Changes to North Carolina Trust Taxation

calendar iconFebruary 13, 2020

Considerations following the Supreme Court Kaestner decision

In a unanimous decision on June 21, 2019, the U.S. Supreme Court held that North Carolina cannot tax a trust if the only connection to the state is the residency of the trust beneficiary. North Carolina Dep’t of Rev. v. Kimberley Rice Kaestner 1992 Family Trust, 588 U.S.        (2019).  The Court held that such a tax violates the Due Process Clause of the Constitution because the trust did not meet the minimum connection requirement to the state.

If you filed a fiduciary income tax return in North Carolina or in another state that taxes based solely on residency of beneficiary and paid tax solely because the trust had a North Carolina resident beneficiary, you should consider reviewing the return filings to determine if filing a protective claim for refund is appropriate.

State income tax planning for trusts is extremely important and often is overlooked until it is too late. In most instances, a trustee will initiate the trust income tax return in a particular state and continue filing in that jurisdiction although the facts surrounding the trust have evolved. Reviewing the information below in existing non-grantor trusts (typically irrevocable trusts that are taxed as separate taxpayers) may identify state income tax planning opportunities, leading to state income tax savings on the client’s behalf.

Review the following for existing non-grantor trusts: 

  • Existing state tax filing to determine if filing in the appropriate jurisdiction.
  • Residency of the current trustee, which may impact existing state filing.
  • Existing trust document to determine if a trust situs change could be beneficial for the trust.
  • Trust provisions to determine if trust changes should be considered (ex. trust decanting for beneficiary protection purposes), which may impact state taxation.
  • Current and past trust administration; activities and meetings between the trustee and the beneficiary(ies).
  • Any significant changes in the trust assets (ex. stock or interest in an operating business that was sold and now the trust holds 100% marketable securities).

Consider the following questions when establishing new, non-grantor trusts:

  • How does the trust situs selection impact state income taxes?
  • How does the residency of settlor of the trust, trustee and/or trust protector impact state filing requirements?
  • Do the settlor’s goals and objectives require consideration for a state with domestic asset protection laws which may result in no state income tax at the trust level?
  • What assets will fund the trust? How long are those assets expected to be in the trust?

What’s next for state fiduciary income taxation?

The Court explained that there are many types of contact that a trust may have with a state that may withstand constitutional scrutiny and attain the level of fairness to warrant taxation, including a trustee residing in the state or a beneficiary receiving income. The decision was unambiguous with regards to North Carolina or any other state asserting an income tax based solely on the premise that a discretionary beneficiary resided in the state. The Court left the door open for many additional questions and provided little insight on how the state should properly tax trusts.

Today, the taxation of trusts throughout the states remain inconsistent. The states continue to impose trust income tax based upon factors such as the residency of the grantor of the trust at the time the trust is created, the residency of the trust beneficiary, the residency of the trustee or the situs of trust administration. A review of existing trusts and adequate planning when establishing new trusts should be conducted, to possibly eliminate the imposition of state income taxes.

If you have questions regarding your trusts and how they may be affected by the changed legislation, contact Mike Kirkman or your trusted Cherry Bekaert professional.