Petition for Writ of Certiorari — North Carolina Department of Revenue, Petitioner v. The Kimberley Rice Kaestner 1992 Family Trust

No. _______

In the

Supreme Court of the United States

NORTH CAROLINA DEPARTMENT OF REVENUE,

Petitioner,

v.

THE KIMBERLY RICE KAESTNER 1992 FAMILY TRUST,

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF NORTH CAROLINA

PETITION FOR A WRIT OF CERTIORARI

Robert F. Orr

ROBERT F. ORR, PLLC

3434 Edwards Mill Rd.

Suite 112-372

Raleigh, NC 27612

(919) 608-5335

Andrew H. Erteschik

Saad Gul

John M. Durnovich

POYNER SPRUILL LLP

Post Office Box 1801

Raleigh, NC 27602

(919) 783-2895

Matthew W. Sawchak

Solicitor General

Counsel of Record

James W. Doggett

Deputy Solicitor General

NORTH CAROLINA

DEPARTMENT OF JUSTICE

Post Office Box 629

Raleigh, NC 27602

(919) 716-6400

msawchak@ncdoj.gov

i

QUESTION PRESENTED

More than $120 billion of our nation’s income flows

through trusts. That income is a vital source of tax

revenue for the states. Eleven states, including North

Carolina, tax trust income when a trust’s

beneficiaries are state residents.

For the last ninety years, however, this Court has

been silent on whether these taxes comport with due

process. The Court’s last words on the subject come

from the Pennoyer era of due-process analysis.

Pennoyer v. Neff, 95 U.S. 714 (1878). As a result,

lower courts and state taxing authorities have been

searching in vain for modern guidance.

There is now a direct split spanning nine states.

Four state courts have held that the Due Process

Clause allows states to tax trusts based on trust

beneficiaries’ in-state residency. Five state courts,

including two state supreme courts this year, have

concluded that the Due Process Clause forbids these

taxes.

The Due Process Clause should not have different

meanings in different states—particularly when

billions of dollars of state-tax revenue hang in the

balance. The question presented to this Court is:

Does the Due Process Clause prohibit states from

taxing trusts based on trust beneficiaries’ in-state

residency?

ii

PARTIES

All parties to the proceedings below are named in

the caption.

iii

TABLE OF CONTENTS

QUESTION PRESENTED .......................................... i

PARTIES ..................................................................... ii

TABLE OF CONTENTS............................................iii

TABLE OF AUTHORITIES ....................................... v

OPINIONS BELOW ................................................... 1

JURISDICTION ......................................................... 1

CONSTITUTIONAL PROVISIONS .......................... 1

INTRODUCTION ....................................................... 2

STATEMENT.............................................................. 5

I.

How and Why States Tax Trust Income ...... 5

II.

The Kaestner Trust ...................................... 6

III. The Trust’s Constitutional Challenge.......... 6

REASONS FOR GRANTING THE PETITION ......... 9

I.

There is a direct split among nine state

courts on the question presented ................. 9

II.

The question presented has significant

implications for the states ........................... 12

A. The question presented affects an

enormous amount of state-tax

revenue ................................................ 12

B. The question presented involves

important principles of federalism ...... 14

III. This case offers the Court an

opportunity to modernize its trusttaxation jurisprudence ............................... 15

iv

A. The absence of modern precedent on

trust taxation has caused confusion .... 15

B. Wayfair is a model for modernizing

this

Court’s

trust-taxation

jurisprudence ....................................... 18

CONCLUSION ......................................................... 22

APPENDIX ............................................................... 1a

Opinion of the

North Carolina Supreme Court

(June 8, 2018) ................................................. 1a

Opinion of the

North Carolina Court of Appeals

(July 5, 2016) ................................................ 27a

Opinion and Order of the

North Carolina Superior Court

(April 23, 2015) ............................................. 41a

v

TABLE OF AUTHORITIES

Cases

Blair v. Comm’r,

300 U.S. 5 (1937) ................................................. 19

Blue v. Dep’t of Treasury,

462 N.W.2d 762 (Mich. Ct. App. 1990) ......... 11, 17

Brown v. Fletcher,

235 U.S. 589 (1915) ............................................. 19

Burger King Corp. v. Rudzewicz,

471 U.S. 462 (1985) ............................................. 17

Chase Manhattan Bank v. Gavin,

733 A.2d 782 (Conn. 1999) ...................... 10, 16, 20

Commonwealth v. Stewart,

12 A.2d 444 (Pa. 1940) ........................................ 20

Curry v. McCanless,

307 U.S. 357 (1939) ............................................. 16

Dows v. City of Chicago,

78 U.S. 108 (1871) ............................................... 14

Fielding v. Comm’r of Revenue,

916 N.W.2d 323 (Minn. 2018) ....................... 12, 17

Greenough v. Tax Assessors of Newport,

331 U.S. 486 (1947) ............................................. 15

Hanson v. Denckla,

357 U.S. 235 (1958) ............................................... 8

Heico Corp. v. Taxation Div. Dir.,

20 N.J. Tax 106 (N.J. Tax Ct. 2002) ................... 11

Int’l Shoe Co. v. Washington,

326 U.S. 310 (1945) .............................. 3, 16, 18, 21

vi

Kimberly Rice Kaestner Family Trust v.

