Respondents Brief — North Carolina Department of Revenue, Petitioner v. The Kimberley Rice Kaestner 1992 Family Trust

Supreme Court briefNov 30, 2018

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No. 18-457

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In The

Supreme Court of the United States

-----------------------------------------------------------------NORTH CAROLINA DEPARTMENT OF REVENUE,

Petitioner,

THE KIMBERLEY RICE KAESTNER

1992 FAMILY TRUST,

Respondent.

-----------------------------------------------------------------On Petition For A Writ Of Certiorari

To The Supreme Court Of North Carolina

-----------------------------------------------------------------BRIEF IN OPPOSITION TO THE NORTH

CAROLINA DEPARTMENT OF REVENUE’S

PETITION FOR A WRIT OF CERTIORARI

-----------------------------------------------------------------THOMAS D. MYRICK

Counsel of Record

NEIL T. BLOOMFIELD

MOORE & VAN ALLEN PLLC

100 North Tryon Street, Suite 4700

Charlotte, North Carolina 28202

Telephone: (704) 331-1000

tommyrick@mvalaw.com

neilbloomfield@mvalaw.com

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COCKLE LEGAL BRIEFS (800) 225-6964

WWW.COCKLELEGALBRIEFS.COM

QUESTION PRESENTED

Did the North Carolina Supreme Court correctly

apply settled due process principles to the unique facts

of this case, in which the State sought to tax the worldwide income of a trust to which it had no connection

based solely on the existence of a discretionary in-state

beneficiary?

TABLE OF CONTENTS

Page

QUESTION PRESENTED...................................

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

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

INTRODUCTION ................................................

STATEMENT OF THE CASE..............................

Background ................................................

II.

Procedural History ....................................

REASONS FOR DENYING THE PETITION ......

Kaestner Is Not Part of a Conflict Among

the Courts of Different States ...................

A. The North Carolina Supreme Court’s

Decision Is Based on a Unique Set of

Facts ....................................................

B. No Court Has Held that a Beneficiary’s Presence Is Sufficient to Tax

the Undistributed Income of a Foreign

Trust .................................................... 10

1. The Fielding and Mercantile-Safe

Deposit Courts Found Taxation of a

Foreign Trust Violates the Due Process Clause Despite the In-State

Presence of a Beneficiary and

Grantor ........................................... 10

iii

TABLE OF CONTENTS – Continued

Page

2. Three Lower Courts Found that

Taxation of a Trust Violates the

Due Process Clause Despite the InState Presence of the Grantor ........ 12

3. The Remaining Three Cases from

California, Connecticut, and Missouri Reject Due Process Challenges But the Taxpayers All Have

Connections to the Taxing State

that Do Not Exist Here................... 14

II.

This Case Is a Poor Vehicle for Addressing

Constitutional Implications of State Taxation of Out-of-State Trusts and Would

Have Limited Precedential Value .............. 18

A. This Case Presents a Unique Fact Pattern that Has Never Been Challenged ..... 19

B. There Are Only Four States with Similar Statutes that Could Possibly Have

a Similar Case and None Have Decided this Issue .................................... 20

C. This Case Is Limited to the Due Process Clause and Would Likely Return

on Commerce Clause Grounds If the

Department Was Successful ................ 23

D. This Case Does Not Present Issues of

Federalism or an Opportunity to “Modernize” Trust Law ................................. 25

TABLE OF CONTENTS – Continued

Page

III.

All of the North Carolina Courts Correctly

Decided that the State’s Tax Was Unconstitutional as Applied to the Kaestner

Trust .......................................................... 28

CONCLUSION..................................................... 31

TABLE OF AUTHORITIES

Page

CASES

Anderson v. Wilson, 289 U.S. 20 (1933) .................. 6, 29

Arizona v. Rumsey, 467 U.S. 203 (1984) .....................27

Blue v. Department of Treasury, 462 N.W.2d 762

(Mich. Ct. App. 1990) ......................................... 13, 14

Brooke v. Norfolk, 277 U.S. 27 (1928) ..................... 6, 26

Chase Manhattan Bank v. Gavin, 733 A.2d 782

(Conn. 1999) ............................................ 6, 14, 17, 24

Complete Auto Transit, Inc. v. Brady, 430 U.S.

274 (1977) ...................................................... 5, 24, 26

Fielding v. Commissioner of Revenue, 916

N.W.2d 323 (Minn. 2018) ............................ 10, 11, 24

Goldberg v. Sweet, 488 U.S. 252 (1989) ......................23

Hans Rees’ Sons, Inc. v. North Carolina, 283 U.S.

123 (1931) ................................................................30

Hanson v. Denckla, 357 U.S. 235 (1958) ................. 6, 26

Linn v. Department of Revenue, 2 N.E.3d 1203

(Ill. App. 2013) ............................................. 12, 13, 24

McCulloch v. Franchise Tax Board, 390 P.2d 412

(Cal. 1964) ......................................... 6, 14, 15, 16, 22

McCulloch v. Maryland, 17 U.S. 316 (1819) ...............26

McNeil v. Commonwealth, 67 A.3d 185 (Pa.

