The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Dep't of Revenue

The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Dep’t of Revenue,
2015 NCBC 36.

STATE OF NORTH CAROLINA IN THE GENERAL COURT OF JUSTICE
SUPERIOR COURT DIVISION
COUNTY OF WAKE 12 CVS 8740

THE KIMBERLEY RICE KAESTNER 1992 )
FAMILY TRUST, )
Plaintiff )
)
v. ) OPINION AND ORDER ON
) MOTIONS FOR SUMMARY
) JUDGMENT
NORTH CAROLINA DEPARTMENT OF )
REVENUE, )
Defendant )

THIS CAUSE, designated a mandatory complex business case by Order of the Chief

Justice of the North Carolina Supreme Court, pursuant to N.C. Gen. Stat. § 7A-45.4(b), and

assigned to the undersigned Special Superior Court Judge for Complex Business Cases,

comes before the Court, pursuant to Rule 56 of the North Carolina Rules of Civil Procedure

("Rule(s)"), upon Plaintiff The Kimberley Rice Kaestner 1992 Family Trust's ("Plaintiff" or

"Trust") Motion for Summary Judgment ("Plaintiff's Motion") and Defendant North Carolina

Department of Revenue's ("Defendant") Motion for Summary Judgment ("Defendant's

Motion") (together with Plaintiff's Motion, "Motions"). On February 24, 2015, the Court held

a hearing on the Motions.

THE COURT, after reviewing the Motions, briefs in support of and in opposition to

the Motions, arguments of counsel, and the evidence and other appropriate matters of record,

CONCLUDES that Plaintiff's Motion should be GRANTED and Defendant's Motion should

be DENIED for the reasons stated herein.

Moore & Van Allen PLLC by Thomas D. Myrick, Esq., Neil T. Bloomfield, Esq., and
Kara N. Bitar, Esq. for Plaintiff The Kimberley Rice Kaestner 1992 Family Trust.

North Carolina Department of Justice by Peggy S. Vincent, Esq. for Defendant North
Carolina Department of Revenue.
McGuire, Judge.

Procedural History

1. Plaintiff filed this action on June 30, 2012, seeking a determination that, as it

was applied to Plaintiff, North Carolina General Statute § 105-160.2 (hereinafter, references

to North Carolina General Statutes will be to "G.S.") violates the Due Process Clause and the

Commerce Clause of the United States Constitution and Section 19 of the North Carolina

Constitution. Plaintiff seeks a refund of all taxes, penalties, and interest paid by it pursuant

to G.S. § 105.160.2 for the tax years 2005 through 2008. In its Complaint, Plaintiff also sought

to enjoin Defendant from enforcing any assessments issued pursuant to G.S. § 105-160.2 and

from issuing future assessments against Plaintiff based on the same provision.

2. On February 11, 2013, the Court granted, in part, Defendant's Motion to

Dismiss pursuant to Rule 12(b)(6). In its Order on Motion to Dismiss, the Court dismissed

Plaintiff's claim for injunctive relief, but denied the Motion to Dismiss as to the constitutional

challenges to the statute.

3. On July 2, 2014, Plaintiff filed its Motion for Summary Judgment. On

September 2, 2014, Defendant filed its Motion for Summary Judgment. Both Motions have

been fully briefed and, on February 24, 2015, the Court held a hearing on both Motions.

4. Both Motions seek summary judgment in the parties' respective favors on the

constitutionality of G.S. § 105-160.2. Therefore, for the purpose of this Opinion and Order,

the Court will address the Motions together.

Factual Background

5. A court does not make findings of fact in ruling upon a motion for summary

judgment. However, the court may summarize material facts that do not appear to be at issue

and which justify the judgment. Hyde Ins. Agency, Inc. v. Dixie Leasing Corp., 26 N.C. App.
138, 142 (1975). There is very little dispute as to any of the facts in this action, and the

dispositive facts are undisputed.

6. In 1992, the Joseph Lee Rice, III Family 1992 Trust ("Family Trust") was

created for the benefit of the children of Joseph Lee Rice, III ("Settlor") under a trust

agreement between Settlor and the initial trustee, William B. Matteson.1 In 2005, Matteson

resigned as trustee of the Family Trust, and David Bernstein ("Bernstein"), a Connecticut

resident and domiciliary, was appointed trustee.2 Bernstein was the trustee of the Family

Trust at all times relevant to this action.