North Carolina Dep’t of Revenue,

814 S.E.2d 43 (N.C. 2018) ................................ 1, 16

Kimberly Rice Kaestner Family Trust v.

North Carolina Dep’t of Revenue,

789 S.E.2d 645 (N.C. Ct. App. 2016) .................... 1

Kimberly Rice Kaestner Family Trust v.

North Carolina Dep’t of Revenue,

12 CVS 8740, 2015 WL 1880607

(N.C. Super. Ct. Apr. 23, 2015) ............................. 1

Linn v. Dep’t of Revenue,

2 N.E.3d 1203 (Ill. App. Ct. 2013)....................... 10

McCulloch v. Franchise Tax Bd.,

390 P.2d 412 (Cal. 1964) ........................... 9, 16, 20

McCulloch v. Maryland,

17 U.S. (4 Wheat.) 316 (1819) ............................. 14

Mercantile-Safe Deposit &

Trust Co. v. Murphy,

203 N.E.2d 490 (N.Y. 1964) .......................... 11, 17

Miller Bros. v. Maryland,

347 U.S. 340 (1954) ............................................. 19

Pennoyer v. Neff,

95 U.S. 714 (1878) ...................................... i, 15, 16

Potter v. Taxation Div. Dir.,

5 N.J. Tax 399 (N.J. Tax Ct. 1983) ....................... 11

Quill Corp. v. North Dakota,

504 U.S. 298 (1992) ................................. 16, 18, 19

Residuary Trust A v. Dir.,

27 N.J. Tax 68 (N.J. Tax Ct. 2013) ..................... 11

vii

Safe Deposit & Trust Co. v. Virginia,

280 U.S. 83 (1929) ................................... 15, 16, 17

South Dakota v. Wayfair, Inc.,

138 S. Ct. 2080 (2018) ................................. passim

Tully v. City of Wilmington,

810 S.E.2d 208 (N.C. 2018) ................................... 7

Walden v. Fiore,

571 U.S. 277 (2014) ................................... 8, 17, 18

Westfall v. Dir. of Revenue,

812 S.W.2d 513 (Mo. 1991) ............................. 9, 10

Constitutional Provisions

U.S. Const. amend. XIV, § 1 ............................. passim

Statutes

28 U.S.C. § 1257(a) ..................................................... 1

28 U.S.C. § 1341.......................................................... 2

44 R.I. Gen. Laws § 44-30-5(c) ................................. 13

Act of Mar. 3, 1923, ch. 4, § 205,

1923 N.C. Sess. Laws 67, 128 .................................. 13

Ala. Code § 40-18-1(33) ............................................. 13

Cal. Rev. & Tax. Code § 17742(a)............................. 13

Conn. Gen. Stat. Ann. § 12-701(a)(4) ....................... 13

Ga. Code Ann. § 48-7-22(a)(1)(A) ............................. 13

Mo. Rev. Stat. § 143.331(1)(b) .................................. 13

Mont. Admin. R. 42.30.101(16) ................................ 13

N.C. Gen. Stat. § 105-160.2 .................................... 5, 6

viii

N.D. Admin. Code 81-03-02.1-04.............................. 13

Ohio Rev. Code Ann. § 5747.01 ................................ 13

Tenn. Code Ann. § 67-2-110(a) ................................. 13

Other Authorities

2 Jerome Hellerstein & Walter Hellerstein,

State Taxation (3d ed. 2003) ................................. 5

2017 Trust Nexus Survey Covering

General Trust Nexus Policies,

Daily Tax Rep. (BNA) No. 175

(Oct. 30, 2017)...................................................... 13

George Gleason Bogert,

The Law of Trusts and Trustees

(3d ed. 2008) .............................................. 2, 19, 20

Internal Revenue Service,

SOI Tax Stats—Fiduciary Returns—

Sources of Income, Deductions, and

Tax Liability—Type of Entity: 2014 ................... 12, 13

Jeffrey Schoenblum, Strange Bedfellows:

The Federal Constitution, Out-of-State

Nongrantor Accumulation Trusts, and the

Complete Avoidance of State Income Taxation,

67 Vand. L. Rev. 1945 (2014) ........................ 15, 21

Restatement (Third) of Trusts

(Am. Law Inst. 2003) ........................................... 19

The Federalist No. 32 (Alexander Hamilton)

(Clinton Rossiter ed., 1961) ...................................... 14

1

OPINIONS BELOW

The opinion of the Supreme Court of North Carolina

(App. 1a) is reported at 814 S.E.2d 43 (N.C. 2018).

The opinion of the Court of Appeals of North

Carolina (App. 27a) is reported at 789 S.E.2d 645

(N.C. Ct. App. 2016).

The state trial court’s decision (App. 41a) is

published at 12 CVS 8740, 2015 WL 1880607 (N.C.

Super. Ct. Apr. 23, 2015).

JURISDICTION

Petitioner, the North Carolina Department of

Revenue, respectfully seeks a writ of certiorari to

review a judgment of the Supreme Court of North

Carolina pursuant to 28 U.S.C. § 1257(a). The

Supreme Court of North Carolina issued its opinion

on June 8, 2018.

