N.C. Dep't of Revenue v. Kimberley Rice Kaestner 1992 Family Trust

• Decision Date: 21 June 2019
• Docket Number: No. 18-457,18-457
• Citation: 139 S.Ct. 2213,204 L.Ed.2d 621
• Parties: NORTH CAROLINA DEPARTMENT OF REVENUE, Petitioner v. THE KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST
• Court: U.S. Supreme Court

139 S.Ct. 2213

204 L.Ed.2d 621

NORTH CAROLINA DEPARTMENT OF REVENUE, Petitioner

v.THE KIMBERLEY RICE KAESTNER 1992 FAMILY TRUST

No. 18-457

Supreme Court of the United States.

Argued April 16, 2019

Decided June 21, 2019

Solicitor General Matthew W. Sawchak for the petitioner.

David A. O'Neil, Washington, DC, for the respondent.

Robert F. Orr, Robert F. Orr, PLLC, Raleigh, NC, Andrew H. Erteschik, Saad Gul, John M. Durnovich, Nathaniel C. Zinkow, Poyner Spruill LLP, Raleigh, NC, Joshua H. Stein, Attorney General, Matthew W. Sawchak, Solicitor General, James W. Doggett, Deputy Solicitor General, Ryan Y. Park, Deputy Solicitor General, North Carolina, Department of Justice, Raleigh, NC, for petitioner.

Thomas Dean Myrick, Moore & Van Allen PLLC, Charlotte, NC, David A. O'Neil, Anna A. Moody, Laura E. O'Neill, Debevoise & Plimpton LLP, Washington, DC, for respondent.

Justice SOTOMAYOR delivered the opinion of the Court.

This case is about the limits of a State’s power to tax a trust. North Carolina imposes a tax on any trust income that "is for the benefit of" a North Carolina resident. N. C. Gen. Stat. Ann. § 105–160.2 (2017). The North Carolina courts interpret this law to mean that a trust owes income tax to North Carolina whenever the trust’s beneficiaries live in the State, even if—as is the case here—those beneficiaries received no income from the trust in the relevant tax year, had no right to demand income from the trust in that year, and could not count on ever receiving income from the trust. The North Carolina courts held the tax to be unconstitutional when assessed in such a case because the State lacks the minimum connection with the object of its tax that the Constitution requires. We agree and affirm. As applied in these circumstances, the State’s tax violates the Due Process Clause of the Fourteenth Amendment.

I

A

In its simplest form, a trust is created when one person (a "settlor" or "grantor") transfers property to a third party (a "trustee") to administer for the benefit of another (a "beneficiary"). A. Hess, G. Bogert, & G. Bogert, Law of Trusts and Trustees § 1, pp. 8–10 (3d ed. 2007). As traditionally understood, the arrangement that results is not a "distinct legal entity, but a ‘fiduciary relationship’ between multiple people." Americold Realty Trust v. Conagra Foods , Inc ., 577 U. S. ––––, ––––, 136 S.Ct. 1012, 1016, 194 L.Ed.2d 71 (2016). The trust comprises the separate interests of the beneficiary, who has an "equitable interest" in the trust property, and the trustee, who has a "legal interest" in that property. Greenough v. Tax Assessors of Newport , 331 U.S. 486, 494, 67 S.Ct. 1400, 91 L.Ed. 1621 (1947). In some contexts, however, trusts can be treated as if the trust itself has "a separate existence" from its constituent parts. Id ., at 493, 67 S.Ct. 1400.¹

The trust that challenges North Carolina’s tax had its first incarnation nearly 30 years ago, when New Yorker Joseph Lee Rice III formed a trust for the benefit of his children. Rice decided that the trust would be governed by the law of his home State, New York, and he appointed a fellow New York resident as the trustee.² The trust agreement provided that the trustee would have "absolute discretion" to distribute the trust’s assets to the beneficiaries "in such amounts and proportions" as the trustee might "from time to time" decide. Art. I, § 1.2(a), App. 46–47.

When Rice created the trust, no trust beneficiary lived in North Carolina. That changed in 1997, when Rice’s daughter, Kimberley Rice Kaestner, moved to the State. She and her minor children were residents of North Carolina from 2005 through 2008, the time period relevant for this case.

A few years after Kaestner moved to North Carolina, the trustee divided Rice’s initial trust into three subtrusts. One of these subtrusts—the Kimberley Rice Kaestner 1992 Family Trust (Kaestner Trust or Trust)—was formed for the benefit of Kaestner and her three children. The same agreement that controlled the original trust also governed the Kaestner Trust. Critically, this meant that the trustee had exclusive control over the allocation and timing of trust distributions.

North Carolina explained in the state-court proceedings that the State’s only connection to the Trust in the relevant tax years was the in-state residence of the Trust’s beneficiaries. App. to Pet. for Cert. 54a. From 2005 through 2008, the trustee chose not to distribute any of the income that the Trust accumulated to Kaestner or her children, and the trustee’s contacts with Kaestner were "infrequent."³ 371 N.C. 133, 143, 814 S.E.2d 43, 50 (2018). The Trust was subject to New York law, Art. X, App. 69, the grantor was a New York resident, App. 44, and no trustee lived in North Carolina, 371 N.C., at 134, 814 S.E.2d at 45. The trustee kept the Trust documents and records in New York, and the Trust asset custodians were located in Massachusetts. Ibid. The Trust also maintained no physical presence in North Carolina, made no direct investments in the State, and held no real property there. App. to Pet. for Cert. 52a–53a.

