Court Opinion

ID: 3219698
Source: CourtListenerOpinion
Date Created: 2016-07-05 12:06:35.632597+00
Date Added: 2024-06-11T07:39:49.498446
License: Public Domain

IN THE COURT OF APPEALS OF NORTH CAROLINA

                                    No. COA15-896

                                   Filed: 5 July 2016

Wake County, No. 12 CVS 8740

THE KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST, Plaintiff,

               v.

NORTH CAROLINA DEPARTMENT OF REVENUE, Defendant.

         Appeal by defendant from order entered 23 April 2015 by Judge Gregory P.

McGuire in Wake County Superior Court. Heard in the Court of Appeals 23 February

2016.

         Attorney General Roy Cooper, by Assistant Attorney General Peggy S. Vincent,
         for the State.

         Moore & Van Allen, PLLC, by Thomas D. Myrick, Neil T. Bloomfield and Kara
         N. Bitar, for plaintiff-appellee.

         BRYANT, Judge.

         Where North Carolina did not demonstrate the minimum contacts necessary

to satisfy the principles of due process required to tax an out-of-state trust, we affirm

the lower court’s grant of summary judgment in favor of the trust and uphold the

order directing the Department of Revenue to refund taxes and penalties paid by the

trust.

         On 21 June 2012, representatives of plaintiff The Kimberley Rice Kaestner

1992 Family Trust (the Trust) filed a complaint against the North Carolina
       THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                   Opinion of the Court

Department of Revenue (the Department) after the Department denied a request to

refund taxes the Trust paid during tax years 2005 through 2008. The claims brought

forth alleged that taxes imposed upon the Trust pursuant to N.C. Gen. Stat. § 105-

160.2 were imposed in violation of due process, the Commerce Clause, and the North

Carolina Constitution. Pursuant to section 105-160.2, taxes are “computed on the

amount of taxable income of the estate or trust that is for the benefit of a resident of

this State[.]”

       In 1992, an inter vivos trust (original trust) was established by settlor Joseph

Lee Rice III, with William B. Matteson as trustee. The situs, or location, of the

original trust 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 (Kimberley Rice Kaestner, Daniel Rice, and Lee Rice).

At that time in 2002, Kimberley Rice Kaestner, the beneficiary of plaintiff Kimberley

Rice Kaestner 1992 Family Trust, was a resident and domiciliary of North Carolina.

On 21 December 2005, William B. Matteson resigned as trustee for the three separate

trusts. The settlor then appointed a successor trustee, who resided in Connecticut.

Tax returns were filed in North Carolina on behalf of the Kimberley Rice Kaestner

1992 Family Trust for tax years ending in 2005, 2006, 2007, and 2008 for income

accumulated by the Trust but not distributed to a North Carolina beneficiary. In

                                          -2-
        THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                          Opinion of the Court

2009, representatives of the Trust filed a claim for a refund of taxes paid to the

Department amounting to $1,303,172.00, for tax years 2005, 2006, 2007, and 2008.

The claim was denied. Trust representatives commenced a contested case action in

the Office of Administrative Hearings (OAH). However, the OAH dismissed the

contested case for lack of jurisdiction: the sole issue was the constitutionality of the

enabling statute, G.S. § 105-160.2. The current action commenced in Wake County

Superior Court and, thereafter, was designated as a mandatory complex business

case.

        On 11 February 2013, the Honorable John R. Jolly, Jr., Chief Special Superior

Court Judge for Complex Business Cases, entered an order ruling on a motion to

dismiss filed by the Department.1 Based on the Court’s order, the Department

asserted Rules 12(b)(1), (2), and (6) as a basis for dismissal of the constitutional claims

and the injunctive relief. Judge Jolly found that “[N.C. Gen. Stat. §] 105-241.19 set

out exclusive remedies for disputing the denial of a requested refund and expressly

prohibit[ed] actions for injunctive relief to prevent the collection of a tax.” Judge Jolly

granted the Department’s motion to dismiss the Trust’s claim for injunctive relief

which sought a refund of all taxes paid.                   However, Judge Jolly denied the

Department’s motion to dismiss the Trust’s constitutional claims, concluding “there

is at least a colorable argument that North Carolina’s imposition of a tax on a foreign

        1   The Department’s motion to dismiss was not made a part of the record on appeal.

                                                 -3-
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                  Opinion of the Court

trust based solely on the presence of a beneficiary in the state does not conform with

the Due Process Clause, the Commerce Clause or Section 19 [of Article I of the North

Carolina Constitution].”