On August 24, 2018, Chief Justice Roberts

extended the time to file this petition until October 9,

2018. North Carolina Dep’t of Revenue v. Kimberly

Rice Kaestner Family Trust, No. 18A210 (U.S. Aug.

24, 2018).

CONSTITUTIONAL PROVISIONS

The Due Process Clause of the Fourteenth

Amendment provides that “[n]o state shall . . . deprive

any person of life, liberty, or property, without due

process of law.” U.S. Const. amend. XIV, § 1.

2

INTRODUCTION

This case asks whether the Due Process Clause

prohibits states from taxing trusts based on trust

beneficiaries’ in-state residency—a question on which

nine state courts have split.

Because of the Tax Injunction Act, this federal

constitutional question is usually litigated in state

courts. 1 State courts are divided in their answers to

this question, however, because they lack modern

guidance from this Court.

Many decades have passed since this Court has

addressed the due-process limits of trust taxation.

Although the Court has recently considered a number

of due-process cases that address states’ jurisdiction

to adjudicate, those cases do not offer clear guidance

on the due-process limits on trust taxation. State

courts have struggled to fill this jurisprudential void.

Part of that struggle stems from the unique nature

of trusts—entities that frustrate conventional dueprocess tests. Unlike an individual, a trust is a legal

abstraction: a fiction created to represent the

tripartite relationship among a settlor, a trustee, and

a beneficiary. George Gleason Bogert, The Law of

Trusts and Trustees § 1 (3d ed. 2008). For this reason,

a trust’s physical location is debatable.

The Tax Injunction Act, 28 U.S.C. § 1341 (2012), provides

that federal courts “shall not enjoin, suspend or restrain the

assessment, levy or collection of any tax under State law where

a plain, speedy and efficient remedy may be had in the courts of

such State.”

1

3

Because of these unusual features of trusts, courts

that have applied rigid, formalistic rules to trusts

have reached unjust conclusions.

In the decision below, for example, a majority of

the North Carolina Supreme Court concluded that a

trust and its beneficiaries are legally separate—in

other words, that beneficiaries are outsiders to a

trust.

On that basis, the majority expressly

disregarded the trust beneficiaries’ in-state residency

and other contacts with North Carolina.

That

analysis led the majority to conclude that the trust at

issue lacked a constitutionally sufficient connection

with the state. Thus, the majority held that the Due

Process Clause barred North Carolina from taxing

undistributed income that the trust earned and held

for the benefit of the beneficiaries.

With that decision, North Carolina joined the

ranks of eight other states that have reached

conflicting decisions on the question presented here.

Five states have concluded that the Due Process

Clause forbids states from taxing trusts based on

trust beneficiaries’ in-state residency. Four states

have concluded the opposite.

Neither side of the split involves uniform reasoning.

Some state courts have followed this Court’s trusttaxation precedents that predate International Shoe

Co. v. Washington, 326 U.S. 310 (1945). Other state

courts have looked to this Court’s modern due-process

decisions—for example, cases involving jurisdictional

challenges by tort defendants—but have struggled to

apply those precedents in the unique context of trust

taxation. Moreover, the courts on both sides of the split

have disagreed internally, with seven jurists dissenting

from the opinions.

4

This split has serious consequences for state-tax

revenues and, more broadly, for federalism principles.

Financially, the states that have barred taxation

face sharp cuts to their tax revenues. In fact, these

states are exposed to hundreds of millions of dollars

of potential claims for tax refunds. In North Carolina,

for example, trustees are already pursuing refunds in

the wake of the decision below.

In addition, the five state courts that have barred

these taxes have undermined important federalism

principles. By grounding their decisions in the federal

Due Process Clause, those courts have not only

forbidden a common form of taxation within their own

borders, but have also called it into question in other

states.

Because these decisions are based on the federal

Due Process Clause, no single state can resolve the

confusion.

The direct split, and the problems

associated with it, will only worsen without this

Court’s intervention.

5

STATEMENT

I. How and Why States Tax Trust Income

Generally, if a trust distributes income to a

beneficiary, the beneficiary (as opposed to the trust

itself) is taxed on that income. 2 Jerome Hellerstein

& Walter Hellerstein, State Taxation ¶ 20.09, at 20148 (3d ed. 2003). But when a trust earns income that

it holds for its beneficiary, the trust itself is taxed. Id.

North Carolina’s statute assesses taxes “on the

amount of the taxable income of the . . . trust that is

for the benefit of a resident of [the] State.” N.C. Gen.

Stat. § 105-160.2 (2017). Before this lawsuit, that

statute (or one of its predecessors) had been in force

and unchallenged since 1923. 2

Taxing a trust’s undistributed income based on the

trust beneficiaries’ in-state residency serves two vital

functions.

First, the revenue pays for the many services that

states provide to those in-state beneficiaries. These

services protect beneficiaries as the undistributed

income in their trusts grows. The value of those

services is considerable.

See South Dakota v.

