N.C. Taxation of Out of State Trusts

In June 2018, the N.C. Supreme Court determined that North Carolina’s state fiduciary income tax was unconstitutional as imposed upon the income earned and accumulated by the Kimberly Rice Kaestner 1992 Family Trust. Although the Court did not find the statute to be unconstitutional “on its face,” or in every situation, the ruling will affect a large number of cases. 

Kimberly Rice Kaestner was a beneficiary of a trust established under New York law in 1992. She relocated to North Carolina in 1997. The Connecticut trustee separated her share of the family trust from the primary trust in 2006, forming the Kimberly Rice Kaestner 1992 Family Trust. The trustee of the Kaestner Trust had sole discretion for all decisions regarding investments and distribution. During the years in question, the Trustee made no distributions to anyone in North Carolina, did not hold any trust property in North Carolina, and did not reside in North Carolina. However, the N.C. Department of Revenue (“NCDOR”) assessed income tax on the income accumulated in the Kaestner Trust based on N.C.G.S. §105-160.2, which says that a tax may be imposed on the taxable income of estates and trusts that are “for the benefit of a resident of this State.”

The state’s position in Kaestner was that the analysis begins and ends with “Does a beneficiary live in North Carolina?” The Kaestner Trust challenged this statute under the Due Process and Commerce Clauses of the U.S. Constitution, as well as “Law of the Land” clause of the N.C. Constitution. The Kaestner Trust argued that the statute was unconstitutional because it subjected an out-of-state trust to taxation by the state of North Carolina based solely on the residence of its beneficiaries within the state. The trial court agreed, finding that residence in N.C. alone did not establish sufficient contacts by the trust with the state to impose taxation. Both the Court of Appeals and the N.C. Supreme Court agreed with the trial court and found for the taxpayer.

The application of this ruling will depend on specific facts. Trustees should carefully evaluate whether tax is due by a trust in North Carolina.  For taxes already paid, Trustee should also evaluate the potential for a refund.