      On 8 July 2014, the Trust moved for summary judgment, alleging there were

no genuine issues of material fact: the Trust had paid the State of North Carolina

over $1.3 million in taxes for tax years 2005 through 2008; the Trust was established

by a non-resident settlor, governed by laws outside of North Carolina, operated by a

non-resident trustee, and did not make any distributions to a beneficiary residing in

North Carolina during the pertinent period. The Trust requested that the court

declare General Statutes, section 105-160.2 unconstitutional and order a refund of all

taxes and penalties paid by the Trust.

      The Department also filed a motion for summary judgment.                In it, the

Department acknowledged that all of the Trust assets were intangibles, and that

during the pertinent years, the Trust beneficiaries received no distributions from the

Trust. However, quoting a case from the State of Connecticut, Chase Manhattan

Bank v. Gavin, 249 Conn. 172, 204–05, 733 A.2d 782, 802 (1999), the Department

stated:

             [J]ust as the state may tax the undistributed income of a
             trust based on the presence of the trustee in the state
             because it gives the trustee the protection and benefits of
             its laws; it may tax the same income based on the domicile
             of the sole noncontingent beneficiary because it gives her the
             same protections and benefits.

                                         -4-
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                  Opinion of the Court

(emphasis added).

      A summary judgment hearing was held in Wake County Superior Court before

the Honorable Gregory P. McGuire, Special Superior Court Judge for Complex

Business Cases. In an order entered 23 April 2015, Judge McGuire granted the

motion for summary judgment filed on behalf of the Trust and denied the

Department’s motion. Judge McGuire concluded that N.C. Gen. Stat. § 105-160.2

was unconstitutional as applied and ordered the Department to refund any taxes and

penalties paid pursuant to that statute. The Department appeals.

                     _______________________________________

      On appeal, the Department argues that the Trust cannot meet its burden to

prove it is entitled to a refund of state taxes paid on its accumulated income.

Specifically, the Department contends that the Business Court erred when it

concluded that taxation of the Trust based on the residence of the beneficiary violated

(A) due process under both the federal and state constitutions, as well as (B) the

Commerce Clause of the federal constitution. We disagree.

                                 Standard of Review

             When assessing a challenge to the constitutionality of
             legislation, this Court's duty is to determine whether the
             General Assembly has complied with the constitution. . . .
             In performing our task, we begin with a presumption that
             the laws duly enacted by the General Assembly are valid.
             Baker v. Martin, 330 N.C. 331, 334, 410 S.E.2d 887, 889
             (1991). North Carolina courts have the authority and

                                         -5-
       THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                     Opinion of the Court

              responsibility to declare a law unconstitutional, but only
              when the violation is plain and clear. State ex rel. Martin
              v. Preston, 325 N.C. 438, 449, 385 S.E.2d 473, 478 (1989).
              Stated differently, a law will be declared invalid only if its
              unconstitutionality is demonstrated beyond reasonable
              doubt. Baker, 330 N.C. at 334–35, 410 S.E.2d at 889.

Hart v. State, 368 N.C. 122, 126, 774 S.E.2d 281, 284 (2015).

                                        Due Process

       The Department contends that the trial court erred when it concluded that

taxation of the Trust based solely on the residence of the beneficiaries violated due

process under both the federal and state constitutions.