Commw. Ct. 2013) ...................................................25

Mercantile-Safe Deposit & Trust Co. v. Murphy,

19 A.D.2d 765 (N.Y. App. Div. 1963), aff ’d, 203

N.E.2d 490 (N.Y. 1964) ............................................11

TABLE OF AUTHORITIES – Continued

Page

Mercantile-Safe Deposit & Trust Co. v. Murphy,

203 N.E.2d 490 (N.Y. 1964) ............................... 10, 11

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

399 (N.J. Tax Ct. 1983) ............................................13

Quill Corp. v. North Dakota, 504 U.S. 298

(1992) ............................................................... passim

Safe Deposit & Trust Co. v. Virginia, 280 U.S. 83

(1929) ................................................................. 26, 29

South Dakota v. Wayfair, Inc., ___ U.S. ___, 138

S. Ct. 2080 (2018) .............................................. 27, 28

Walden v. Fiore, 571 U.S. 277 (2014) ............................6

Westfall v. Director of Revenue, 812 S.W.2d 513

(Mo. 1991) .......................................................... 14, 17

CONSTITUTIONAL PROVISIONS

U.S. Const. art. I, § 8 ........................................... passim

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

STATUTES

35 Ill. Comp. Stat. § 5/201(a) ......................................12

Ala. Code § 40-18-1 .....................................................22

Cal. Rev. & Tax Code § 17742 ......................... 15, 21, 22

Cal. Rev. & Tax Code § 17745 ............................... 16, 22

Cal. Rev. & Tax Code § 17745(a) ................................15

Conn. Gen. Stat. § 12-701(a)(4) ..................................23

vii

TABLE OF AUTHORITIES – Continued

Page

Ga. Code Ann. § 48-7-22(a)(1)(c).................................21

Mich. Comp. Laws § 206.18(1)(c)................................14

Minn. Stat. § 290.01, subd. 7b.(a)(2) ..........................11

Mo. Rev. Stat. § 143.331 ..............................................17

Mo. Rev. Stat. § 143.331(3) .........................................22

Mont. Admin. R. § 42.30.101(16)(c) ............................22

N.C. Gen. Stat. § 105-160.2 .................................... 8, 20

N.D. Admin. Code § 81-03-02.1-04 .............................21

N.J. Stat. § 54A:1-2 .....................................................13

Ohio Rev. Code Ann. § 5747.01(I)(3)(a) ......................22

R.I. Gen. Laws § 44-30-5(c)(4)(5) ................................23

Tenn. Code Ann. § 67-2-102 ........................................21

Tenn. Code Ann. § 67-2-110 ........................................21

Tenn. Code Ann. § 67-2-124 ........................................21

Tenn. Pub. Acts 181 § 15 ............................................21

RULES

Supreme Court Rule 10 ..............................................27

Supreme Court Rule 14.1(g).......................................20

OTHER AUTHORITIES

Roger John Traynor, State Taxation of Trust Income, 22 Iowa L. Rev. 268 (1936-1937) ...................15

INTRODUCTION

This case presents a unique, fact-bound dispute

that does not raise any significant question of federal

law. The North Carolina Supreme Court correctly followed the well-established due process analysis from

this Court and applied it to the unique facts of this action. This Court should deny the petition for three

principal reasons.

First, the decision below does not conflict with the

decision of any other state court on any question of federal law. The cases the Department cites as establishing a purported conflict present different factual

circumstances from one another and from this case

that explain their different outcomes. The Department

has identified only two states whose highest courts

held that the state could tax the accumulated income

of an out-of-state trust. The trusts in those cases had

more connections with the taxing state than the residence of an in-state beneficiary. In fact, all of the cases

relied upon by the Department involve connections to

the taxing state other than the residence of the beneficiary; two do not involve a beneficiary residing in the

taxing state; and one does not even involve the taxation of a trust. The Department has identified no decision in which a state has attempted, much less

succeeded in, the taxation of an out-of-state trust

based solely on the presence of a beneficiary. There is

no conflict that a decision by this Court would resolve.

Second, this case presents a poor vehicle for

addressing the Constitutional implications of state

taxation of out-of-state trusts because it is limited to

its facts and the arguments heard by the lower court.

This case does not impact the taxation of all trusts. Instead, it relates to the taxation of an out-of-state trust

where the only purported connection is the in-state

presence of a beneficiary. In the almost 100 years that

the North Carolina law has been in existence, no similarly situated trust has filed a challenge. Only four

states have similar statutes to North Carolina that

even would permit taxation on these facts. And of those

four states, none have seen a challenge by a similarly

situated trust. In addition, the North Carolina trial

court recognized that taxing the trust in these circumstances would violate the Commerce Clause, but the

two North Carolina appellate courts found it unnecessary to reach this issue because they held that the tax

failed under the Due Process Clause. Because of the

unaddressed Commerce Clause implications, a decision by this Court may not finally resolve even this

specific litigation. These limitations on both the facts

and the law make a review by this Court unwarranted.

Third, the North Carolina Supreme Court correctly reached its decision based on the application of

long established precedent of this Court applied to the

particular set of facts presented. Due Process demands

that where a state seeks to tax, it must have provided

some benefit. There is no connection between North

Carolina and the trust in this case. And there is no

cause for this Court to devote its limited resources to

reviewing the application of settled due process principles to a unique factual circumstance.

The petition for certiorari should be denied.

------------------------------------------------------------------

STATEMENT OF THE CASE

Background

The Joseph Lee Rice, III Family 1992 Trust (the

“Family Trust”) was created in New York under an

agreement dated December 30, 1992 (the “Trust Agreement”) between Joseph Lee Rice III as Settlor (the

“Settlor”) and William B. Matteson as trustee (the “Initial Trustee”). App. 2a. The Family Trust is governed

by New York law. App. 2a. At the Family Trust’s creation there were no connections to North Carolina:

•

The Settlor was a resident and domiciliary of New York, App. 44a;

•

The Initial Trustee was a resident and

domiciliary of New York, App. 44a;

•

The primary beneficiaries of the Family

Trust were the Settlor’s descendants,

none of whom were residents of North

Carolina, App. 44a;

•

The contingent beneficiaries of the Family Trust were the Settlor’s spouse and

sister, none of whom were residents of

North Carolina, App. 44a–45a;

•

All of the assets of the Family Trust were

located outside of North Carolina, App.

3a; and

•

The Family Trust was a separate tax paying entity subject to all applicable New

York income tax, App. 3a.

Ultimately, pursuant to Section 1.2 of the Trust

Agreement, the Family Trust was divided into three

separate share trusts, including the Kimberley Rice

Kaestner 1992 Family Trust (the “Kaestner Trust”).

App. 3a. The separate share trusts continued to be administered by the Trustee under the terms of the Trust

Agreement. App. 45a–46a.

The beneficiary of the Kaestner Trust is Kimberley Rice Kaestner. She was a resident of North Carolina during the tax years at issue after moving to the

state in 1997. App. 2a. The contingent remainder beneficiaries of the Kaestner Trust were residents of New

York (the Settlor’s other children and the Settlor’s

spouse) and Connecticut (the Settlor’s sister). See App.

44a–45a. Ms. Kaestner has since moved to California;

during the time she resided in North Carolina, she received no distributions from the trust.

