Dear Clients, Colleagues, and Friends,
For those who live in a high-tax state and earn passive income or expect to have a significant liquidity event from the sale of a business or other capital assets, you now have options. On June 21, 2019, the U.S. Supreme Court ruled that North Carolina is not allowed to tax income earned by a trust formed outside the state just because the trust’s beneficiaries reside in NC.(1)
By establishing a properly structured non-grantor irrevocable trust in a low- or no-tax state like NV, you now have the opportunity to shift your passive income generating assets, the ownership of your company or other capital assets out of your high-tax state provided the trust income is not brought back into the high-tax state.
In Kaestner case, the taxpayer, a resident of NY, formed a trust for the benefit of his children who resided in North Carolina. Despite the children never having received a distribution from the NY trust, North Carolina attempted to tax the trust under a state statute that allowed the state to tax any trust income that is “for the benefit of” a state resident.(2) During the years in question the beneficiaries did not receive any distributions, nor did the trust have any physical presence or hold any real property in the State of North Carolina.(3) The U.S. Supreme Court, in a 9-0 decision, held that the presence of in-state beneficiaries alone does not provide a sufficient nexus to allow the state to impose an income tax on the out of state taxpayer – the trust. The court noted that the Due Process Clause limits states imposing only taxes that “[b]ear fiscal relation to protection, opportunities and benefits given by the state.”
The importance of this case is that it further illustrates with proper planning, high-tax state residents don’t have to leave the state, just their passive income generating and capital gains assets do.
If you have a non-grantor irrevocable trust with income derived outside of your high-tax state for which the trust has paid income tax to the high-tax state, the new case may be entitled to a tax refund. The trustee has a limited period of time within which to file for a claim of refund. If your CPA or tax preparer has been reporting the trust’s non-local sourced income subject to your high-tax state, you should revisit this in light of Kaestner and make a protective filing to preserve the opportunity for the tax refund.
So, what should you be doing in the wake of this very important SCOTUS ruling? Contact your tax advisor to see if your situation would benefit from structuring an irrevocable trust under the new Kaestner ruling. If your tax advisor is not familiar with this area, contact us and we can help you analyze the benefits. Helping you upgrade your planning from “coach” to “first-class.”
(1) N. Carolina Dep’t of Revenue v. Kimberly Rice Kaestner 1992 Family Tr., 139 S. Ct. 915, 202 L. Ed. 2d 641 (2019).
(2) N. Carolina Dep’t of Revenue v. Kimberly, 139 S. Ct. 915 (2019); N.C. Gen. Stat. Ann. § 105-160.2.
(3) Id.
__________________________________________________________________________________________________________
Jeffrey M. Verdon, Esq.
For more information about any of the information discussed in this Client Alert, or any other income or estate tax planning or asset protection planning assistance, please contact the: Jeffrey M. Verdon Law Group, LLP at jeff@jmvlaw.com or 949-333-8152.