       “The Fourteenth Amendment to the United States Constitution provides that

‘[n]o State shall . . . deprive any person of life, liberty, or property, without due process

of law[.]’ U.S. Const. amend. XIV.” Johnston v. State, 224 N.C. App. 282, 304, 735

S.E.2d 859, 875 (2012) (alteration in original), writ allowed, review on additional

issues denied, 366 N.C. 562, 738 S.E.2d 360, aff'd, 367 N.C. 164, 749 S.E.2d 278

(2013). “No person shall be . . . in any manner deprived of his life, liberty, or property,

but by the law of the land.” N.C. Const. art. I, § 19. “ ‘The term “law of the land” as

used in Article I, Section 19, of the Constitution of North Carolina, is synonymous

with “due process of law” as used in the Fourteenth Amendment to the Federal

Constitution.’ ” Rhyne v. K-Mart Corp., 358 N.C. 160, 180, 594 S.E.2d 1, 15 (2004)

(quoting In re Moore, 289 N.C. 95, 98, 221 S.E.2d 307, 309 (1976)). “For purposes of

taxation, ‘the requirements of . . . “due process” are, for all practical purposes, the

                                            -6-
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                  Opinion of the Court

same under both the State and Federal Constitutions.’ ” In re appeal of Blue Ridge

Hous. of Bakersville LLC, 226 N.C. App. 42, 58, 738 S.E.2d 802, 813 (2013) (citation

omitted) (quoting Leonard v. Maxwell, 216 N.C. 89, 93, 3 S.E.2d 316, 320 (1939)) .

                    In analyzing federal constitutional questions, we
             look to decisions of the United States Supreme Court. We
             also look for guidance to the decisions of the North Carolina
             Supreme Court construing federal constitutional and State
             constitutional provisions, and we are bound by those
             interpretations. State v. Elliott, 360 N.C. 400, 421, 628
             S.E.2d 735, 749, (2006) (“The Supreme Court of the United
             States is the final authority on federal constitutional
             questions.”)[.] We are also bound by prior decisions of this
             Court construing those provisions, which are not
             inconsistent with the holdings of the United States
             Supreme Court and the North Carolina Supreme Court. In
             the Matter of Appeal from Civil Penalty, 324 N.C. 373, 379
             S.E.2d 30 (1989).

Johnston, 224 N.C. App. at 288, 735 S.E.2d at 865.

                    The Commerce Clause and the Due Process Clause
             impose distinct but parallel limitations on a State’s power
             to tax out-of-state activities. See Quill Corp. v. North
             Dakota, 504 U.S. 298, 305–306, 112 S.Ct. 1904, 119
             L.Ed.2d 91 (1992). . . . The “broad inquiry” subsumed in
             both constitutional requirements is whether the taxing
             power exerted by the state bears fiscal relation to
             protection, opportunities and benefits given by the state—
             that is, whether the state has given anything for which it
             can ask return.

MeadWestvaco Corp. ex rel. Mead Corp. v. Ill. Dep't of Revenue, 553 U.S. 16, 24–25,

170 L. Ed. 2d 404, 412 (2008) (citations and quotations omitted). “The Due Process

Clause requires [(1)] some definite link, some minimum connection, between a state

                                         -7-
       THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                   Opinion of the Court

and the person, property or transaction it seeks to tax, and [(2)] that the income

attributed to the State for tax purposes must be rationally related to           values

connected with the taxing State.” Quill Corp. v. N. Dakota, 504 U.S. 298, 306, 119 L.

Ed. 2d 91, 102 (1992).

                                 Minimum Contacts

       As to the question of whether there exists some minimum connection between

a state and the . . . property . . . it seeks to tax, see id., “[our Supreme Court has]

framed the relevant inquiry as whether a [party] had minimum contacts with the

jurisdiction ‘such that the maintenance of the suit does not offend traditional notions

of fair play and substantial justice.’ ” Id. at 307, 119 L. Ed. 2d at 103 (quoting Int’l

Shoe Co. v. Washington, 326 U.S. 310, 316, 90 L. Ed. 95, 102 (1945)).

              Application of the “minimum contacts” rule will vary with
              the quality and nature of the [party's] activity, but it is
              essential in each case that there be some act by which the
              [party] purposefully avails itself of the privilege of
              conducting activities within the forum State, thus invoking
              the benefits and protections of its laws.

Skinner v. Preferred Credit, 361 N.C. 114, 123, 638 S.E.2d 203, 210–11 (2006)

(citation and some quotation marks omitted).