Wayfair, Inc., 138 S. Ct. 2080, 2096 (2018) (observing

that state taxes “fund the police and fire

departments,” “maintain the public roads and

municipal services,” and “support the sound local

banking institutions” enjoyed by residents).

In North Carolina, as in most states, the taxable income of

an estate or trust “is the same as taxable income for such an

estate or trust under the provisions of the [Internal Revenue]

Code,” with adjustments similar to the adjustments that apply

to individual taxation. N.C. Gen. Stat. § 105-160.2 (2017).

2

6

Second, taxing a trust’s undistributed income

ensures that beneficiaries cannot permanently

shelter income earned for their benefit. In the

absence of a statute like North Carolina’s, a

beneficiary could enjoy the protections of a state for

most of her life, then avoid taxation by relocating to a

non-taxing state before taking a distribution.

For these reasons, eleven states (including North

Carolina) tax trusts based on trust beneficiaries’ instate residency.

II. The Kaestner Trust

The Kimberly Rice Kaestner 1992 Family Trust is

an irrevocable, inter vivos (non-testamentary) trust

that was created for the benefit of Kimberly Rice

Kaestner and her children. During the relevant period,

the Trust contained more than $13 million in assets.

The Trust was created in New York. Its trustee

was a resident of Connecticut during the tax years at

issue. During those years, Ms. Kaestner and her

children were residents of North Carolina.

North Carolina law provides that the state’s

Department of Revenue may tax trust income “that is

for the benefit of a resident of this State.” N.C. Gen.

Stat. § 105-160.2. Thus, the Department assessed

taxes on the undistributed income that accumulated

in the Trust from 2005 to 2008.

The Trust paid roughly $1.28 million in taxes

under protest. Then it filed this lawsuit.

III. The Trust’s Constitutional Challenge

The Trust brought this lawsuit as a

constitutional challenge in state court. Among its

claims, the Trust asserted that North Carolina had

7

violated the Due Process Clause by assessing taxes on

undistributed income held by the Trust for the benefit

of Ms. Kaestner and her children. 3 The Trust argued

that the Trust itself—as opposed to the Trust’s

beneficiaries—did not have a constitutionally

sufficient connection with North Carolina.

The state trial court concluded that North

Carolina’s assessment of taxes on the Trust violated

the Due Process Clause, and therefore ordered a

refund. 4 App. 69a. The North Carolina Court of

Appeals affirmed. App. 27a.

In a 6-1 decision, the North Carolina Supreme

Court affirmed the decision of the court of appeals.

App. 1a. The majority held that the in-state residence

of the Trust’s beneficiaries is not a sufficient

connection with North Carolina for due-process

purposes.

The majority first characterized a trust as

something separate from its beneficiaries—

reasoning, in essence, that trust beneficiaries are

In addition to the Trust’s due-process claim, the Trust also

brought claims under the Commerce Clause and under the

North Carolina Constitution’s law-of-the-land clause. That

state-constitutional claim is dependent on the Trust’s federal

due-process claim. See, e.g., Tully v. City of Wilmington, 810

S.E.2d 208, 216–17 (N.C. 2018) (explaining that North

Carolina’s “‘law of the land’ [clause] is synonymous with ‘due

process of law,’ a phrase appearing in the Federal Constitution

and the organic law of many states”).

3

In addition, the trial court held that the Department’s

assessment of taxes on the Trust violated the Commerce

Clause—an issue that neither of the state appellate courts

ultimately reached.

4

8

third parties to a trust. App. 13a. Next, the majority

borrowed principles from this Court’s decision in

Walden v. Fiore, 571 U.S. 277 (2014), which held, in

the context of a tort claim, that third parties’ contacts

with a forum state do not matter for due-process

purposes. 5 Id. Finally, the court merged these two

points and concluded that the Trust’s beneficiaries’

contacts with North Carolina do not matter in a dueprocess analysis. On this basis, the court held that

North

Carolina’s

trust-tax

statute

was

unconstitutional as applied to the Trust. App. 18a.

Justice Sam J. Ervin, IV, dissented. Criticizing

the

majority’s

“formalistic,

presence-focused”

approach, Justice Ervin concluded that the

beneficiaries’ in-state residency “has some bearing on

the proper performance of the required due process

analysis.” App. 24a.

Justice Ervin viewed this Court’s due-process

precedent as requiring a wider-ranging analysis of

the Trust’s connection with North Carolina—an

analysis that would give weight to the in-state

residency of the Trust’s beneficiaries. Id. Applying

that analysis, Justice Ervin concluded that the Trust

had a constitutionally sufficient connection with

North Carolina—a connection that brought the Trust

within North Carolina’s taxing jurisdiction. Id.

The majority also cited Hanson v. Denckla, 357 U.S. 235

(1958), to support this general proposition about third-party

contacts. Hanson involved a trust, but the issue there was

whether a beneficiary’s contacts with a state were sufficient to

establish adjudicative jurisdiction over a trustee, not a trust. Id.

at 253. Thus, Hanson offers no guidance on the question

presented here.

5

9

REASONS FOR GRANTING THE PETITION

I. There is a direct split among nine state courts on

the question presented.

A trust is a legal abstraction that evades

conventional due-process tests. See infra pp. 15–18.

