In North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust,1 a unanimous Supreme Court held that the Due Process Clause prohibited states from taxing undistributed trust income based solely on the in-state residency of trust beneficiaries who have no right to demand such income and no certainty of ever receiving it. While the decision provided little additional insight into the analysis of Due Process nexus and was narrowly drawn to the specific facts presented, it is now clear that the bifurcation of Due Process nexus and Commerce Clause nexus in Quill Corporation v. North Dakota2 is still valid in the wake of last year’s historic South Dakota v. Wayfair3 decision overturning the physical presence rule for sales and use tax.
The background in Kaestner concerned North Carolina’s attempt to tax the undistributed assets of a New York trust whose sole connection to the Tar Heel state was a beneficiary who moved from New York to North Carolina several years after the trust was formed. The trust agreement gave the trustee exclusive control over the allocation and timing of trust distributions. Furthermore, New York law gave the trustee discretion to roll the trust into a new trust ahead of its scheduled termination date, making it legally uncertain whether the beneficiary would ever receive any distributions from the trust.4 While the applicability of state income tax to distributions from a trust received by a beneficiary residing in the subject state is well-settled,5 the North Carolina Department of Revenue took a more aggressive tack. Specifically, the Department of Revenue assessed an income tax deficiency of $1.3 million on the accumulated trust income over a 4-year period during which no distributions were made. The trustee paid the tax under protest and sued for refund in state court on Due Process grounds, winning at every level of the North Carolina legal system.
Justice Sotomayor began her discussion by conspicuously citing Due Process Clause language from Quill, clarifying that Quill was overruled on grounds other than Due Process in last year’s Wayfair case. The decision went on to flesh out the Due Process analysis from Quill.
The Court applies a two-step analysis to decide if a state tax abides by the Due Process Clause. First, and most relevant here, there must be “some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax.” Second, “the income attributed to the State for tax purposes must be rationally related to ‘values connected with the taxing State.’ ”6
A footnote in the opinion7 notes that the North Carolina trial court held that the trust’s taxation violated the Dormant Commerce Clause but adds that the issue is not addressed by the Court, leaving little doubt as to the validity of Quill’s bifurcation of the Commerce Clause and Due Process Clause post-Wayfair.
Starting with the first prong of the Quill Due Process analysis requiring “some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax,”8 the Court applied three factors to determine that the beneficiary’s residence alone did not provide sufficient “minimum connection” necessary to sustain the tax.
First, the beneficiaries did not receive any income from the Trust during the years in question. ... Second, the beneficiaries had no right to demand trust income or otherwise control, possess, or enjoy the trust assets in the tax years at issue. ... Third, not only were Kaestner and her children unable to demand distributions in the tax years at issue, but they also could not count on necessarily receiving any specific amount of income from the Trust in the future.9
The Court reserved judgment on whether a different result would arise if an in-state beneficiary were certain to receive funds at some point in the future. Justice Alito’s concurring opinion joined by Justice Gorsuch and Chief Justice Roberts made clear the opinion of the Court was narrowly tailored to the facts immediately at issue by applying existing precedent in Brooke v. City of Norfolk10 and Safe Deposit & Trust Co. of Baltimore, Md., v. Commonwealth of Virginia,11 both of which rejected the state taxation of out-of-state trusts where an in-state beneficiary lacked control or possession of the trust assets.
North Carolina is one of a small handful of states that rely on beneficiary residency as a sole basis for trust taxation, and an even smaller number that rely on the residency of beneficiaries regardless of whether the beneficiary is certain to receive trust assets.12 Given the fact that the taxpayer prevailed at every level of the North Carolina court system and the narrowness of the Supreme Court’s decision, perhaps certiorari was granted to allow the Court to clarify Quill’s continuing relevance for Due Process analysis. ■