       On this point, we note that Judge McGuire made the following unchallenged

findings of fact:

              23.  [N]othing in the record indicates, and [the
              Department] does not argue, that [the Trust] maintained
              any physical presence in North Carolina during the tax

                                          -8-
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                   Opinion of the Court

             years at issue. The undisputed evidence in this matter
             shows that [the Trust] never held real property located in
             North Carolina, and never invested directly in any North
             Carolina based investments. . . . The record also indicates
             that no trust records were kept or created in North
             Carolina, or that the trust could be, in any other manner,
             said to have a physical presence in the State. Moreover,
             because the trustee’s usual place of business where trust
             records were kept was outside the State, it is clear from the
             record that [the Trust’s] principal place of administration
             was not North Carolina.

             ...

             26.   [The Department] concedes that the only
             “connection between the [Plaintiff] trust and North
             Carolina in the case at hand is the residence of the
             beneficiaries.”

      The Department supports its argument that the residence of the beneficiaries

is sufficient to satisfy the minimum contacts criteria of the Due Process Clause by

citing to state court opinions from Connecticut and California: Chase Manhattan

Bank v. Gavin, 249 Conn. 172, 733 A.2d 782 (1999), and McCulloch v. Franchise Tax

Bd., 61 Cal. 2d 186, 390 P.2d 412 (1964).

      In both Gavin and McCulloch, the state appellate court noted that the United

States Supreme Court had previously upheld the taxation of trust income based on

the domicile of the trustee, citing Greenough v. Tax Assessors, 331 U.S. 486, 91 L. Ed.

1621 (1947). And the Gavin and McCulloch courts reasoned that similar to the

benefits and protections provided by a state to a trustee, the state of the beneficiary’s

domicile provided benefits and protections sufficient to satisfy the minimum contacts

                                          -9-
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                   Opinion of the Court

criteria of due process for taxation of the trust. See Gavin, 249 Conn. at 204–05, 733

A.2d at 802 (“[J]ust as a state may tax all of the present income of a domiciliary, . . .

a state may . . . tax the income of an inter vivos trust that is accumulated for the

ultimate benefit of a noncontingent domiciliary, and that is subject to her ultimate

power of disposition.”); McCulloch, 61 Cal. 2d at 196, 390 P.2d at 419 (“[T]he

beneficiary’s state of residence may properly tax the trust on income which is payable

in the future to the beneficiary, although it is actually retained by the trust, since

that state renders to the beneficiary that protection incident to his eventual

enjoyment of such accumulated income.”). On this basis, the Department contends

that its taxation of the Trust, predicated solely on the residency of Kimberley

Kaestner in North Carolina did not violate due process.

      Representatives of the Trust, on the other hand, assert that the Department’s

contention that a beneficiary’s domicile alone is sufficient to satisfy the minimum

contacts requirement of the Due Process Clause and allow the state to tax a non-

resident trust conflates what the law recognizes as separate legal entities—the trust

and the beneficiary. “[W]e do not forget that the trust is an abstraction, . . . [and] the

law has seen fit to deal with this abstraction for income tax purposes as a separate

existence, making its own return under the hand of the fiduciary and claiming and

receiving its own appropriate deductions.” Anderson v. Wilson, 289 U.S. 20, 27, 77 L.

                                          - 10 -
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                   Opinion of the Court

Ed. 1004, 1010 (1933). In other words, for income tax purposes the trust has a

separate existence. Id.

      In support of their position, the Trust representatives direct our attention to

Greenough, 331 U.S. 486, 91 L. Ed. 1621, a United States Supreme Court opinion.

Greenough upheld a Rhode Island law authorizing the levy of an ad valorem tax upon

a resident trustee based on a proportionate legal interest of a foreign trust, finding no

violation of due process. Greenough was a decision from which four justices, including

the Chief Justice, dissented. We note with particular interest the dissent of Justice

Rutledge, who wrote that “if the beneficiary's residence alone is insufficient to sustain

a state's power to tax the corpus of the trust, cf. Brooke v. Norfolk, 277 [U.S.] 27, 72

[L. Ed.] 767, 48 [S. Ct.] 422, it would seem that the mere residence of one of a number

of trustees hardly would supply a firmer foundation.” Id. at 503, 91 L. Ed. at 1633

(footnote omitted). After a careful look at Brooke, 277 U.S. 27, 72 L. Ed. 767 (1928),

we find it to be not only relevant to the instant case, but also controlling.