7. The Family Trust was created in New York and is governed by New York Law.3

At the time the Family Trust was created, Settlor and the initial trustee were residents and

domiciliaries of New York.4 At the time of its creation, no primary or contingent beneficiary

was a resident or domiciliary of North Carolina.5 In 1997, Kimberley Rice Kaestner

("Kaestner"), a daughter of the Settlor and a primary beneficiary of the Family Trust,

relocated to North Carolina.6

8. On December 30, 2002, by operation of the trust agreement, the Family Trust

was divided into separate share trusts for each of the Settlor's three children, including

Kaestner.7 In 2006, Bernstein "physically divided" the share trusts into three trusts.8

Plaintiff is the separate share trust formed for the benefit of Kaestner.9 The current

beneficiaries of Plaintiff are Kaestner and her three children, all of whom were residents and

1 Bernstein Aff. (July 2, 2014) ¶ 3.
2 Id. ¶ 13.
3 Id. ¶ 4.
4 Id. ¶ 5.
5 Id.
6 Id. ¶¶ 7-8.
7 Id. ¶ 7.
8 Bernstein Dep. 6.
9 Bernstein Aff. ¶ 7.
domiciliaries of North Carolina in the tax years at issue.10 The contingent remainder

beneficiaries of Plaintiff are the Settlor's remaining children, the Settlor's spouse, and the

Settlor's sister, none of whom are, or were, residents or domiciliaries of North Carolina.11

9. The Family Trust, which includes Plaintiff, is an irrevocable inter vivos trust.12

The terms of the Family Trust provided that when Kaestner turned 40 years of age, the

Trustee was to distribute the trust assets to Kaestner. Kaestner turned 40 on June 2, 2009.

Prior to turning 40, Ms. Kaestner had conversations with her father and Bernstein as to

whether she wished to receive the trust assets at her 40th birthday.13 Kaestner determined

she preferred to extend the Trust.14 Accordingly, in 2009, prior to Kaestner's 40th birthday,

Bernstein transferred the assets of the Trust into a new trust, the KER Family Trust. It is

undisputed that the transfer of assets occurred after the tax years at issue in this case, and

the KER Family Trust is not a party to this action.

10. During the tax years at issue in this case, the assets held by Plaintiff consisted

of various financial investments including equities, mutual funds, and investments in

partnerships. The custodian of Plaintiff's assets was located in Boston, Massachusetts. Other

documents related to the Trust, including ownership documents of some assets of Plaintiff,

financial books and records, and legal records, were all kept in New York.15 Additionally, all

tax returns and Trust accountings have been prepared in New York.16

11. Under the terms of the Trust, the beneficiaries, including Kaestner, had no

absolute right to any of the assets or income of the Plaintiff, as the distributions of assets or

10 Id. ¶ 10.
11 Id. ¶ 11.
12 Id. ¶ 12.
13 Kaestner Dep. 8-10.
14 Kaestner Dep. 9.
15 Bernstein Aff. ¶ 14.
16 Id.
income are made at the sole discretion of the trustee, Bernstein.17 Furthermore, under the

terms of the Trust, Bernstein had broad authority to manage the property held by the Trust

"as if the absolute owner thereof."18 During the years in question no distributions were made

to a beneficiary in North Carolina.19

12. Notwithstanding the discretionary nature of the Trust and the broad authority

granted to the trustee, it is undisputed that two loans were made from the Trust for the

benefit of Kaestner or other beneficiaries. In 2007 or 2008, Plaintiff loaned $250,000.00

directly to Kaestner in order to allow her to pursue an investment in vanilla.20 In 2008 or

2009, a loan was made from Plaintiff to a related trust, the Special Asset Trust, to enable the

Special Asset Trust to make a capital call on a limited partnership interest that it held.21

Both loans were made at the lowest interest rate allowable by the Internal Revenue Service

and both loans were ultimately repaid.22

13. Bernstein occasionally communicated with Kaestner regarding Plaintiff.

Kaestner was provided an accounting of the Trust,23 and received legal advice regarding the

Trust from Bernstein and his firm.24 Additionally, Bernstein met with Kaestner and her

husband in New York to discuss the Trust, whether the Kaestners desired to receive income

distributions, and certain investments the Trust held.25

14. During the tax years at issue, 2005 to 2008, Defendant taxed Plaintiff on the

income accumulated in the Trust during each year, although no income was distributed to a

17 Id. ¶ 16; see also id. Ex. A, Art. 1, § 1.2(a).
18 Id. Ex. A., Art. 5, § 5.2(r).
19 Id. ¶ 17.
20 Bernstein Dep. 48-49.
21 Bernstein Dep. 47. In 2007, some assets of the Plaintiff were transferred, or decanted, into the newly

formed Special Asset Trust. The Special Asset Trust is not the Plaintiff in this action. Id. 32.
22 Id. at 47-49, 52.
23 Bernstein Dep. 60.
24 Id. at 56-57.
25 Id. at 64-73.
North Carolina beneficiary.26 Plaintiff seeks refunds totaling in excess of $1.3 million,

including $79,634.00 paid for the year 2005; $106,637.00 paid for 2006; $1,099,660.00 paid

for 2007; and $17,241.00 paid for 2008.27 Plaintiff's request for a refund was denied on

February 11, 2011.28 Although Plaintiff's Complaint seeks return of penalties paid on these

amounts, no penalties were paid to the State of North Carolina after Plaintiff received a

complete waiver of these fees.29

Discussion

15. In this lawsuit, Plaintiff challenges the Department's authority to impose

income taxes on the Trust during the years 2005–2008 pursuant to G.S. § 105-160.2. For

purposes of context, G.S. § 105-160.2 provides, in pertinent part, as follows:

The tax imposed by this part applies to the taxable income of
estates and trusts as determined under the provisions of the
Code . . . . The tax is computed on the amount of the taxable
income of the estate or trust that is for the benefit of a resident
of this State, or for the benefit of a nonresident to the extent that
the income (i) is derived from North Carolina sources and is
attributable to the ownership of any interest in real or tangible
personal property in this State or (ii) is derived from a business,
trade, profession, or occupation carried on in this State . . . . The
fiduciary responsible for administering the estate or trust shall
pay the tax computed under the provisions of this Part.