The abstract character of trusts, coupled with a lack

of contemporary guidance from this Court, has led to

confusion among the state courts that have grappled

with the question presented. The confusion has

produced a direct split that spans nine states.

Four state courts have concluded that the Due

Process Clause allows states to tax trusts based on

trust beneficiaries’ in-state residency:

•

In McCulloch v. Franchise Tax Board, 390 P.2d

412 (Cal. 1964), the California Supreme Court

found no constitutional prohibition against

taxing a trust based on the trust beneficiary’s

in-state residence. The court began by noting

that this Court “ha[d] not yet had occasion to

decide the validity of a tax with respect to [a

trust’s] accumulated income where the trustee

is a nonresident and the tax is founded on the

residence of the beneficiary.” Id. at 418. The

court went on to hold that a beneficiary’s state

of residence can tax the trust because “that

state renders to the beneficiary . . . protection

incident to his eventual enjoyment of such

accumulated income.” Id. at 419.

•

In Westfall v. Director of Revenue, 812 S.W.2d

513 (Mo. 1991), the Missouri Supreme Court

held that Missouri could tax a trust’s

undistributed income because the trust at issue

had several points of contact with the state, one

10

of which was the presence of an in-state

beneficiary. Id. at 514. Two justices dissented,

opining that the tax was unconstitutional

because the trustee, the “legal owner of the

trust property,” was a nonresident. Id. at 517

(Blackmar, J., dissenting).

•

In Chase Manhattan Bank v. Gavin, 733 A.2d

782, 802 (Conn. 1999), the Connecticut

Supreme Court held that states can tax

undistributed trust income based on trust

beneficiaries’ in-state residency. The court

emphasized the “protection and benefits” that

states provide beneficiaries and found that the

beneficiary’s in-state residency was the

“critical link” justifying taxation. Id. at 802

n.25. Two justices dissented, focusing on the

fact that the income at issue “was produced

outside the state of Connecticut.” Id. at 807

(McDonald, J., dissenting).

•

In Linn v. Department of Revenue, 2 N.E.3d

1203, 1209 (Ill. App. Ct. 2013), the Illinois

Appellate Court favorably cited Connecticut’s

Gavin decision and held that the critical link

between a state and a trust for tax purposes is

the residence of the beneficiary. 6

In contrast, the courts of five states (including the

North Carolina Supreme Court in this case) have

concluded that the Due Process Clause prohibits

states from taxing trusts based on trust beneficiaries’

in-state residency:

Linn ultimately held that the state could not tax a trust

merely because the trust’s settlor had been an Illinois resident.

2 N.E.3d at 1210.

6

11

•

In Mercantile-Safe Deposit & Trust Co. v.

Murphy, 203 N.E.2d 490, 491 (N.Y. 1964), the

New York Court of Appeals held that the Due

Process Clause prohibited New York from

taxing the income of a trust administered in

Maryland. The court reached this conclusion

even though the trust beneficiary was a New

York resident.

•

In Potter v. Taxation Division Director, 5 N.J.

Tax 399, 405 (N.J. Tax Ct. 1983), the New

Jersey Tax Court held that the “fact that

contingent beneficiaries are domiciled in New

Jersey does not constitute a contact sufficient to

empower New Jersey to tax undistributed trust

income where the contingent beneficiaries have

no right to the undistributed trust income.” 7

•

In Blue v. Department of Treasury, 462 N.W.2d

762, 764 (Mich. Ct. App. 1990), the Michigan

Court of Appeals held that only the presence of

“the trustee [or] trust property . . . within the

state” can justify taxation of a trust’s income.

•

The North Carolina Supreme Court concluded

here that Ms. Kaestner’s in-state residency

could not justify taxing the Trust. App. 18a.

•

A month after the North Carolina Supreme

Court decided this case, the Minnesota Supreme

Court likewise concluded that a beneficiary’s instate residence is not a sufficient basis for

Part of the holding in Potter has been superseded by statute,

as recognized in Heico Corp. v. Taxation Div. Dir., 20 N.J. Tax

106 (N.J. Tax Ct. 2002). However, the New Jersey Tax Court

continues to rely on Potter’s holding on trust taxation. See

Residuary Trust A v. Dir., 27 N.J. Tax 68 (N.J. Tax Ct. 2013).

7

12

taxation.

The court reasoned that “the

Minnesota residency of [the] beneficiary . . . does

not establish the necessary minimum

connection to justify taxing the trust’s income.”

Fielding v. Comm’r of Revenue, 916 N.W.2d 323,

331 (Minn. 2018). Two justices dissented,

focusing on the beneficiaries’ residency. See id.

at 334 (Lillehaug, J., dissenting).

In sum, there is a direct split among nine state

courts on an important constitutional question. This

split has intensified recently, culminating in three

decisions in the past five years. That direct split, by

itself, shows the need for this Court’s review.

II. The

question

presented

implications for the states.

has

significant

The

question

presented

has

significant

implications for the states in at least two ways. First,

the question presented affects billions of dollars in

state-tax revenue. Second, the question presented

involves important principles of federalism.

A. The question presented affects an enormous

amount of state-tax revenue.

