I have written extensively about the application of the due process requirements under both the Florida and United States Constitutions in previous blogs and cannot resist touching upon a recent opinion in a state court case applying federal due process law: Kimberly Rice Kaesterner 1992 Family Trust v. North Carolina Dep’t of Revenue 789 S.E.2d 645 (N.C.Ct. App. 2016).
New York probate and Florida probate lawyers understand that it has long been the law of the land that the fact that beneficiaries of a trust are not residents does not deprive property subject to the trust situs in the state where the trustee is domiciled. Typically, the trust property is taxed to the holder of the legal title—the trustee—or where the property is located. The tax is not imposed on the trust beneficiary.
In fact, Chief Justice Oliver Wendell Holmes and the United States Supreme Court has ruled that a trustee cannot be taxed as trust property held in her possession in the state of the trustee’s residence in a state where she does not live merely because the beneficiary under the trust lives in such state. Brooke v. City of Norfolk, 277 U.S. 27, 48 S.Ct. 422, 72 L.Ed. 767 (1928).
This past summer, a state court looked to the erudite wisdom of Justice Holmes in a dispute between a trustee of a family trust and the state department of revenue. A state statute in North Carolina imposed a tax on estate and trust income that benefits any state resident. The trust at issue was created in New York by a New York resident and was governed by New York law. The New York trustee received a tax bill from the North Carolina taxing authority where one of the trust beneficiaries lived. After the trustee paid the tax, she sued the department of revenue and won.
On appeal, the court looked to Brooke v. City of Norfolk and recognized that the Commerce Clause and the Due Process Clause of the United States Constitution impose distinct but parallel limitations on a State’s power to tax out-of-state activities. Simply stated, the constitutional analysis begins with an inquiry into whether the taxing power exerted by the state bears fiscal relation to protection, opportunities, and benefits given by the state, i.e., whether the state has given anything for which it can ask return. When the test was applied to the fact scenario in Kaesterner 1992 Family Trust, the court determined that the state statute computing taxes on the amount of an irrevocable inter vivos New York trust’s taxable income for the benefit of another state’s resident violated due process as applied to the trust because the trust was created and governed by New York law, the trustee resided outside of the state, the trust did not own property in the taxing state, and although the trust beneficiary lived in the taxing state, she had no control over the trust during the period for which the income tax was assessed and did not receive a taxable distribution from the trust during years for which income tax was assessed.