16. In actuality, the only part of G.S. § 105-160.2 that is at issue in this action is

the clause of the above-quoted language that provides for a trust to pay taxes on income "that

is for the benefit of a resident of this State."30

17. Plaintiff alleges that Section 105-160.2 is unconstitutional on its face and as

applied under the Due Process and Commerce Clauses of the United States Constitution, and

26 Bernstein Aff. ¶¶ 19, 21.
27 Id. ¶ 22.
28 Id. ¶ 23.
29 Koonce Aff. ¶¶ 4-5.
30 Compl. ¶ 2.
a violation of Article I, Section 19 of the North Carolina Constitution.31 "When a

constitutional question is properly presented, it is the duty of the court to ascertain and

declare the intent of the framers of the Constitution and to reject any legislative act which is

in conflict therewith." Mitchell v. N. C. Indus. Dev. Fin. Auth., 273 N.C. 137, 144 (1968); see

also Williams v. Blue Cross Blue Shield, 357 N.C. 170, 183 (2003) (noting this duty and

striking down a local act as unconstitutional).

18. "In challenging the constitutionality of a statute, the burden of proof is on the

challenger, and the statute must be upheld unless its unconstitutionality clearly, positively,

and unmistakably appears beyond a reasonable doubt or it cannot be upheld on any

reasonable ground." Guilford Cnty Bd. of Educ. v. Guilford Cnty Bd. of Elections, 110 N.C.

App. 506, 511 (1993). When questioning the authority in court of the State to exert its taxing

power, "only clear and demonstrated usurpation of power will authorize judicial interference

with legislative action." Railway Express Agency, Inc. v. Maxwell, 199 N.C. 637, 642 (1930)

(quoting Green v. Frazier, 253 U.S. 233, 239 (1920)). As the Supreme Court of the United

States has explained, "[a] state is free to pursue its own fiscal policies, unembarrassed by the

Constitution, if by the practical operation of a tax the state has exerted its power in relation

to opportunities which it has given, to protection which it has afforded, to benefits which it

has conferred by the fact of being an orderly, civilized society." Wisconsin v. J. C. Penney

Co., 311 U.S. 435, 444 (1940).

19. The parties agree that the dispositive facts necessary for the Court to decide

this case are not in dispute. The question for determination is whether Defendant has the

authority under the United States and North Carolina Constitutions to tax Plaintiff on the

31 Compl. ¶¶ 40, 47, and 49.
undistributed income of the Trust based solely upon the beneficiaries' residence in this

State.32

Due Process Challenge

20. Plaintiff challenges §105-160.2 under the Due Process Clause of the United

States Constitution and the Law of the Land Clause of the North Carolina Constitution. The

Fourteenth Amendment to the United States Constitution provides that no state shall

"deprive any person of life, liberty, or property, without due process of law." U.S. Const.

amend XIV, § 1. Article I, Section 19 of the Constitution of North Carolina guarantees due

process rights by providing that no person shall be "in any manner deprived of his life, liberty,

or property, but by the law of the land." The North Carolina Supreme Court has noted that

"[t]he term 'law of the land' as used in Article I, Section 19, of the Constitution of North

Carolina, is synonymous with 'due process of law' as used in the Fourteenth Amendment to

the Federal Constitution." Rhyne v. K-Mart Corp., 358 N.C. 160, 180 (2004). Accordingly,

these provisions are, "for all practical purposes, the same under both the State and Federal

Constitutions." Leonard v. Maxwell, 216 N.C. 89, 93 (1939). Under either constitution, "a

State's 'exaction of a tax constitutes a deprivation of property' subject to the safeguards of

the Due Process Clause." Delhaize Am., Inc. v. Lay, 222 N.C. App. 336, 343 (2012) (quoting

McKesson Corp. v. Div. of Alcoholic Beverages & Tobacco, 496 U.S. 18, 36 (1990)).

Accordingly, Plaintiff's due process challenge to the statute under the United States and

North Carolina Constitutions may be analyzed together.

21. When a state seeks to impose a tax, the Due Process Clause requires: (1) "some

definite link, some minimum connection, between a state and a person, property or

transaction it seeks to tax;" and (2) "that the income attributed to the State for tax

32 Def.'s Br. Supp. Mot. Summ. J. 19-20.
purposes . . . be rationally related to values connected with the taxing state." Quill v. North

Dakota, 504 U.S. 298, 306 (1992). Under the first requirement, courts consider whether a

taxed entity's "connections with a State are substantial enough to legitimate the State's

exercise of power over" it. Id. at 312. Where the taxed entity has no physical presence in a

state, the entity must "purposefully avail itself of the benefits of an economic market in the

forum state." Id. at 307. This requirement ensures that the taxed entity is given "fair

warning that its activity may subject it to the jurisdiction of a foreign sovereign." Id. at 308

(emphasis added). Under the second requirement, courts analyze "whether the taxing power

exerted by the state bears fiscal relation to protection, opportunities and benefits given by

the state." J. C. Penney Co., 311 U.S. at 444.