In 2014 alone, trusts filed more than 2.7 million

federal tax returns. 8

Collectively, those trusts

8

See Internal Revenue Service, SOI Tax Stats—Fiduciary

Returns—Sources of Income, Deductions, and Tax Liability—

Type of Entity: 2014, available at https://www.irs.gov/

statistics/soi-tax-stats-fiduciary-returns-sources-of-incomedeductions-and-tax-liability-by-type-of-entity.

This figure includes returns filed on behalf of complex trusts,

simple trusts, grantor trusts, qualified-disability trusts, splitinterest trusts, and pooled-income funds. It does not include

13

reported income of more than $120 billion. 9 Taxes on

these billions of dollars are a critical source for

funding states’ essential government services.

Nearly every state taxes trust income. 10 At least

eleven states currently tax undistributed trust

income when a trust beneficiary lives in the taxing

state. 11 Until the state supreme court’s decision in

this case, North Carolina had assessed these taxes

since 1923. See Act of Mar. 3, 1923, ch. 4, § 205, 1923

N.C. Sess. Laws 67, 128.

With decisions like the one in this case, however,

the states collectively stand to lose hundreds of

millions of dollars in state-tax revenue annually—

losses that will reach billions of dollars over the next

decade alone. In North Carolina, the Department has

already received more than 450 contingent incometax returns from trusts that are awaiting the outcome

of this petition.

In short, the question presented has enormous

implications for the fiscal health of many states.

returns filed on behalf of decedents’ estates, Chapter 7

bankruptcy estates, and Chapter 11 bankruptcy estates.

9

See id.

2017 Trust Nexus Survey Covering General Trust Nexus

Policies, Daily Tax Rep. (BNA) No. 175, at 10–11 (Oct. 30, 2017).

10

Those states (other than North Carolina) are Alabama, see

Ala. Code § 40-18-1(33); California, see Cal. Rev. & Tax. Code

§ 17742(a); Connecticut, see Conn. Gen. Stat. Ann. § 12701(a)(4); Georgia, see Ga. Code Ann. § 48-7-22(a)(1)(A);

Missouri, see Mo. Rev. Stat. § 143.331(1)(b); Montana, see Mont.

Admin. R. 42.30.101(16); North Dakota, see N.D. Admin. Code

81-03-02.1-04; Ohio, see Ohio Rev. Code Ann. § 5747.01; Rhode

Island, see 44 R.I. Gen. Laws § 44-30-5(c); and Tennessee, see

Tenn. Code Ann. § 67-2-110(a).

11

14

B. The question presented involves important

principles of federalism.

As the Framers recognized, the states have always

“possessed an independent and uncontrollable

authority to raise their own revenues for the supply

of their own wants.” The Federalist No. 32, at 197

(Alexander Hamilton) (Clinton Rossiter ed., 1961);

see also Wayfair, 138 S. Ct. at 2096 (describing state

taxes as a “valid exercise of the States’ sovereign

power”).

This broad power to tax is a cornerstone of

federalism. As Chief Justice Marshall noted in

McCulloch v. Maryland, “the power of taxing the

people and their property is essential to the very

existence of government.” 17 U.S. (4 Wheat.) 316, 428

(1819). He stressed that this power covers “[a]ll

subjects over which the sovereign power of a state

extends.” Id. at 429.

Acting on these principles, this Court has

cautioned that the “modes adopted [by the states] to

enforce the taxes levied should be interfered with as

little as possible.” Dows v. City of Chicago, 78 U.S.

108, 110 (1871).

Now, however, five state courts have reached

federal constitutional decisions that slight these

principles of federalism. Those courts have rejected a

common mode of trust taxation. They have also cast

doubt on the constitutionality of that mode of taxation

for the other states that have adopted it, as well as

states that may consider assessing these taxes in the

future.

Together, these decisions mark “an

extraordinary imposition by the Judiciary on States’

authority to collect taxes and perform critical public

functions.” Wayfair, 138 S. Ct. at 2095 (describing the

15

former “physical-presence rule” under the Commerce

Clause).

As these points show, the question presented

raises important fiscal concerns and involves

important federalism principles.

III. This case offers the Court an opportunity to

modernize its trust-taxation jurisprudence.

A. The absence of modern precedent on trust

taxation has caused confusion.

It has been more than seventy years since the

Court addressed the power of states to tax trusts. See

Greenough v. Tax Assessors of Newport, 331 U.S. 486

(1947); Jeffrey Schoenblum, Strange Bedfellows: The

Federal Constitution, Out-of-State Nongrantor

Accumulation Trusts, and the Complete Avoidance of

State Income Taxation, 67 Vand. L. Rev. 1945, 1968

(2014). Given the lack of contemporary guidance from

the Court, state courts are confused over how to apply

the Due Process Clause in the context of trust

taxation.

Some state courts have looked to this Court’s early

decisions on trust taxation—decisions from the era of

Pennoyer v. Neff, 95 U.S. 714. Other state courts, like

the North Carolina Supreme Court in this case, have

attempted to apply the Court’s more recent dueprocess decisions. In both sets of cases, the courts’

opinions have shown the need for more direct

guidance from this Court.