None of the beneficiaries had any right to withdraw the assets because distributions were made at

the sole discretion of the Trustee. App. 3a. No funds

were distributed from the Kaestner Trust during the

relevant tax years. App. 3a. The beneficiaries also had

no role in the management of the Kaestner Trust’s assets; the Trustee had and exercised sole discretion to

make all investment decisions. App. 46a.

The facts are undisputed. The Department “concedes that the only ‘connection between the [Kaestner]

Trust and North Carolina in the case at hand is the

residence of the beneficiaries.’ ” App. 54a.

II.

Procedural History

At every level, North Carolina courts were confronted with the same issue—whether the Constitution prohibited the state from taxing a foreign trust

based solely on the presence of an in-state beneficiary.

See App. 1a; App. 27a; App. 41a. And at every level, the

North Carolina courts correctly held that the State’s

tax of a foreign trust was unconstitutional.

The North Carolina Business Court held that the

State’s attempt to tax the Kaestner Trust violated the

Due Process Clause. The Business Court did not take

an outdated, formalistic approach as the Department

alleges. In citing this Court’s decision in Quill Corp. v.

North Dakota, the Business Court held that where a

party is not physically located in the taxing state, the

taxed entity must “ ‘purposefully avail[ ]’ itself of the

benefits, economic and otherwise, and the laws of

North Carolina.” App. 53a. The Business Court further

concluded under the second prong of the Quill due process analysis that the income attributed to North Carolina—all of the Kaestner Trust’s worldwide income—

was not rationally related to the connection to the

state. App. 57a. The Business Court then followed this

Court’s holding in Complete Auto Transit, Inc. v. Brady

in holding that the State’s tax also violated the Commerce Clause. App. 67a–68a.

The Court of Appeals unanimously affirmed the

Business Court. The Court of Appeals relied on this

Court’s decision in Brooke v. Norfolk in holding that

the Due Process Clause prohibited North Carolina

from taxing a foreign trust based solely on the residence of a beneficiary. App. 38a–40a; see also Brooke v.

Norfolk, 277 U.S. 27, 28–29 (1928). The Court of Appeals did not reach the Commerce Clause challenge because it was unnecessary.

The North Carolina Supreme Court affirmed the

decision of the Court of Appeals. Like the lower courts,

the North Carolina Supreme Court considered

whether the State could tax the Kaestner Trust “solely

based on the North Carolina residence of the beneficiaries during the tax years 2005 through 2008.” App.

2a. The court cited this Court’s decision in Anderson v.

Wilson for the proposition that a trust is a separate entity for income tax purposes. App. 12a; see Anderson v.

Wilson, 289 U.S. 20, 27 (1933). It then relied on this

Court’s decision in Walden v. Fiore and Hanson v.

Denckla to conclude that the trust cannot satisfy the

minimum contact requirements based on the activity

of a third party. App. 13a; see Walden v. Fiore, 571 U.S.

277, 284–85 (2014); Hanson v. Denckla, 357 U.S. 235,

253 (1958). Finally, the North Carolina Supreme Court

distinguished Gavin and McCulloch in favor of this

Court’s analysis in Quill in deciding that North Carolina’s taxation of the Kaestner Trust violated Due Process. App. 14a–17a.

------------------------------------------------------------------

REASONS FOR DENYING THE PETITION

This Court should deny the Petition because, contrary to the Petitioner’s efforts to inflate its significance, the case presents only the narrow question of

whether a state’s attempt to tax a foreign trust based

solely on the presence of an in-state beneficiary violates the Due Process Clause. The case is not a part of

any split of authority. North Carolina is the only state

to address the validity of a statute that provides for the

taxation of a foreign trust based solely on the in-state

residence of a beneficiary. This is a fact-bound case

that was correctly decided below and would have limited precedential value because of the unique facts and

the limitations on the arguments ruled upon. This

Court’s review is not warranted.

Kaestner Is Not Part of a Conflict Among

the Courts of Different States

The Kaestner Trust is unique. No case cited by the

Department or by the courts below addressed a trust

where the only possible connection to the state for minimum contacts analysis was the in-state presence of a

beneficiary. The cases the Department does cite are inapposite. The two cases emphasized by the Department throughout this litigation and the six cases it has

added to their argument to manufacture a split of authority all address the due process rights of trusts that

have connections to the taxing state that do not exist

here. Five of these cases have held that the tax violates

the Constitution and therefore do not support review.

The three remaining cases all involve multiple connections to the taxing state.

A. The North Carolina Supreme Court’s Decision Is Based on a Unique Set of Facts

The North Carolina Supreme Court held that Section 105-160.2 of the North Carolina General Statutes,

as applied to the Kaestner Trust, violated the Due Process Clause of the Fourteenth Amendment because the

Trust did not have sufficient minimum contacts with

North Carolina. In considering the Kaestner Trust’s

“as applied challenge . . . [the court] look[ed] to

whether the statute is constitutional in the limited

context of the facts of the case before” them. App. 9a.

The court considered whether the Department could

tax the Kaestner Trust’s income “solely based on the

North Carolina residence of the beneficiaries during

tax years 2005 through 2008.” App. 2a.

No court has been confronted with the stark fact

pattern presented here. The Kaestner Trust has no

connection to North Carolina. The Family Trust was

created in 1992 when both the Settlor and the initial

trustee were New York residents. App. 43a–44a. The

Family Trust was created under New York law and the

Trust Agreement provides that New York law governs

the trust in all respects. App. 2a. In 1997, five years

after the Family Trust was created, the beneficiary

moved to North Carolina. App. 2a. She has since moved

to another state.

At all relevant times after the Kaestner Trust was

formed as a separate share trust, the beneficiary did

not receive any distributions of funds, including during

the period when she resided in North Carolina. App.

3a. All of the Kaestner Trust’s assets were located outside of North Carolina. App. 3a. All of the business of

the Kaestner Trust took place in New York—its attorneys were located in New York; its financial books and

records were located in New York; the custodian of the

trust’s assets was in Massachusetts, and its tax returns and accountings were prepared in New York.

App. 45a–46a. The Trustee generated income exclusively from investments outside of North Carolina.

App. 65a.

