State taxation of trusts varies widely, based on where a trust is set up, where the trustee resides, where the trust income comes from, and whether the beneficiaries are residents or nonresidents. In short, a trust usually must have some significant connection to be subject to a state’s tax. Despite this general rule, some states tax nonresident trusts based on very limited connections to the state, such as the presence of one resident beneficiary.
This practice, however, recently has been invalidated by the U.S. Supreme Court in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust. The high Court’s holding could have positive implications for trusts with a connection to the State of Georgia, but careful planning is needed. The Georgia Department of Revenue (DOR) has weighed in on the Kaestner decision in a policy bulletin explaining how Georgia will analyze trust tax liability going forward.
The Kaestner Holding
In Kaestner, the Supreme Court held that North Carolina violated the U.S. Constitution’s Due Process Clause by taxing a nonresident New York trust based solely on the existence of an in-state beneficiary. The trust agreement granted the New York trustee “absolute discretion” to distribute the trust’s assets to the beneficiaries. In 1997, one of the beneficiaries, Kimberley Rice Kaestner, moved to North Carolina. North Carolina sought to tax one of three sub-trusts, the Kimberley Rice Kaestner 1992 Family Trust, under a law authorizing the State to tax any trust income that “is for the benefit of” a state resident.
The State assessed a tax of more than $1.3 million for tax years 2005 through 2008. During that period, Kaestner had no right to, and did not receive, any distributions. Nor did the Trust have a physical presence, make any direct investments, or hold any real property in the North Carolina. The trustee paid the tax under protest and then sued North Carolina, arguing that the tax as applied to the Trust violates the Fourteenth Amendment’s Due Process Clause. The Supreme Court agreed stating that “the presence of in-state beneficiaries alone does not empower a State to tax trust income that has not been distributed to the beneficiaries where the beneficiaries have no right to demand that income and are uncertain to receive it.”
Despite the taxpayer victory, the Supreme Court took pains to insist its ruling had a narrow focus and is only applicable to situations with the same set of circumstances where the beneficiary lacks control over income decisions.
Georgia Weighs Scope of Decision
Since the decision was handed down, states have been evaluating their trust taxation schemes to gauge compliance with the Supreme Court’s mandate. Georgia DOR’s Policy Bulletin IT-2019-02 says the state will follow the Kaestner case (it has no choice) but it will forego trust taxation only under facts mirroring those in Kaestner, identified by the DOR as:
- The beneficiaries did not receive any income from the trust during the years in question.
- The beneficiaries had no right to demand trust income or otherwise control, possess, or enjoy the trust assets in the tax years at issue.
- Not only were the beneficiaries unable to demand distributions in the tax years at issue, but it was also uncertain whether they would ever receive any income from the trust in the future.
Under these facts, the DOR says a nonresident trust fiduciary would not be subject to Georgia taxation. Otherwise, the fiduciary would be subject to taxation and must file a return, if other connections to the state exist. Under Georgia law, both resident and nonresident trustees can be taxed on trust income if they A) receive income from business done in the state; B) manage funds or property located in the state; or C) manage funds or property for the benefit of a resident of the state.
Because some aspects of Georgia law have been vague with regard to which out-of-state trusts are exempt from taxation, some trusts may have been overpaying–not apportioning income between resident and nonresident beneficiaries and paying tax even if the only connection to Georgia is a resident beneficiary. Now that Kaestner and the DOR have clarified the limits of Georgia’s authority to tax trusts, trustees should reconsider the taxes paid under Georgia law going forward and even look back to see if over-payments were made in years still open for amendment. Properly apportioning accumulated income between resident and nonresident beneficiaries is more important than ever. Your Frazier & Deeter tax advisor can assist you with this analysis.