      In Brooke, the petitioner—a Virginia resident and trust beneficiary—appealed

to the United States Supreme Court after the City of Norfolk and the State of Virginia

assessed taxes upon the corpus of a trust created by a Maryland resident. Id. at 28,

72 L. Ed. at 767–78. The petitioner contended that the assessment of the taxes was

contrary to the Fourteenth Amendment. Id. at 28, 72 L. Ed. at 767. The Maryland

resident created a testamentary trust and bequeathed to it $80,000.00, naming

                                          - 11 -
       THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                         Opinion of the Court

petitioner as beneficiary. The trustee, Safe Deposit & Trust Company of Baltimore,

was directed to pay income from the trust to the petitioner for life. Id. at 28, 72 L.

Ed. at 768. The Court noted that “[t]he property held in trust has remained in

Maryland and no part of it is or ever has been in Virginia.” Id.

               The petitioner has paid without question a tax upon the
               income received by her. But the doctrine contended for now
               is that the petitioner is chargeable as if she owned the
               whole. . . . But here the property is not within the state,
               does not belong to the petitioner and is not within her
               possession or control. The assessment is a bare proposition
               to make the petitioner pay upon an interest to which she is
               a stranger. This cannot be done. See Wachovia Bank & T.
               Co. v. Doughton, 272 U. S. 567, 575, 71 L. [E]d. 413, 419,
               47 Sup. Ct. Rep. 202.

Id. 28–29, 72 L. Ed. at 768.

       The strong similarities between the facts in Brooke and the instant case cannot

be ignored. While the trust in Brooke was a testamentary trust and the Trust here

an inter vivos trust, both were created and governed by laws outside of the state

assessing a tax upon the trust. The trustee for both trusts resided outside of the state

seeking to tax the trust. The beneficiary of the trust who resided within the taxing

state had no control over the trust during the period for which the tax was assessed.

And, the trusts did not own property in the taxing state.2 In the instant case, the

       2  In Brooke, it was duly noted that the petitioner paid tax assessments in Virginia on the
distributions made to her as a resident of the state; however, she had no duty under the law (or
constitution) to pay taxes on the corpus of the trust which existed in another state and over which she
had no control. See 277 U.S. at 28–29, 72 L. Ed. at 768.

                                                - 12 -
      THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                                  Opinion of the Court

Trust’s beneficiary did not receive a taxable distribution from the Trust during the

years for which the Department has assessed a tax.

      In determining that the authority as set forth by the United States Supreme

Court in Brooke controls the analysis and outcome of this issue, we must decline the

Department’s request that we accept as persuasive the authority as set out by the

California Supreme Court, McCulloch, 61 Cal. 2d 186, 390 P.2d 412, or the

Connecticut Supreme Court, Gavin, 249 Conn. 172, 733 A.2d 782. Thus, because of

Brooke, we hold that based on the facts of the instant case, the connection between

North Carolina and the Trust was insufficient to satisfy the requirements of due

process. Therefore, the Department’s assessment of an income tax levied pursuant

to the authority set out in General Statutes, section 105-160.2 was in violation of the

Due Process Clause of the United States Constitution, and the Law of the Land

Clause of the North Carolina Constitution. Accordingly, we affirm Judge McGuire’s

order granting summary judgment for the Trust and directing that the Department

refund any and all taxes and penalties paid by the Trust pursuant to section 105-

160.2 with interest.

      As a consequence, we do not address the Department’s contention that the

Business Court erred when it concluded taxation of the Trust based on the residence

of the beneficiary violated the Commerce Clause of the federal constitution.

      AFFIRMED.

                                         - 13 -
THE KIMBERLEY RICE KAESTNER 1992 FAM. TR. V. NC DEPT. OF REVENUE

                        Opinion of the Court

Judges STEPHENS and McCULLOUGH concur.

                               - 14 -