The Trustee made all the decisions for the

Kaestner Trust. App. 46a. The beneficiary had no control over the management of the Kaestner Trust or the

distribution of its funds. App. 46a. In fact, the beneficiary was not even aware of its existence until nine

years after she had moved to North Carolina.

In 2005 through 2008, the Department taxed all of

the accumulated, worldwide income of the Kaestner

Trust on the sole basis that Ms. Kaestner, a discretionary beneficiary of the trust, was a North Carolina resident during the tax years at issue. App. 4a.

Every other state that sought to tax a trust in the

cases cited by the Department had a connection to the

trust that does not exist here.

B. No Court Has Held that a Beneficiary’s

Presence Is Sufficient to Tax the Undistributed Income of a Foreign Trust

The cases invoked in the Petition do not establish

any split of authority with this case. Two of these cases

do not present a conflict because, even with the presence of connections to the taxing state that are not present here, the courts concluded that the tax was

unconstitutional. Three of the cases are decisions of

lower level state courts that all similarly concluded

that taxation was unconstitutional. Of the remaining

three cases, all are distinguishable because they (i) are

not decided based on a state statute permitting taxation based solely on the residency of the beneficiary, (ii)

the trusts have connections with the taxing state that

are not present here, and (iii) one involves taxation of

funds held by the in-state beneficiary.

1. The Fielding and Mercantile-Safe Deposit Courts Found Taxation of a Foreign Trust Violates the Due Process

Clause Despite the In-State Presence

of a Beneficiary and Grantor

The Minnesota Supreme Court in Fielding v. Commissioner of Revenue and the Court of Appeals of New

York in Mercantile-Safe Deposit & Trust Co. v. Murphy

both held that the state’s taxation of the trust violated

the Due Process Clause of the Fourteenth Amendment.

Fielding, 916 N.W.2d 323, 334 (Minn. 2018), petition

for cert. filed, Comm’r of Rev. v. Fielding, No. 18-664

(Nov. 15, 2018); Mercantile-Safe Deposit & Tr. Co., 203

N.E.2d 490, 581 (N.Y. 1964). Both courts concluded

that Due Process prohibited taxation even though, unlike in this case, the trusts had connections to the taxing state beyond an in-state beneficiary.

The relevant statute in Fielding, Section 290.01 of

the Minnesota Statutes, defines a resident trust as “an

irrevocable trust, the grantor of which was domiciled

in this state at the time the trust became irrevocable.”

Minn. Stat. § 290.01, subd. 7b.(a)(2). Unlike this case,

the grantor of the trusts was a resident of the taxing

state when the trusts became irrevocable, and some of

the Fielding trusts’ income was derived from sources

in Minnesota. Fielding, 916 N.W.2d at 330. Despite

these additional connections, the Supreme Court of

Minnesota held that the trust “lack[ed] sufficient relevant contacts with Minnesota during the applicable

tax year to be permissibly taxed consistent with due

process.” Id. at 325.

The Mercantile-Safe Deposit court had to determine whether New York could tax “a nonresident trustee of an inter vivos trust created in Maryland by a

resident of New York.” 19 A.D.2d 765, 765 (N.Y. App.

Div. 1963), aff ’d, 203 N.E.2d 490 (N.Y. 1964). Both the

grantor of the trust and the trust’s beneficiary were

New York residents. Id. Despite the in-state presence

of the grantor and the beneficiary, the New York Court

of Appeals held that the state could not tax the accumulated income of the trust. 203 N.E.2d at 581.

2. Three Lower Courts Found that Taxation of a Trust Violates the Due

Process Clause Despite the In-State

Presence of the Grantor

The Department cites three lower court decisions

from Illinois, Michigan, and New Jersey, none of which

supports the petition for this Court’s review. Each of

those decisions rejected taxation of trusts that had connections to the taxing state that are not present here.

None of the relevant statutes permitted taxation based

solely on the in-state presence of a beneficiary. None of

the non-contingent beneficiaries resided in the taxing

state. And even if these cases were on point, which they

are not, these are cases decided by a trial court and two

intermediate state appellate courts; the highest courts

of these states should be permitted to address the issue

before review by this Court may be warranted or appropriate.

In Linn v. Department of Revenue, the issue before

the Appellate Court of Illinois was whether the state

could tax a trust whose only connections to the state

was that the grantor was a resident of Illinois at the

time the trust was made irrevocable. 2 N.E.3d 1203,

1209–11 (Ill. App. Ct. 2013). The beneficiaries of the

trust did not reside in Illinois. Id. at 1210. The Illinois

statute at issue provides that an irrevocable trust is a

resident of Illinois, and thus can be taxed pursuant to

35 Ill. Comp. Stat. § 5/201(a), when “the grantor [of the

trust] was domiciled in this State at the time such

trust became irrevocable.” Id. at 1208 (quoting 35 Ill.

Comp. Stat. § 5/1501(a)(20)(D) (2006)). The Linn court

held that Illinois could not tax a trust where the trust’s

only connection with the state was the fact that the

grantor of the trust resided in Illinois. Id. at 1211. Linn

therefore did not even address the question that the

Department seeks to present here.

Similarly, in Potter v. Taxation Division Director,

the New Jersey Tax Court addressed whether the

state’s taxation of the accumulated income of the trust

based on the residency of the grantor violated the Due

Process Clause. 5 N.J. Tax 399, 404–05 (N.J. Tax Ct.

1983). The New Jersey statute provides that the state

can tax the accumulated income of a trust if the grantor resided in the state at the time the trust became

irrevocable. N.J. Stat. § 54A:1-2. In Potter, the settlor

of the trust resided in New Jersey. 5 N.J. Tax at 402.

But the trustee and non-contingent beneficiaries resided outside the state.1 Id. at 403. The New Jersey Tax

Court held that the state did not have sufficient contacts to tax the trust when the only relationship between the trust and the state was that the grantor was

a New Jersey resident. Id. at 404–05.

