In a unanimous decision, the United States Supreme Court has ruled states cannot utilize a beneficiary’s residence, alone, to subject undistributed trust income to state income tax.
Mr. Rice, a New York resident, as grantor, created a trust for benefit of his children, appointing another New York resident to serve as trustee.
Over twenty years ago, one of Mr. Rice’s daughters, Kimberly, moved to North Carolina. A North Carolina statute stated the state could tax any trust income “for the benefit of” a North Carolina resident. North Carolina is not the only state with a similar statute.
The North Carolina courts had previously interpreted this statute to mean the state could tax income of the trust, as long as the beneficiary lived within North Carolina, even though the beneficiary received no income for the trust during the applicable year and had no right to demand any such income, as the trustee had absolute discretion over the distribution of trust assets.
Utilizing this discretion, the trustee made no distributions to Kimberly for four years.
After being assessed, the trust paid the tax under protest, alleging violations of the Due Process Clause under the Fourteenth Amendment. The state courts agreed with the trust. The North Carolina Department of Revenue appealed the case to the United States Supreme Court.
The dominant focus of the Supreme Court was whether residency provided sufficient contact for the state to be able to tax the trust. The law is clear that the state could tax income actually distributed to a resident beneficiary or based on the trust having a situs within the state. However, in this case, North Carolina was seeking to tax a New York trust on undistributed income based solely on Kimberly residing in North Carolina.
In summation, the Supreme Court concluded the beneficiary’s residence was simply insufficient contact with the state to justify imposing tax undistributed income.