22. The focus of the due process inquiry must be on the entity being called upon to

pay taxes under G.S. §105-160.2; here, Plaintiff itself.33 Accordingly, the Court must

scrutinize Plaintiff's contacts with, and relationship to, North Carolina, as well as benefits

conferred upon it by North Carolina, to determine the State's authority to tax Plaintiff.

23. Turning to Plaintiff's contacts with the State of North Carolina, nothing in the

record indicates, and Defendant does not argue, that Plaintiff maintained any physical

presence in North Carolina during the tax years at issue. The undisputed evidence in this

matter shows that Plaintiff never held real property located in North Carolina, never owned

personal property located in North Carolina, and never invested directly in any North

Carolina based investments.34 The record also indicates that no trust records were kept or

33 The parties do not dispute that the Plaintiff Trust, and not Kimberly Kaestner or her children, is

the taxed entity. See Anderson v. Wilson, 289 U.S. 20, 27 (1933) (holding "the law has seen fit to deal
with this abstraction [a trust] for income tax purposes as a separate existence").
34 The Court recognizes that, during the tax years at issue, Plaintiff held investments in entities that,

in turn, made investments that may have been related to North Carolina, incurring losses of less than
$2.50 in the tax years at issue. However, such an indirect connection is not a sufficient contact to
satisfy due process standards. See Residuary Trust A. v. Director, 27 N.J. Tax 68, 76-77 (2013) (holding
created in North Carolina, or that the trust could be, in any other manner, said to have a

physical presence in the State. Moreover, because the trustee's usual place of business where

trust records were kept was outside the State, it is clear from the record that Plaintiff's

principal place of administration was not North Carolina.35

24. Defendant contends, however, that the situs, or residence, of the trust is

irrelevant as many of its assets are "stored in the cloud" and therefore do not exist in tangible

form.36 However, the Court notes that other courts have treated the situs of intangible assets

such as securities as the physical location of the owner or at which the physical certificates

are maintained. See Safe Deposit & Trust Co. v. Virginia, 280 U.S. 83, 92 (1929) ("Intangible

personal property may acquire a taxable situs where permanently located, employed and

protected;" and cases cited therein); Hanson v. Denckla, 357 U.S. 235, 247 n. 16 (1958). These

items being located, held, and protected outside North Carolina, the Court finds Defendant's

position unpersuasive.

25. Since Plaintiff has no physical presence in the State, the Court must determine

whether Plaintiff has "purposefully availed" itself of the benefits, economic and otherwise,

and laws of North Carolina. As noted above, it is the taxed entity that must direct its actions

towards the taxing state. Such actions could include "the keeping of tangible or intangible

personality within a state," "the use and sale of property," and incorporation in, or permission

to conduct business granted by, a state. Miller Brothers Co. v. Maryland, 347 U.S. 340, 345

(1954). More specific to a trust, the maintenance of offices, the ownership of assets, or the

that a trust did not own New Jersey assets simply by investing in an entity that owned New Jersey
assets).
35 See G.S. § 36C-1-103 (defining the principal place of administration for a trust); see also G.S. § 36C-

2-203(d) (recognizing a distinction between trusts administered inside and outside North Carolina).
36 See Def.'s Br. Supp. Mot. Summ. J. 7-9.
transaction of business in a state might provide sufficient minimum connection to tax the

trust. Hanson, 357 U.S. at 251.

26. Defendant concedes that the only "connection between the [Plaintiff] Trust

and North Carolina in the case at hand is the residence of the beneficiaries."37 Defendant

contends, however, that Kaestner and her three children have "made North Carolina their

home, residence and domicile" since 1997 and that "all of the income earned by the Trust in

the years at issue was for the benefit of Ms. Kaestner and her three children."38 Defendant

argues that because the beneficiaries had an equitable interest in Plaintiff's assets, and could

potentially have received future distributions, the Trust should be taxable in North Carolina

based on their residence in the State.39 The Court finds Defendant's position unpersuasive

for two reasons.

27. First, Defendant's position conflates the beneficiaries' contact with North

Carolina with that of the Trust. As noted above, trusts and their beneficiaries are separate

legal entities. See Anderson, 289 U.S. at 27 (recognizing that, for income tax purposes, trusts

are a "separate existence"). Accordingly, Plaintiff's contacts with North Carolina are relevant

here, but not those of its beneficiaries. Nothing in the record indicates that Plaintiff itself

ever engaged in the sort of "purposeful availment" that would subject it to taxation in North

Carolina. See Miller Brothers Co., 347 U.S. at 345 (recognizing actions that would constitute

sufficient contact to permit taxation by the State of Maryland).