In Blue v. Department of Treasury, the Michigan

Court of Appeals addressed whether the state could

lawfully tax the accumulated income of a trust where

the trust was created by a Michigan settlor, but had no

other connections to the state. 462 N.W.2d 762, 763

(Mich. Ct. App. 1990). The Michigan statute provides

The New Jersey Tax Court noted that the contingent beneficiaries resided in New Jersey, but did not consider that as a connection between the trust and the state. Id. at 405.

that the state may tax a trust that was created by a

Michigan resident. Mich. Comp. Laws § 206.18(1)(c);

see also Blue, 462 N.W.2d at 763. Neither the beneficiary nor the trustee was a resident of Michigan. Blue,

462 N.W.2d at 763. The Michigan Court of Appeals held

that the trust did not have sufficient contacts with the

state when the trust’s only connection to the state was

that the settlor was a Michigan resident. Id. at 764.

These decisions are inapposite and are not by the

highest courts of these states and therefore do not provide a reason for this Court to review the unique facts

of this case.

3. The Remaining Three Cases from

California, Connecticut, and Missouri

Reject Due Process Challenges But

the Taxpayers All Have Connections

to the Taxing State that Do Not Exist

Here

The remaining three cases on which the Department relies present fundamentally different facts. The

Department has repeatedly emphasized the Supreme

Court of California’s decision in McCulloch v. Franchise

Tax Board and the Connecticut Supreme Court’s decision in Chase Manhattan Bank v. Gavin. McCulloch,

390 P.2d 412 (Cal. 1964); Gavin, 733 A.2d 782 (Conn.

1999). The North Carolina Supreme Court correctly

distinguished these cases. App. 14a–17a. The Department now also cites Westfall v. Director of Revenue, 812

S.W.2d 513 (Mo. 1991), an almost 30-year-old case

which it has never previously relied upon and which

does not assist it here. Each of these cases involved

statutes that did not permit taxation based solely on

the beneficiary’s residence and the trusts at issue had

contacts with the taxing state that are not present

here.

As the North Carolina Supreme Court noted,

McCulloch v. Franchise Tax Board is distinguishable

from the instant case on a number of grounds—(i) California taxed the distribution in the hands of the instate beneficiary, not the out-of-state trust and (ii) the

California resident beneficiary was also a trustee. See

390 P.2d at 414.

The statute at issue in McCulloch provides that a

resident beneficiary—not the trust—may be taxed for

income accumulated by the trust and distributed to the

beneficiary.2 See 390 P.2d at 416; see also Cal. Rev. &

The Supreme Court of California did not address the constitutionality of the separate California statute providing that a

trust may be taxed on its accumulated income when the trustee

or beneficiary is a resident of the state. Cal. Rev. & Tax Code

§ 17742 (providing that the state can tax the entire taxable income of a trust “if the fiduciary or beneficiary (other than a beneficiary whose interest in such trust is contingent) is a resident,

regardless of the residence of the settlor”) (emphasis added). But

at least one justice deciding McCulloch was aware of the potential

constitutional challenges a state would face when directly taxing

a foreign trust. Justice Roger Traynor recognized that taxation of

a trust based on the residency of a beneficiary would be difficult.

See Roger John Traynor, State Taxation of Trust Income, 22 Iowa

L. Rev. 268, 278 (1936-1937). Justice Traynor concluded that to

tax accumulated income of a trust, a state should tax the income

after it was distributed to the in-state beneficiary. Id. at 275,

Tax Code § 17745(a). In McCulloch, the Supreme Court

of California acknowledged that “[t]he purpose of section 18106 of the Revenue and Taxation Code,” the

statute at issue, “is to avoid the difficulties which the

state might otherwise encounter in attempting to enforce tax collection directly against foreign trustees.”

390 P.2d at 420. The Supreme Court of California held

that “California can constitutionally tax the beneficiary at the time he receives the accumulated income.”

Id. at 414.

Even if California had taxed the income in the

hands of the trust, the case is distinguishable because

the in-state beneficiary was also a trustee. The McCulloch court relied upon the well-established principle

that a state may “tax the entire income of a discretionary trust administered by a resident trustee whether

he elects to distribute any part of such income or not.”

Id. at 420–21 (citing Guaranty Trust Co. v. Virginia,

305 U.S. 19, 22 (1938)). Accordingly, the Supreme Court

of California held that “[n]o possible doubt attaches to

California’s constitutional power to tax plaintiff as a

trustee.” Id. at 421. The McCulloch opinion contains a

discussion of whether the beneficiary’s residency on its

own could establish a sufficient connection to tax the

accumulated income of the trust, but this discussion is

dicta because the McCulloch court taxed the beneficiary, not the trust and that beneficiary was also a trustee.

279–80. That is exactly what Section 18106, now codified at Cal.

Rev. & Tax Code § 17745, allows.

The Department’s reliance on Chase Manhattan

Bank v. Gavin is also misplaced. 733 A.2d 782. In

Gavin, the Connecticut Supreme Court addressed different statutory language applied to different facts.

The Connecticut statute provides that a resident inter

vivos trust is “a trust, or portion of a trust, consisting

of the property of (i) a person who was a resident of this

state at the time the property was transferred to the

trust if the trust was then irrevocable. . . .” Id. at 789

(citing Conn. Gen. Stat. § 12-701(a)(4)(D)). The beneficiary and the settlor of the trust were residents of Connecticut. Id. at 787–88. Unlike the action here, the

beneficiary’s residency was not the sole contact relied

upon by the Connecticut Supreme Court.

The Missouri Supreme Court’s decision in Westfall

v. Director of Revenue is also inapposite. 812 S.W.2d

513. The Missouri statute provides that the state can

tax a trust if either the settlor or grantor of the trust

is a resident of the state and at least one income beneficiary resides in the state.3 Id. at 514. The Westfall

trust had four contacts with the state—(1) the settlor

resided in Missouri, (2) the trust was created in

Missouri, (3) property generating income for the trust

was located in Missouri, and (4) two contingent

beneficiaries were located in Missouri. Id. at 514. The

Mo. Rev. Stat. § 143.331 (defining a resident trust as a trust

that was either (1) “created by will of a decedent who at his or her

death was domiciled in this state” or (2) “created by, or consisting

of property of, a person domiciled in this state on the date the

trust or portion of the trust became irrevocable” and “[h]as at least

one income beneficiary who, on the last day of the taxable year,

was a resident of this state.”).

Missouri Supreme Court’s decision was based on all of

these connections.

