus. Co. v. Superior Court, 480 U.S. 102 (1987); Burnham v. Superior Court, 495 U.S. 604 (1990); J. McIntyre Machinery, Ltd., v. Nicastro, 564 U.S. 873 (2011); Goodyear Dunlop Tires Operations, S.A. v. Brown, 564 U.S. 915 (2011); BNSF Ry. Co. v. Tyrrell, 137 S. Ct. 1549 (2017).
. Americold Realty Tr. v. Conagra Foods, Inc., 136 S. Ct. 1012, 1016 (2016).
. Hanson, 357 U.S. 235.
. Hanson, 357 U.S. at 251.
. See supra note 33.
. 2018 Guidance for Tennessee’s Hall Income Tax Return, Tenn. Dep’t Revenue (July 12, 2017), https://www.tn.gov/content/dam/tn/revenue/documents/taxguides/indincguide.pdf [https://perma.cc/F3FX-X8L8].
. See Nenno, supra note 9.
. See, e.g., Sessions v. Morales-Santana, 137 S. Ct. 1678 (2017) (making changes to derivative citizenship rules on a prospective basis only).
. This would be similar to the existing tax laws of California, for example. See Cal. Rev. & Tax Code § 17745 (West 2019).
. A Multistate Tax Commission took up, but ultimately abandoned for lack of consensus, a project to create a uniform tax law for trusts and estates. See, e.g., Trusts Work Group, Multistate Tax Comm’n, http://www.mtc.gov/Uniformity/Project-Teams/Trusts-Work-Group [https://perma.cc/F6ZW-3ABX].
. Stuart Taylor, Jr., Reading the Tea Leaves of a New Term, N.Y. Times, Dec. 22, 1986, at B14 (quoting J. Blackmun).

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