The two primary constitutional weapons used to combat the application of state tax laws are the Due Process Clause and the Commerce Clause. That said, for decades Due Process Clause arguments were often afterthoughts to those made under the Commerce Clause. All that changed when the U.S. Supreme Court’s decision in South Dakota v. Wayfair. The Court’s holding in Wayfair calls into question the going forward usefulness of taxpayer challenges brought under the Commerce Clause. Despite the far-reaching impact of the decision in Wayfair, however, the Court did not address the Due Process Clause. Enter Kaestner Trust.
On January 11, 2019, the Court agreed to hear the case of The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue. The facts of the case are straightforward enough. In 1992, a New York resident created a trust for the benefit of his three children. One of these three children, Ms. Kaestner, moved to North Carolina in 1997. In 2006, the trustee, a Connecticut resident, divided the trust into three separate trusts – one for each of the three children. All duties relating to the administration of the trusts were performed in New York, and the trusts were governed by New York law. The beneficiaries did not have an absolute right to the trust income or assets. The trustee had sole authority to manage the trust assets and income and discretion relating to trust distributions.
North Carolina law provides that the accumulated income of nonresident trusts is subject to tax if a beneficiary of the trust resides in the state. Having previously paid tax to North Carolina on its accumulated income, the Kaestner Trust filed a refund claim contending that the North Carolina law violated the Due Process Clause. Stated simply, the Due Process Clause requires that the taxpayer have “minimum contacts” with the taxing state. In such circumstances, state taxation is permitted as a recoupment of the benefits and protections afforded the state to the taxpayer.
Ruling for the taxpayer, the Supreme Court of North Carolina made clear that a trust and its beneficiaries are separate and distinct entities under state law. For this reason, the court held, the minimum contacts of the resident beneficiary cannot be attributed to the nonresident trust. Likewise, the court continued, the Due Process Clause mandates that the benefits and protections provided by North Carolina to a resident beneficiary are not deemed attributable to the nonresident trust. North Carolina successfully petitioned the U.S. Supreme Court for review arguing that the relationship between a trust and its beneficiaries is complex and reflects a symbiotic connection demanding a more fact-intensive analysis.
In the wake of Wayfair, the Court’s decision in Kaestner Trust could have wide-ranging significance. For example, consider the all-too-common use of limited liability companies to conduct multistate business operations. States routinely argue that the benefits and protections afforded the limited liability companies accrue to the benefit of the members thereby satisfying the Due Process Clause. If the core holding of the lower court is upheld, however, the door may be open for innumerable Due Process Clause challenges to state tax laws.
Tempest in a teapot? We will see.