There is no split in authority among the states on

the issue of whether the beneficiary’s presence alone is

sufficient to tax a foreign trust. There are no other

cases. The cases cited by the Department simply underscore why review of the decision below would be unwarranted and inappropriate. Each of those cases

turns on its particular set of facts, none of which is the

same as the unique factual situation presented here.

II.

This Case Is a Poor Vehicle for Addressing

Constitutional Implications of State Taxation of Out-of-State Trusts and Would Have

Limited Precedential Value

A decision on the facts of this case would provide

limited guidance for courts addressing the taxability of

trusts. First, as discussed above, the factual scenario

in which the only purported connection between the

taxing state and the out-of-state trust was the presence of the in-state beneficiary has never been litigated in any other state. Second, only five states,

including North Carolina, have statutes that permit

taxation based on the in-state presence of a beneficiary,

which limits where this type of case could arise. Third,

the North Carolina Supreme Court’s analysis was limited to the Due Process Clause. Foreign-state taxation

of a trust based on the contacts presented here also

raises issues under the Commerce Clause, which were

not briefed for or addressed by the North Carolina Supreme Court, and should not now be addressed by this

Court.

A. This Case Presents a Unique Fact Pattern that Has Never Been Challenged

This case is limited to the North Carolina Supreme Court’s decision addressing taxation in the

unique situation where the trust’s sole connection to

the state is the in-state residency of the beneficiary.

See infra. Section I.A. Contrary to the Department’s

assertions about the financial implications of this holding, the North Carolina court’s decision is likely to

have very little, if any, financial impact outside this litigation.

Only five states, including North Carolina, have

statutes that as a theoretical matter would permit taxation solely on the basis of an in-state beneficiary. Even

in those five states, there has not been a legal challenge by a similarly situated trust. Indeed, the Department observes that North Carolina’s tax has not been

challenged in the ninety-five years of its existence.

That is almost certainly because most of the trusts

paying taxes under the statute, unlike the Kaestner

Trust, had some connection to North Carolina.

For another case to arise like this one, all of the

following eight factors would need to be true: (1) the

trustee is not a resident of the state; (2) the grantor or

settlor of the trust is not a resident of the state; (3) the

trust is administered outside the state; (4) there is at

least one in-state beneficiary; (5) all of the trust’s income is generated from sources outside the state; (6)

all of the trust’s assets are located out-of-state; (7) the

trust is not governed by the state’s laws; and (8) the

trust has not distributed the income to the in-state

beneficiary.

These factors have coalesced one time.4 It is this

case.

B. There Are Only Four States with Similar Statutes that Could Possibly Have a

Similar Case and None Have Decided

this Issue

Forty-five states have chosen not to permit taxation of a trust based solely on a beneficiary’s residence.

The North Carolina statute provides that the state

may tax “the amount of the taxable income of the estate or trust that is for the benefit of a resident of this

State.” N.C. Gen. Stat. § 105-160.2. Only four other

The Department states for the first time, and without any

support in the record, that it has received “more than 450 contingent income-tax returns from trusts that are awaiting the outcome of this petition.” (Pet. for Writ of Cert. at 13.) The

Department provides no information about whether the referenced trusts remotely resemble the current trust, on what basis

these returns were filed, and whether any particular return

would be affected by the outcome of this case. This Court should

disregard this vague outside-the-record assertion. See Sup. Ct. R.

14.1(g) (requiring that the statement of the case in a petition for

certiorari rely on “specific portions of the record or summary

thereof, with specific reference to the places in the record where

the matter appears”).

states5 have statutes that provide for taxation of undistributed income of trusts based on nothing more

than the residency of a beneficiary—California, Georgia, North Dakota6, and Tennessee.7 And none of these

states have addressed whether the Constitution would

permit taxation solely on that basis.

See Cal. Rev. & Tax Code § 17742 (explaining that “the entire taxable income of a trust” is taxable to the trust “if the fiduciary or beneficiary (other than a beneficiary whose interest in

such trust is contingent) is a resident, regardless of the residence

of the settlor”); Ga. Code Ann. § 48-7-22(a)(1)(c) (imposing an income tax upon resident fiduciaries and nonresident fiduciaries

who are “[m]anaging funds or property for the benefit of a resident of this state”); N.D. Admin. Code § 81-03-02.1-04 (defining a

resident trust as a trust that “has a relationship to the state sufficient to create nexus,” including the fact that “[a] beneficiary of

the trust or estate is a domiciliary or resident of this state”); Tenn.

Code Ann. § 67-2-110 (“Trustees, guardians, administrators, executors, and other persons acting in a fiduciary capacity who receive

income taxable under this chapter for the benefit of residents of

Tennessee shall be required to make returns under this chapter

and to pay the tax levied by this chapter.”).

Unlike North Carolina’s statute, North Dakota does not explicitly provide that the state can tax solely based on the presence

of an in-state beneficiary. Instead, North Dakota’s statute suggests that the residence of a beneficiary may be sufficient on its

own to create a nexus with the state; however, it also lists five

other contacts that may be considered when assessing whether

there is a nexus with the state. N.D. Admin. Code § 81-03-02.1-04.

The language of the statute is ambiguous and has not been interpreted by the North Dakota Supreme Court.

Unlike North Carolina, Tennessee only taxes “on incomes

derived by way of dividends from stocks or by way of interest on

bonds.” Tenn. Code Ann. § 67-2-102. Further, Tennessee has enacted a bill that completely eliminates the income tax in 2022. See

Tenn. Code Ann. § 67-2-124; Tenn. Pub. Acts 181 § 15.

The Supreme Court of California in McCulloch did

not address this issue. Section 17742 provides that the

state can tax “the entire taxable income of a trust, if

the fiduciary or beneficiary . . . is a resident, regardless

of the residence of the settlor.” Cal. Rev. & Tax Code

§ 17742. But in McCulloch, the Supreme Court of California upheld a tax on the beneficiary—not the trust—

under Section 18106, now codified at Section 17745.

McCulloch, 390 P.2d at 416. There are no cases for the

other three states that are remotely on point.

The other six states cited by the Department do

not allow for the taxation of undistributed tax income

based solely on the in-state residency of a beneficiary.