28. Second, Defendant's position ignores the undisputed facts that Kaestner and

her children had no control over Plaintiff's assets or ability to generate income from those

assets, and had no authority to compel Plaintiff to distribute income earned by the Trust. In

37 Id. at 7, 9.
38 Id. at 7.
39 Id. at 9-11.
North Carolina, the beneficiaries of a trust have no legal interest in the trust's current or

future income unless and until they are distributed. Sabine v. Gill, 229 N.C. 599, 605 (1948)

(trust income "is an intangible which belongs to the trust estate and becomes [the

beneficiary's] only by distribution"). Accordingly, the Court concludes that even if the

beneficiaries' interest in the Trust's income and assets constitutes an "equitable interest," as

Defendant contends, such a remote interest does not provide a sufficient nexus between the

Trust and the State of North Carolina such that the latter can tax the income of the former.

29. Defendant also disputes "Plaintiff's unqualified characterization" that the

Trustee managed Plaintiff without any consultation with Kaestner.40 Defendant contends

that Kaestner was provided information about the Trust from Bernstein as trustee, received

advice concerning the Trust, and even received two loans from the Trust. This contact with

the Trustee, Defendant appears to contend, constitutes a contact between Plaintiff and the

State and further demonstrates that Kaestner had some input in, and thus some control over,

operations of the Trust.

30. While the record indicates that Kaestner received information concerning the

Trust and received one direct loan from the Trust,41 it remains undisputed that the actual

control of Plaintiff remained with the Trustee in his absolute discretion.42 Moreover, such

infrequent contact as reflected in the record,43 contact driven by the beneficiary and not

Plaintiff, cannot, as a matter of law, constitute sufficient contact of Plaintiff with the State

such that all of Plaintiff's undistributed income is subject to taxation in North Carolina.

40 Def.'s Br. Opp. Pl.'s Mot. Summ. J. 12.
41 In addition to the loan to the Special Asset Trust that, Defendant contends, was for Kaestner's

benefit. See supra, ¶ 12.
42 See Bernstein Aff. ¶ 16 (noting that the Trustee never consulted with the beneficiaries concerning
investment decisions, and that Trustee had, at all relevant times, the sole discretion to make all
investment decisions).
43 See Bernstein Dep. 81-84 (describing infrequent, "maybe once a year," meetings with the Kaestners).
31. Under these circumstances, the Court does not believe that the residency of

the beneficiaries in North Carolina, standing alone, can be viewed as the Trust's "purposeful"

activity in this State. Safe Deposit & Trust Co., 280 U.S. at 91; Mercantile-Safe Deposit &

Trust Co. v. Murphy, 203 N.E.2d 490 (N.Y. 1964) ("[T]he imposition of a tax in the State in

which the beneficiaries of a trust reside, on securities in the possession of the trustee in

another State, to the control or possession of which the beneficiaries have no present right,

is in violation of the Fourteenth Amendment").44 Ultimately, Plaintiff has "clearly, positively,

and unmistakably" established that it did not have contacts of a sufficient quality or quantity

to be subjected to taxes by the State of North Carolina and to satisfy the requirements of due

process.

32. Plaintiff also has established that the tax levied on the Trust fails to satisfy

the second requirement of the due process analysis because the income attributed to North

Carolina for tax purposes is not rationally related to values connected with North Carolina.

See Quill, 504 U.S. at 306. Under this prong, courts must analyze "whether the taxing power

exerted by the state bears fiscal relation to protection, opportunities and benefits given by

the state." J. C. Penney, 311 U.S. at 444. The Supreme Court distilled the analysis even

further: "The simple but controlling question is whether the state has given anything for

which it can ask return." Id. As discussed above, the undisputed evidence shows that

Plaintiff, as a taxed entity distinct from its beneficiaries, has not done anything to seek out

the protection, opportunities, and benefits conferred by North Carolina, and North Carolina

has not provided anything to the Trust for which it can ask return.

44 To the extent Defendant contends that Kaestner's or her children's activities in North Carolina

constitute the Trust's activities, their activities clearly cannot satisfy the minimum contacts required
by due process. Hanson, 357 U.S. at 255. ("The unilateral activity of those who claim some relationship
with a nonresident defendant cannot satisfy the requirement of contact with the forum state.")
33. Defendant does not expressly address this second requirement of the due

process analysis. Instead, Defendant contends that Quill did not create a rigid test for

determining whether due process standards have been met. Defendant argues that the

relevant inquiry is whether the taxed entity "had minimum contacts with the jurisdiction

'such that maintenance of the suit does not offend traditional notions of fair play and

substantial justice'" and whether the taxed entity's contacts with the forum made it

reasonable for the jurisdiction to impose the tax.45 Even applying these standards, however,

the tax levied against Plaintiff does not meet due process requirements. As discussed above,

the entity that is subjected to the taxes still must have sufficient contacts with the state that

make it fair and reasonable that the state impose the taxes at issue. Again, the only contact

that Plaintiff has with North Carolina is the presence in the State of beneficiaries who hold,

at most, only equitable interests in the Trust. Not only have the beneficiaries not enjoyed

any distribution from the Trust, it is undisputed that Kaestner and her children cannot

compel distributions, have no right to control the assets held by Plaintiff and have had no

influence over the amount of income generated by Plaintiff. While the presence of Kaestner

and her children in North Carolina may provide some contact with the State, absent any

other contact by Plaintiff, it does not provide the minimum contacts necessary to satisfy the

due process requirement of the United States and North Carolina Constitutions.

