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Supreme Court - Beneficiary Residency Alone is Insufficient Basis for State Trust Taxation

Updated: Dec 9, 2019

MARKET TREND: In which state is a trust subject to taxation? The recently decided Kaestner case provides the U.S. Supreme Court’s latest guidance on this important income tax issue.

SYNOPSIS: On June 21, 2019, the U.S. Supreme Court rendered its decision in the case of North Carolina Department of Rev. v. Kimberley Rice Kaestner 1992 Family Trust, a case which asked for a decision on whether a non-grantor trust can be subjected to state income taxes on its undistributed income solely on the basis of a beneficiary’s residence in such state. The Supreme Court held no, so long as the beneficiaries: (1) did not receive any income from the trust during the years in question; (2) had no right to demand trust income or otherwise control, possess, or enjoy the trust assets in the years at issue; and (3) could not count on receiving income from the trust in the future. The Supreme Court, however, clearly limited its ruling to the circumstances presented, holding that it did not “imply approval or disapproval of trust taxes that are premised on the residence of beneficiaries whose relationship to trust assets differs from” those in the Kaestner case.

TAKE AWAYS: The Kaestner decision likely avoided a pandora’s box of issues that could have resulted from permitting state taxation based solely on a beneficiary’s residence, including other states seeking to expand their trust taxation and increased administrative burdens for trusts with beneficiaries in multiple states. Notably, though, the limited holding does not appear to prevent a state from considering a beneficiary’s residence as one of many factors when taxing a trust. Accordingly, clients and advisors should continue to monitor the residency of trust fiduciaries and beneficiaries to confirm that trust income is being accurately reported and paid to the appropriate states. They also should use this opportunity to review the situs of their trusts and whether any changes are recommended to address the trust’s state tax exposure. Such potential exposure also should be considered when selecting a jurisdiction for a new non-grantor trust, factoring in the residence of the grantor, current and future trustees and beneficiaries, the sources of trust income, etc.

This material is intended for informational purposes only and should not be construed as legal or tax advice. It is not intended to replace the advice of a qualified attorney, tax advisor, or plan provider.

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