Some state courts that have relied on older dueprocess precedents have followed this Court’s 1929

decision in Safe Deposit & Trust Co. v. Virginia, 280

U.S. 83. In Safe Deposit, this Court held that Virginia

could not assess property taxes on trust property that

16

was held in Maryland for a Virginia beneficiary. Id.

The Court premised this holding on its assumption

that the Due Process Clause does not allow multiple

states to tax the same intangible property. Id. at 94.

Safe Deposit, however, does not involve a modern

due-process analysis. It was decided under the rigid,

presence-based regime of Pennoyer v. Neff. It was

decided fifteen years before International Shoe, which

replaced Pennoyer’s rigid test with the more flexible

“minimum contacts” test. 326 U.S. at 316. It was also

decided long before Quill Corp. v. North Dakota, 504

U.S. 298 (1992), which rejected “formalistic tests” for

assessing jurisdiction to tax. 12

Id. at 307–08

(eliminating the former “physical presence” rule

under the Due Process Clause).

Furthermore, Safe Deposit was premised on the

notion that the Due Process Clause prohibits double

taxation—a prohibition that the Court later

abandoned in Curry v. McCanless, 307 U.S. 357, 363

(1939). With that linchpin removed, Safe Deposit is

no longer good law. See, e.g., Gavin, 733 A.2d at 803

(noting that the double-taxation concern was

“[c]entral to the Court’s reasoning in Safe Deposit,”

but that this rationale “has long been abandoned as a

limitation on taxation under the due-process clause”);

Kaestner, 814 S.E.2d at 53 (Ervin, J., dissenting)

(opining that Safe Deposit did not support, much less

compel, the majority’s decision); see also McCullough,

390 P.2d at 418 (acknowledging Safe Deposit without

following it).

Although both International Shoe and Quill were cases

involving state taxes, neither case involved trusts, much less

due-process limits on trust taxation. Thus, neither decision

answers the question presented here.

12

17

Despite these points, a number of state-court

majorities and dissents have followed Safe Deposit.

See Blue, 462 N.W.2d at 764; Fielding, 916 N.W.2d at

330; Fielding, 916 N.W.2d at 337 n.4 (Lillehaug, J.,

dissenting); Murphy, 203 N.E.2d at 490. They have

done so largely without asking whether Safe Deposit

has been displaced by the Court’s modern due-process

decisions.

State courts that have relied on the Court’s more

modern due-process decisions have shown equal

confusion.

The North Carolina Supreme Court’s decision in

this case is a prime example. The majority borrowed

general principles from recent adjudicativejurisdiction cases that are silent on trust taxation and

the unique relationship between a trust and a

beneficiary. App. 13a.

Most notably, the state supreme court relied on

Walden v. Fiore, 571 U.S. 277, a case that decided

whether two Nevada gamblers could bring a tort

lawsuit in Nevada against a Georgia-based law

enforcement agent who seized their gambling winnings

in Georgia. The Walden Court explained that a

plaintiff cannot use the forum contacts of a “third

party”—there, the plaintiffs themselves—to justify

personal jurisdiction over a defendant. Id. at 286.

Walden’s rationale does not apply in the context of

a trust and its beneficiaries, where the beneficiary is

not a genuine third party. Unlike the brief interaction

between the tortfeasor and the plaintiffs in Walden,

the fiduciary relationship between a trustee and a

beneficiary is enduring; indeed, such a relationship

often lasts many decades. See Burger King Corp. v.

Rudzewicz, 471 U.S. 462, 480 (1985) (recognizing that

18

long-term relationships can serve as a basis for

jurisdiction, depending on the quality and nature of

those relationships).

And unlike the adverse

relationship between the tortfeasor and the plaintiffs

in Walden, the relationship between a trust and its

beneficiaries is symbiotic. After all, the beneficiaries

are why the trust exists. See infra p. 19.

In sum, neither the Court’s pre-International Shoe

decisions nor its modern decisions have resolved the

question presented. The lack of on-point decisions

has caused confusion among state courts.

B. Wayfair is a model for modernizing this Court’s

trust-taxation jurisprudence.

In the recent Wayfair decision, the Court updated

its Commerce Clause jurisprudence to reflect presentday realities in the context of sales taxes. This case

offers the Court a similar opportunity to modernize its

due-process jurisprudence in the context of trust taxes.

In Wayfair, the Court reaffirmed Quill’s holding

that a taxpayer “need not have a physical presence in

a state to satisfy the demands of due process.”

Wayfair, 138 S. Ct. at 2084–85. The Court expressly

rejected “arbitrary, formalistic” distinctions that

lower courts had used to “prevent States from

collecting taxes.” Id. at 2094. The Court also

condemned “judicially created tax shelter[s].” Id.

This case gives the Court a similar opportunity to

modernize the constitutional analysis of trust

taxation in ways that parallel Wayfair.

First, like Wayfair, this case presents an

opportunity for the Court to reject “arbitrary,

formalistic” distinctions that prevent states from

assessing taxes. The North Carolina Supreme Court’s

19

formalistic

rationale—the

idea

that

trust

beneficiaries’ contacts with a taxing state are not

contacts of the trust itself—is an outdated notion,

reminiscent of the physical-presence rule that was

retired in Wayfair.