34. Defendant relies heavily on two decisions from other states, McCulloch v.

Franchise Tax Board, 390 P.2d 412 (Cal. 1964), and Chase Manhattan Bank v. Gavin, 733

A.2d 782 (Conn. 1999). In McCulloch, a beneficiary residing in California received a terminal

distribution in 1951 from a non-resident trust. The distribution included the trust assets and

the income earned and accumulated in the trust during the years 1946-1950. Id. at 415.

45 Def.'s Reply to Pl.'s Resp. 6.
California taxed the beneficiary for the income earned by the trust during the five years prior

to the distribution and for which the trust had not paid taxes to California. Id. The

beneficiary challenged the assessment of the tax on the income earned by the trust on due

process grounds. The Supreme Court of California held that the tax met due process

requirements because it concluded that the beneficiary's "residence [in California] confers

the essential 'minimum connection' necessary for due process of law." Id. at 419. The Court

reasoned that "the beneficiary's state of residence may properly tax the trust on income which

is payable in the future to the beneficiary, although it is actually retained by the trust, since

that state renders to the beneficiary that protection incident to his eventual enjoyment of the

accumulated income." Id.

35. As a preliminary matter, the McCulloch case has features which distinguish it

from this case. In McCulloch, the taxed beneficiary was also a trustee of the trust. While

not the basis for its holding, the Court explained that "[n]o possible doubt attaches to

California's constitutional power to tax plaintiff as a trustee. His secondary role as trustee

reinforces the independent basis of taxing plaintiff as beneficiary." Id. at 421. Ms. Kaestner

and her children are not trustees of the Trust.

36. In addition, the precise question before the court in McCulloch was California's

right to tax the beneficiary for the trust's accumulated income upon a distribution, not the

direct taxation of the trust itself. McCulloch, 390 P.2d. at 414-15, 419, 421. The court stated:

[T]o hold that California could not levy this tax upon the beneficiary when the
trust is distributed to him would expose this state to serious impediments in
the collection of its taxes. The purpose of section 18106 of the Revenue and
Taxation Code in imposing upon the beneficiary at the time of the trust
distribution his personal obligation to pay taxes due, but unpaid, by the trust
is to avoid the difficulties which the state might otherwise encounter in
attempting to enforce tax collection directly against foreign trustees.
Id. at 420. Here, of course, the tax is not being assessed against Kaestner or her children,

and is not being collected upon a distribution.

37. Ultimately, however, this Court simply does not find McCulloch persuasive

and reaches a different result. The Court concludes that the beneficiary's residence in North

Carolina, standing alone, is not a sufficient contact by the Trust with this State to support

the imposition of the tax at issue, and that the benefits enjoyed by Ms. Kaestner and her

children as residents of North Carolina are not "protection, opportunities, and benefits"

conferred upon the Trust. J.C. Penney, 311 U.S. at 444.

38. In Gavin, the Supreme Court of Connecticut reached a similar result to

McCulloch, concluding "just as the state may tax the undistributed income of a trust based

on the presence of the trustee in the state because it gives the trustee the protection and

benefits of its laws . . . it may tax the same income based on the domicile of the sole non-

contingent beneficiary because it gives her the same protections and benefits." Gavin, 733

A.2d at 802.46 Like McCulloch, the facts of Gavin provide grounds for distinguishing it from

this matter. In Gavin, the settlor of the trust was also a Connecticut domiciliary when he

created the trust and, accordingly, the trust was a Connecticut "resident inter vivos trust."

Id. at 787, 789.47 In this case, the Settlor of the Trust was a resident of New York, and there

is no North Carolina statute making the Kaestner Trust a resident trust of this State.

39. In reaching its conclusion, the court in Gavin also stated that it was "not

persuaded that . . . Safe Deposit & Trust Co. v. Virginia . . . is still good law" because the

holding was based, in part, on the potential that the trust could be subjected to "double

46 InGavin, the Court expressly relied upon McCulloch as supporting its holding. Gavin, 733 A.2d at
803.
47 Connecticut General Statute § 12-701(a)(4)(D) provided 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."
taxation," that is, taxation in more than one state. Id. at 802. First, Safe Deposit & Trust

Co. v. Virginia has not been expressly overruled. Second, a close reading of Safe Deposit &

Trust Co. v. Virginia demonstrates that the Court considered many of the same factors

present in this case in reaching its holding. Central to the analysis in Safe Deposit & Trust

Co., the Court noted that, as is the case here, the possessor of the legal title to the securities

held in trust in that case resided outside of the state imposing the tax on those assets, and

the beneficiaries had no "present right to their enjoyment or power to remove them." Safe

Deposit & Trust Co., 280 U.S. at 92. Accordingly, the Court does not agree that Safe Deposit

& Trust Co. is no longer "good law," as characterized by the Gavin court, but remains, at a

minimum, instructive as to the due process implications of taxing a trust with such bare

connections to the taxing State.