The Trust agreement provided that the Kaestner Trust would terminate when Kaestner turned 40, after the time period relevant here. After consulting with Kaestner and in accordance with her wishes, however, the trustee rolled over the assets into a new trust instead of distributing them to her. This transfer took place after the relevant tax years. See N. Y. Est., Powers & Trusts Law Ann. § 10–6.6(b) (West 2002) (authorizing this action).

B

North Carolina taxes any trust income that "is for the benefit of" a North Carolina resident. N. C. Gen. Stat. Ann. § 105–160.2. The North Carolina Supreme Court interprets the statute to authorize North Carolina to tax a trust on the sole basis that the trust beneficiaries reside in the State. 371 N.C., at 143–144, 814 S.E.2d at 51.

Applying this statute, the North Carolina Department of Revenue assessed a tax on the full proceeds that the Kaestner Trust accumulated for tax years 2005 through 2008 and required the trustee to pay it. See N. C. Gen. Stat. Ann. § 105–160.2. The resulting tax bill amounted to more than $ 1.3 million. The trustee paid the tax under protest and then sued in state court, arguing that the tax as applied to the Kaestner Trust violates the Due Process Clause of the Fourteenth Amendment.

The trial court decided that the Kaestners’ residence in North Carolina was too tenuous a link between the State and the Trust to support the tax and held that the State’s taxation of the Trust violated the Due Process Clause. App. to Pet. for Cert. 62a.⁴ The North Carolina Court of Appeals affirmed, as did the North Carolina Supreme Court. A majority of the State Supreme Court reasoned that the Kaestner Trust and its beneficiaries "have legally separate, taxable existences" and thus that the contacts between the Kaestner family and their home State cannot establish a connection between the Trust "itself" and the State. 371 N.C., at 140–142, 814 S.E.2d at 49.

We granted certiorari to decide whether the Due Process Clause prohibits States from taxing trusts based only on the in-state residency of trust beneficiaries. 586 U. S. ––––, 139 S.Ct. 915, 202 L.Ed.2d 641 (2019).

II

The Due Process Clause provides that "[n]o State shall ... deprive any person of life, liberty, or property, without due process of law." Amdt. 14, § 1. The Clause "centrally concerns the fundamental fairness of governmental activity." Quill Corp. v. North Dakota , 504 U.S. 298, 312, 112 S.Ct. 1904, 119 L.Ed.2d 91 (1992), overruled on other grounds, South Dakota v. Wayfair , Inc. , 585 U. S. ––––, ––––, 138 S.Ct. 2080, 2092–2093, 201 L.Ed.2d 403 (2018).

In the context of state taxation, the Due Process Clause limits States to imposing only taxes that "bea[r] fiscal relation to protection, opportunities and benefits given by the state." Wisconsin v. J. C. Penney Co. , 311 U.S. 435, 444, 61 S.Ct. 246, 85 L.Ed. 267 (1940). The power to tax is, of course, "essential to the very existence of government," McCulloch v. Maryland , 4 Wheat. 316, 428, 4 L.Ed. 579 (1819), but the legitimacy of that power requires drawing a line between taxation and mere unjustified "confiscation." Miller Brothers Co. v. Maryland , 347 U.S. 340, 342, 74 S.Ct. 535, 98 L.Ed. 744 (1954). That boundary turns on "[t]he simple but controlling question ... whether the state has given anything for which it can ask return." Wisconsin , 311 U.S. at 444, 61 S.Ct. 246.

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.’ " Quill , 504 U.S. at 306, 112 S.Ct. 1904. Second, "the ‘income attributed to the State for tax purposes must be rationally related to "values connected with the taxing State." ’ " Ibid .⁵

To determine whether a State has the requisite "minimum connection" with the object of its tax, this Court borrows from the familiar test of International Shoe Co. v. Washington , 326 U.S. 310, 66 S.Ct. 154, 90 L.Ed. 95 (1945). Quill , 504 U.S. at 307, 112 S.Ct. 1904. A State has the power to impose a tax only when the taxed entity has "certain minimum contacts" with the State such that the tax "does not offend ‘traditional notions of fair play and substantial justice.’ " International Shoe Co. , 326 U.S. at 316, 66 S.Ct. 154 ; see Quill , 504 U.S. at 308, 112 S.Ct. 1904. The "minimum contacts" inquiry is "flexible" and focuses on the reasonableness of the government’s action. Quill , 504 U.S. at 307, 112 S.Ct. 1904. Ultimately, only those who derive "benefits and protection" from associating with a State should have obligations to the State in question. International Shoe , 326 U.S. at 319, 66 S.Ct. 154.

III

One can imagine many contacts with a trust or its constituents that a State might treat, alone or in combination, as providing a ...