The question presented here calls for a more

flexible approach to trust taxation—one that

expressly recognizes that a beneficiary is no stranger

to a trust. This approach is consistent with the

Court’s existing due-process jurisprudence, which

requires only “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

(quoting Miller Bros. v. Maryland, 347 U.S. 340, 344–

45 (1954)).

In the context of trust taxation, the required

“minimum connection” is the residency of the

beneficiary in the taxing state. This residency creates

a “definite link” between the trust and the taxing

state; indeed, if not for the in-state beneficiary who

consumes the resources of the taxing state, the trust

itself could not exist. See Bogert, supra, § 543 (noting

that a trust fails for lack of a beneficiary);

Restatement (Third) of Trusts § 44 (Am. Law Inst.

2003) (same).

The definite link is even stronger when one

considers the vested interest that the beneficiary has

in the trust. This Court has characterized that

interest as an “estate in and to property” of the trust.

Blair v. Comm’r, 300 U.S. 5, 14 (1937) (quoting Brown

v. Fletcher, 235 U.S. 589, 599 (1915)). In other words,

the trustee has legal ownership of property held in the

trust, but the beneficiary enjoys equitable ownership

of that property—“an actual property interest in the

20

subject-matter of the trust.”

Commonwealth v.

Stewart, 12 A.2d 444, 446–47 (Pa. 1940), aff’d mem.,

312 U.S. 649 (1941); see also Bogert, supra, § 114.

As these points show, the North Carolina Supreme

Court’s formalistic “separateness” theory clashes with

this Court’s modern due-process jurisprudence and

overlooks the essential nature of trusts. This case

presents an ideal opportunity for the Court to reject

these arbitrary, formalistic distinctions and adopt an

approach that is more appropriate for analyzing trust

taxation under the Due Process Clause.

Second, like Wayfair, this case presents an

opportunity for the Court to eliminate a “judicially

created tax shelter.” 138 S. Ct. at 2094.

Five state courts have now concluded that taxing

trusts based on trust beneficiaries’ in-state residency

is unconstitutional. In those five states, beneficiaries

like Ms. Kaestner can establish residency, consume

state resources, and accept other protections from the

state, while income earned for their benefit goes

untaxed. See id. at 2096 (observing that state taxes

fund local police and fire departments, public roads,

municipal services, local banking, and the court

system for the benefit of residents); see also Gavin,

733 A.2d at 795 (recognizing that trusts benefit from

states’ protection of their beneficiaries); McCullough,

390 P.2d at 419 (same).

These state benefits are not hypothetical. For

example, one of the Kaestner Trust’s main purposes

was to provide for Ms. Kaestner’s education. That

purpose was fulfilled when Ms. Kaestner earned a

master’s degree at UNC-Chapel Hill. Her university

education was subsidized by North Carolina’s

taxpayers. And if Ms. Kaestner died in the absence of

21

contingent trust beneficiaries, her interest would pass

through North Carolina’s probate system—another

benefit funded by North Carolina’s taxpayers.

Worse still, the five state-court decisions that have

rejected jurisdiction have enabled beneficiaries to

avoid paying state taxes altogether. Beneficiaries like

Ms. Kaestner can now accumulate income in their

trusts over several decades, avoid taxes on that

income, and then, before taking a distribution from

their trusts, simply move—even temporarily—to a

state like Florida that does not assess income taxes.

Nothing would stop these beneficiaries from

returning the following year to their home state to

resume residency after taking tax-free distributions

from their trusts.

As one commentator put it, decisions like the one

in this case “facilitate an extraordinary stratagem by

which wealthy individuals are able to avoid all state

income taxes on investment income through the use

of a carefully crafted out-of-state trust.” Schoenblum,

supra, at 1997.

Under any notion of “fair play and substantial

justice,” Int’l Shoe, 326 U.S. at 320, this “judicially

created tax shelter” is one that warrants elimination.

Wayfair, 138 S. Ct. at 2094.

***

The Due Process Clause should not have different

meanings across nine states, especially when billions

of dollars in state-tax revenue hang in the balance.

Without guidance from this Court, the split at issue

here will continue to worsen, with serious

consequences for the states.

22

For these reasons, the

warrants this Court’s review.

question

presented

CONCLUSION

The petition should be granted.

Respectfully submitted,

JOSHUA H. STEIN

Attorney General

/s/ Matthew W. Sawchak

Matthew W. Sawchak

Solicitor General

Counsel of Record

James W. Doggett

Deputy Solicitor General

NORTH CAROLINA

DEPARTMENT OF JUSTICE

Post Office Box 629

Raleigh, NC 27602

(919) 716-6400

Robert F. Orr

ROBERT F. ORR, PLLC

3434 Edwards Mill Rd.

Suite 112-372

Raleigh, NC 27612

(919) 608-5335

October 9, 2018

Andrew H. Erteschik

Saad Gul

John M. Durnovich

POYNER SPRUILL LLP

Post Office Box 1801

Raleigh, NC 27602

(919) 783-2895