40. For the same reasons stated above, the Court concludes that the beneficiary's

residence in North Carolina, standing alone, is not a sufficient contact by the Trust with this

State to support the imposition of the tax at issue, and declines to follow the reasoning in

Gavin.

41. Accordingly, the Court concludes that the portion of G.S. § 105-160.2 providing

that a trust may be taxed on income "that is for the benefit of a resident of this State" violates

the Due Process Clause of the United States Constitution and Article I, Section 19 of the

North Carolina Constitution as applied to Plaintiff in this case where the only basis for

imposition of the taxes is the beneficiaries' residence in the State of North Carolina.

Commerce Clause Analysis

42. Plaintiff also challenges the constitutionality of G.S. § 105-160.2 under the

Commerce Clause of the United States Constitution.48 Contained in Article 1, Section 8, that

48 For a thorough discussion of the distinction between the constitutionality of a tax under the Due

Process Clause and the Commerce Clause, see Quill v. N. Dakota, 504 U.S. 298 (1992).
clause provides Congress with the authority to "regulate Commerce . . . among the several

States."49 As the Supreme Court of the United States has recognized, that Clause "'by its own

force' prohibits certain state actions that interfere with interstate commerce." Quill v. N.

Dakota, 504 U.S. 298, 309 (1992) (quoting S. Carolina State Highway Dept. v. Barnwell Bros.,

Inc., 303 U.S. 177, 185 (1938)). This "negative sweep" of the Commerce Clause, or dormant

Commerce Clause, has been interpreted to place specific limitations on the ability of states

to levy taxes on interstate commerce and activity. Quill, 504 U.S. at 309.

43. In Complete Auto Transit, Inc. v. Brady, the Supreme Court articulated the

now well-established four prong analysis for determining the constitutionality of a tax under

the Commerce Clause. 430 U.S. 274, 279 (1977); see also Goldberg v. Sweet, 488 U.S. 252,

259-260 (1989); Quill, 504 U.S. at 311. A state tax withstands scrutiny under the Commerce

Clause if: (1) it is applied to an activity with a substantial nexus to the taxing state; (2) it is

fairly apportioned so as to tax only the activities connected to the taxing state; (3) it does not

discriminate against interstate commerce; and (4) it is fairly related to services provided by

the state. "To pass constitutional muster, all four prongs must be satisfied and the failure to

meet any one of these requirements renders the tax unconstitutional." McNeil v.

Commonwealth of Pa., 67 A.3d 185, 192 (Pa. Commw. Ct. 2013) (citing Complete Auto

Transit, Inc., 430 U.S. at 279) (emphasis in original). Because the Court, largely for reasons

already discussed above, finds that the application of G.S. § 105-160.2 to Plaintiff fails to

satisfy the first and fourth prongs of Complete Auto, the Court need not address prongs two

and three of that test.

44. The Complete Auto test first requires that the activity taxed have a

"substantial nexus" to the taxing State. The Supreme Court has explained that, although

49 U.S. Const. art. I, § 8, cl. 3.
similar to the minimum contacts required under a due process analysis, the "substantial

nexus" required under the Commerce Clause reflects a concern over the impact of State

regulation on the national economy and, therefore, requires more than "minimum contacts"

with the taxing State. Quill v. N. Dakota, 504 U.S. 298, 312-13 (1992). Additionally, the

Supreme Court has specifically noted that an entity "may have the 'minimum contacts' with

a taxing State as required by the Due Process Clause, and yet lack the 'substantial nexus'

with that State as required by the Commerce Clause." Id. at 313.

45. Here, the Court already has found that the Trust itself, as a separate legal

entity from its beneficiaries, lacked sufficient "minimum contacts" with North Carolina to

satisfy the Due Process Clause. Similarly, the mere presence of the beneficiaries in North

Carolina, while some contact with the State, is not a "substantial nexus" between the Trust

and the State of North Carolina. As noted above, all Trust records were compiled and retained

outside of North Carolina, all real or personal property held by the Trust was located outside

North Carolina, and all income generated by the Trust was generated from investments

located outside North Carolina.50 Accordingly, both the Trust and the income it generated

lacked a substantial nexus with this State sufficient to satisfy the Complete Auto test.

46. Additionally, the fourth prong of the Complete Auto test requires that the tax

imposed be fairly related to services provided by the State. This prong ensures that "a State's

tax burden is not placed upon persons who do not benefit from services provided by the State."

Goldberg, 488 U.S. at 266-67 (1989). For this reason, the focus of this prong is on "the

presence and activities of the taxpayer within the State." Id. at 266 (emphasis added). Here,

as noted above, Plaintiff had no presence in North Carolina.51 Plaintiff engaged in no activity

in the State of North Carolina; it did not make investments in North Carolina, it made no

50 See supra ¶ 23.
51 Id.
distributions to North Carolina residents, and it did not maintain any records in North

Carolina.52

47. On this point, the recent decision of the Commonwealth Court of Pennsylvania

in McNeil v. Commonwealth, a case factually similar to the present case, is instructive. In

McNeil, Pennsylvania "assessed Pennsylvania income Tax and interest on all of the income

of two inter vivos trusts which are located in, administered in, and governed by, the law of

Delaware and which had no Pennsylvania income or assets" on the basis that the trusts'

discretionary beneficiaries and settlor were Pennsylvania residents. 67 A.3d at 187-88. The

trusts had no obligation to pay any distributions to the beneficiaries and the beneficiaries

had no current or future right to the income or assets of the trusts. See id. at 194.