Instead, those six states require both the in-state presence of at least one beneficiary and that the grantor of

the trust was a resident of the state at the time the

trust was made irrevocable.8

See Ala. Code § 40-18-1 (defining a resident trust as a trust

created “by a person who was an Alabama resident at the time

such trust became irrevocable” and “either a fiduciary of the trust

or a beneficiary of the trust to whom distributions currently may

be made” resides in the state); Mont. Admin. R. § 42.30.101(16)(c)

(defining resident trust to include “any irrevocable trust created

by, or consisting of property of, a Montana resident on the date the

trust or portion of the trust became irrevocable and has at least

one income beneficiary who, for all or some portion of the trust’s

current taxable year, was a Montana resident”); Mo. Rev. Stat.

§ 143.331(3) (defining resident trust to include “[a] trust that: (a)

[w]as created by, or consisting of property of, a person domiciled

in this state on the date the trust or portion of the trust became

irrevocable; and (b) [h]as at least one income beneficiary who, on

the last day of the taxable year, was a resident of this state”);

Ohio Rev. Code Ann. § 5747.01(I)(3)(a) (“A trust resides in this

state for the trust’s current taxable year to the extent . . . that the

C. This Case Is Limited to the Due Process

Clause and Would Likely Return on

Commerce Clause Grounds If the Department Was Successful

The Due Process Clause and the Commerce

Clause “pose distinct limits on the taxing powers of the

States,” meaning “a State may, consistent with the Due

Process Clause, have the authority to tax a particular

taxpayer,” but “imposition of the tax may nonetheless

violate the Commerce Clause.” Quill Corp. v. North Dakota, 504 U.S. 298, 305 (1992). This Court has explained that the Commerce Clause imposes limits

upon a state’s ability to tax interstate commerce and

activity. See Goldberg v. Sweet, 488 U.S. 252, 259

trust consists . . . of assets . . . that were transferred . . . to the

trust by . . . [a] person who was domiciled in this state for purposes of this chapter when the person directly or indirectly transferred assets to an irrevocable trust, but only if at least one of the

trust’s qualifying beneficiaries is domiciled in this state for the

purposes of this chapter during all or some portion of the trust’s

current taxable year.”); Conn. Gen. Stat. § 12-701(a)(4) (defining a

resident trust to include an irrevocable trust “consisting of the

property of (i) a person who was a resident of this state at the time

the property was transferred to the trust if the trust was then

irrevocable” or “a person who . . . was a resident of this state at

the time the trust became irrevocable” and noting that the taxable

income of the trust is modified if all the non-contingent beneficiaries do not reside within the state); R.I. Gen. Laws § 44-305(c)(4)(5) (defining a resident trust to include “[a]n irrevocable

trust created by or consisting of property contributed by a person

who is a resident individual in this state at the time the trust was

created” and “the beneficiaries are Rhode Island resident individuals”).

(1989); Complete Auto Transit, Inc. v. Brady, 430 U.S.

274, 279 (1977).

This case does not present an opportunity to address the Commerce Clause. The validity of a state tax

under the Commerce Clause is determined by the fourpart test set forth by this Court in Complete Auto

Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977). Under

the Complete Auto test, a state complies with the Commerce Clause if: “the tax (1) is applied to an activity

with a substantial nexus with the taxing State, (2) is

fairly apportioned, (3) does not discriminate against interstate commerce, and (4) is fairly related to the services provided by the State.” Quill Corp., 504 U.S. at

311 (quoting 430 U.S. at 279). If a tax does not satisfy

all four elements of the Complete Auto test, then it

must be struck down for violating the Commerce

Clause. Complete Auto Transit, 430 U.S. at 279. Given

the Kaestner Trust’s lack of connection to North Carolina, it is unlikely that it could pass any of these four

prongs, but it certainly could not pass all four.

There are cases where lower courts have ruled on

both points. At least three of the eight cases cited by

the Department in support of a purported split raised

both Due Process and Commerce Clause challenges.9

Fielding v. Comm’r of Rev., 916 N.W.2d 323, 327 (Minn.

2018) (“Having decided the case on due process grounds, the Tax

Court did not reach the Trusts’ claims under the Commerce

Clause.”); Linn v. Department of Revenue, 2 N.E.3d 1203, 1211 (Ill.

App. 2013) (explaining that the court did not need to address

plaintiff ’s commerce clause argument because it found the taxation of the trust to violate the due process clause); Chase Manhattan Bank v. Gavin, 733 A.2d 782, 806 (Conn. 1999) (holding that

Other cases cited by the Department throughout this

litigation have also asserted Commerce Clause challenges where the state taxed the undistributed income

of a trust.10

Thus, a decision by this Court may not finally resolve even this fact-bound dispute. If the Court were to

grant review and decide that that state’s extraterritorial taxation does not violate the Due Process Clause,

the litigation would continue and could return on Commerce Clause grounds.

D. This Case Does Not Present Issues of

Federalism or an Opportunity to “Modernize” Trust Law

The Department’s arguments based on federalism

and the purported need to “modernize” trust jurisprudence lack merit. Federalism does not stand for the

principle that one state should be able to exercise the

power to tax over a resident of another state. Nor is

review appropriate in order to “modernize” this Court’s

trust law jurisprudence; this is a solution looking for a

problem. Trust law has been around since the 12th

century and neither modern technology nor the facts of

this case have done anything to cause this Court to

“the incentives and risks have not been sufficiently established so

as to result in a dormant commerce clause violation”).

See, e.g., McNeil v. Commonwealth, 67 A.3d 185, 195 (Pa.

Commw. Ct. 2013) (holding that Pennsylvania’s taxation of the

Trust’s income violated the Commerce Clause where the trust’s

only purported connections to the state was the residency of the

settlor and beneficiaries).

revisit and upset settled understandings about the relationship between a trust and beneficiary.

A state cannot invoke federalism principles to justify imposing a tax on an entity with no connection to

that state. It is ironic that the Department cites

McCulloch v. Maryland to support its argument that

the North Carolina Supreme Court’s decision challenges principles of federalism. In McCulloch v. Maryland, the Supreme Court prevented the state from

taxing a federal institution within its borders because

the state could claim no control over it. 17 U.S. 316,

430 (1819). What the Department attempts to do

here—to reach outside its borders to tax an entity under control of and receiving the protection of another

state—is far beyond what this Court rejected in

McCulloch v. Maryland. This Court has continually

imposed limits on a state’s power to tax out-of-state

entities without thwarting the general principle that

states have the power to tax entities over which the

state’s sovereignty extends. See, e.g., Quill Corp., 504

U.S. at 305; Complete Auto Transit, 430 U.S. at 279;

Hanson, 357 U.S. at 253; Safe Deposit & Tr. Co. v. Virginia, 280 U.S. 83, 92 (1929); Brooke, 277 U.S. at 28–29.