Pennsylvania law classified the trusts as resident trusts based on the residency of the settlor

and taxed the trusts on all of their income. Id. at 187, 190. The Court concluded that the tax

violated three prongs of the Complete Auto test because (a) the residency of the beneficiaries

and settlor did not establish a substantial nexus between Pennsylvania and trusts, (b) the

tax was not fairly apportioned as the trust had no Pennsylvania income or assets and the

trustees had no presence in Pennsylvania, and (c) the tax was not fairly related to services

provided by Pennsylvania as the trusts had no physical presence in Pennsylvania, none of

their income was derived from Pennsylvania sources, none of their assets or interests were

located in Pennsylvania, and they were established under and were governed by Delaware

law. Id. at 192-97. To be sure, the beneficiaries themselves, as residents of Pennsylvania,

received benefits from Pennsylvania; nonetheless, the McNeil court made clear that it was

the trust that was subject to taxation, not the beneficiaries themselves. Id. at 198 (noting the

beneficiaries will pay Pennsylvania tax on any distributions they receive from the trusts).

52 Id.
Ultimately, the court in McNeil recognized that, although the beneficiaries were provided a

benefit from the Commonwealth of Pennsylvania, because the plaintiff trusts themselves

"d[id] not benefit from Pennsylvania's . . . economic markets, . . . courts, and laws," the fourth

prong of Complete Auto was not satisfied. Id. at 197-98.

48. Similarly, notwithstanding the absence of the Trust's meaningful contact with

or activity in North Carolina, Defendant argues that this prong is satisfied because "North

Carolina provides the beneficiaries with a civilized society . . . [and] the environment for the

enjoyment of the Trust, whether assets are distributed now or later."53 However, as noted

above, the Complete Auto test examines the activities "of the taxpayer" in the taxing State.

Goldberg, 488 U.S. at 266. Defendant has only taxed Plaintiff, not the beneficiaries or any

North Carolina resident. Accordingly, the Court is limited to examining the benefit conferred

by the State on Plaintiff as a separate legal entity from the beneficiaries. See Anderson, 289

U.S. at 27. Unlike the beneficiaries, Plaintiff does not benefit from any services or legal

framework provided by the State of North Carolina. See McNeil, 67 A.3d at 197-98. Similarly,

the Court concludes that application of G.S. § 105-160.2 to Plaintiff does not satisfy the fourth

prong of Complete Auto.

49. Ultimately, because the application of G.S. § 105-106.2 fails to satisfy the first

or fourth prongs of the Complete Auto test, the Court concludes that the portion of G.S. §

105-160.2 providing that a trust may be taxed on income "that is for the benefit of a resident

of this State" violates the Commerce Clause of the United States Constitution and Article I,

Section 19 of the North Carolina Constitution as applied to Plaintiff in this case where the

only basis for imposition of the taxes is the beneficiaries' residence in the State of North

Carolina.

53 Def.'s Br. Supp. Mot. Summ. J. 30.
Conclusion

50. Although Plaintiff must satisfy a high burden to prove that a State statute is

unconstitutional, North Carolina case law has shown that such a burden is not

insurmountable. See McIntyre v. Clarkson, 254 N.C. 510 (1961) (holding statute at issue

constitutionally invalid where challenger showed the statute's unconstitutionality beyond a

reasonable doubt). Accord Board of Managers James Walker Memorial Hospital v.

Wilmington, 237 N.C. 179, 189 (1953); Rockford-Cohen Group, LLC v. N.C. Dep't of Ins., __

N.C. App. __, 749 S.E.2d 469 (2013).

51. Ultimately, after a thorough review of the record in this action and

consideration of the arguments of the parties, the Court concludes that Plaintiff has shown,

beyond a reasonable doubt, that the portion of G.S. § 105-160.2 providing that a trust may

be taxed on income "that is for the benefit of a resident of this State" is unconstitutional

under the Due Process and Commerce Clauses of the United States Constitution and Article

1, Section 19 of the North Carolina Constitution as applied to Plaintiff in this case where the

only basis for imposition of the taxes is the beneficiaries' residence in the State of North

Carolina. For the reasons stated above, it appears to the Court that Plaintiff's Motion for

Summary Judgment should be GRANTED, and Defendant's Motion for Summary Judgment

should be DENIED.

THEREFORE, IT IS ORDERED that:

52. Plaintiff's Motion for Summary Judgment is GRANTED. Defendant shall

refund any and all taxes and penalties paid by Plaintiff pursuant to G.S. § 105-160.2, with

interest.

53. Defendant's Motion for Summary Judgment is DENIED.
This the 23rd day of April, 2015.