The North Carolina Supreme Court’s decision

does not impose an “extraordinary imposition” on the

state. Instead, it requires that the state comply with

the well-established principles governing Due Process.

To tax an out-of-state entity the state must demonstrate that the entity has some connections with the

state and “that the ‘income attributed to the State for

tax purposes must be rationally related to values

connected with the taxing State.’ ” Quill Corp., 504 U.S.

at 306 (quoting Moorman Mfg. Co. v. Bair, 437 U.S. 267,

273 (1978)).

The Department incorrectly states that this Court

has not provided guidance concerning the taxation of

trusts since the “Pennoyer era of due-process,” which

was decided in 1878. (Pet. for Writ of Cert. at i.) The

Department contradicts the statement twice in its own

petition—first, stating that it has been ninety years

since the Court has addressed taxation of a trust, then

changing the calculation to seventy years. (Pet. for

Writ of Cert. at i, 15.)

Ultimately it is irrelevant how long it has been

since the Court has addressed this issue. The correct

question is whether there are “compelling reasons” to

warrant the Court to readdress the issue. Sup. Ct. R.

10. This Court has noted that “any departure from the

doctrine of stare decisis demands special justification.”

Arizona v. Rumsey, 467 U.S. 203, 212 (1984). The Department has failed to provide any compelling reason

for this Court to grant its Petition or any justification

for revisiting well-established precedent.

The Department suggests that the Due Process

principles applicable to trusts should be “modernized,”

comparing the circumstances of this case to those in

Wayfair. The comparison is inapt. In Wayfair, unlike in

this case, the outcome of the case had significant implications. “Forty-one States, two Territories, and the

District of Columbia” asked the Court to revisit the

Commerce Clause physical presence rule as applied to

sales tax. South Dakota v. Wayfair, Inc., ___ U.S. ___,

138 S. Ct. 2080, 2086 (2018). The issue presented has

only been addressed by North Carolina and at most

this decision could impact only the five states with

statutes permitting taxation of undistributed income

of an out-of-state trust based solely on the residency of

the beneficiary.

In Wayfair, this Court held that the Commerce

Clause physical presence rule “must give way to the

‘far-reaching systemic and structural changes in the

economy’ and ‘many other societal dimensions’ caused

by the Cyber Age.” Id. at 2097 (quoting Direct Mkt.

Ass’n v. Brohl, 575 U.S. ___, 135 S. Ct. 1124, 1135

(2015) (Kennedy, J., concurring)). But there have been

no changes or modernization of trusts that require a

corresponding modernization of the Due Process analysis used to determine whether a state can tax an outof-state trust. Further, unlike the Commerce Clause

physical presence rule, the Due Process minimum contacts analysis has not been applied in formalistic and

rigid manner dating back to at least Quill and its test

for purposeful availment.

III. All of the North Carolina Courts Correctly

Decided that the State’s Tax Was Unconstitutional as Applied to the Kaestner Trust

There is no need to grant the petition to correct

error in this case because there is none. The Due Process Clause prohibits a state from taxing the income

of an entity, unless the entity has some minimum

connection to the state and the tax is rationally related

to the values the entity derives from the taxing state.

Quill Corp., 504 U.S. at 306. Longstanding precedent

from this Court on the issue of due process prohibits

taxation where, as here, the only contact is the presence of a resident beneficiary. A statute that seeks such

a tax violates the Constitution.

The Kaestner Trust is a foreign entity. Its only connection to North Carolina is that a beneficiary moved

to the state years after the Trust Agreement was executed. The presence of a beneficiary is not sufficient to

tax a foreign trust’s worldwide income. This Court

reached that conclusion in Safe Deposit & Trust Co. v.

Virginia, 280 U.S. 83 (1929). As in Safe Deposit, the

North Carolina statute “undertakes to tax things

wholly beyond [its] jurisdiction or control” and for that

reason “conflicts with the Fourteenth Amendment.”

280 U.S. at 92.

The Court provided additional guidance in Quill

that dictates the same outcome. Under Quill, due process requires among other things “some definite link,

some minimum connection between a state and the

person, property or transaction it seeks to tax.” Quill

Corp., 504 U.S. at 306. In the case of trusts, the connections must be to the trust. “[T]he law has seen fit to

deal with this abstraction [i.e., a trust] for income tax

purposes as a separate existence.” Anderson v. Wilson,

289 U.S. 20, 27 (1933).

Where the only alleged connection is the residence

of an in-state beneficiary, Safe Deposit and Quill align

to stand for the proposition that the in-state residence

of a beneficiary is not alone a sufficient definite link or

minimum connection between a state and the trust it

seeks to tax.

Even if the beneficiary were to constitute some

minimum connection, which it does not, “the income

attributed to the State for tax purposes . . . [must] be

rationally related to ‘values connected with the taxing

State.’ ” Quill Corp., 504 U.S. at 306 (quoting Moorman

Mfg. Co., 437 U.S. at 273); see Hans Rees’ Sons, Inc. v.

North Carolina, 283 U.S. 123, 134–35 (1931) (finding

that taxing 80% of the taxpayer’s income when only

17% was sourced within the taxing state was out of

proportion to the business transacted within the state).

There is no rational relationship here. The Kaestner

Trust held all of its assets outside the state and all of

its income was generated from sources outside of

North Carolina. The Department taxed 100% of the

trust’s income while providing no opportunity to the

Kaestner Trust to create that income.

------------------------------------------------------------------

CONCLUSION

The petition should be denied.

Respectfully submitted,

THOMAS D. MYRICK

Counsel of Record

NEIL T. BLOOMFIELD

MOORE & VAN ALLEN PLLC

100 North Tryon Street, Suite 4700

Charlotte, North Carolina 28202

Telephone: (704) 331-1000

November 30, 2018

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.