Two recent state appellate decisions dealing with the taxation of trusts and trustees could be instructive for trust clients trying to determine whether their activities will be considered taxable in states other than their home state.

On July 11, the Massachusetts Supreme Judicial Court (SJC) affirmed the Massachusetts Appellate Tax Board (ATB) in Bank of America, N.A., trustee, v Commissioner of Revenue, denying requests by Bank of America (the Bank), in its capacity as corporate trustee, to abate fiduciary income taxes paid by 34 trusts. The SJC held that the Bank qualified as an "inhabitant" of the Commonwealth and was therefore subject to Massachusetts fiduciary income tax.

On July 5, the North Carolina Court of Appeals affirmed the decision of the Business Court in Kimberly Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue. The Appeals Court held that the state violated the Due Process Clause of the US Constitution, as well as the North Carolina Constitution, by taxing a New York resident trust on income accumulated for, but never distributed to, a beneficiary in North Carolina. The case challenged the constitutionality of a state statute (NC G.S. 105-160.2) permitting the North Carolina Department of Revenue (NC DOR) to tax trusts based solely on the residence of a beneficiary. (See Tax Alert 2015-864 for background.)

Bank of America decision

The Bank has its principal place of business in Charlotte, North Carolina, and is domiciled in North Carolina, not in Massachusetts. The Bank served as trustee for certain irrevocable, inter vivos trusts created by individuals who were Massachusetts inhabitants at the time of the trusts' creation. In the year at issue (2007), the trusts paid tax to Massachusetts but had no Massachusetts-source income.

The Bank carried on general business activities as a financial institution with more than 200 branch offices in Massachusetts and performed activities related to trust administration in the Commonwealth. In 2011, the Bank applied for abatement and refund of the taxes paid. In June 2015, the ATB concluded that the Bank was an "inhabitant" of the Commonwealth for purposes of the fiduciary income tax statutes, and denied the Bank's request for abatement.

For a trust to be subject to income tax under Massachusetts law (M.G.L. ch. 62 Section 10), at least one grantor, one beneficiary and one trustee must be an "inhabitant" of the Commonwealth. M.G.L. ch. 62 Section 1(f) defines "inhabitant" generally as: "(1) any natural person domiciled in the commonwealth, or (2) any natural person who is not domiciled in the commonwealth but who maintains a permanent place of abode in the commonwealth." M.G.L. ch. 62 Section 14 says corporations acting as trustee or in any other fiduciary capacity are subject to this chapter in the same manner and under the same conditions as individual inhabitants acting in similar capacities. Here, the grantors of the subject trusts were inhabitants of Massachusetts upon the trusts' creation, and the trusts are deemed to have Massachusetts beneficiaries. Therefore, the issue was whether the Bank, as trustee, is considered an inhabitant.

The SJC established a two-prong test for whether a corporate non-domiciliary trustee is an inhabitant: (1) Did the corporate trustee establish enough general corporate presence in the Commonwealth? (2) Did the trustee carry on material business within the Commonwealth related to the specific trusts? The SJC concluded that the Bank is considered an inhabitant for fiduciary income tax purposes it: (1) carried on general corporate business for more than half of the year by maintaining branches and doing business in Massachusetts; and (2) conducted sufficient trust-specific business within the Commonwealth.

Implications of Bank of America case

The SJC decided this case on statutory grounds, not on constitutional grounds. Therefore, this particular case is not necessarily as important as some other recent cases involving states' ability to tax a trust (such as the Kaestner case discussed below). Nonetheless, Bank of America is noteworthy because of its broad impact on banks conducting trust business in Massachusetts and its message that even a non-domiciliary trustee could come within the purview of the Commonwealth's taxing ability. Also, some other states base their jurisdiction to tax a trust upon the presence of a fiduciary in the state. If a state's law does not already provide clear guidance on when a corporate fiduciary is considered a "resident," the state might find the Bank of America decision persuasive.

Kaestner decision

In Kaestner, the trust's only connection with North Carolina was that the current beneficiary, who received no distributions during the tax years in issue, was a resident of North Carolina. N.C. Gen. Stat. Section 105-160.2 says "taxes are computed on the amount of taxable income of the estate or trust that is for the benefit of a resident of this State." The appeals court held that assessing an income tax under the North Carolina statute in this case violated the Due Process Clause of the US Constitution and the Law of the Land Clause of the North Carolina Constitution.

Implications of Kaestner case

It is reasonable to expect that the NC DOR may appeal the case to the North Carolina Supreme Court. The appellate decision may, however, have some immediate considerations for taxpayers. Trusts located outside of North Carolina that have been subject to state tax based solely on beneficiary residence may contemplate opportunities to file protective claims for refund. Amended North Carolina income tax returns requesting refunds generally must be filed within three years of the date the original return was due, including any approved extensions, or within two years after the tax was paid, whichever is later, although special exceptions can apply.

Because Kaestner may be considered a "contingent event" until fully resolved in the courts, taxpayers might hold off on filing immediate refund claims and instead consider filing Form NC-14, Notice of Contingent Event or Request to Extend Statute of Limitations, within the three-year filing window to extend the statute of limitations for a given tax. If approved by the NC DOR, the filing of NC-14 allows taxpayers to wait to file refund claims until Kaestner is completely settled in the courts. Taxpayers should consider all the facts and circumstances to determine whether filing a refund claim or Form NC-14 is advisable and should monitor any future developments resulting from the appeals court's decision.

It is also worth noting that a bill has been introduced in the North Carolina Senate to amend the statute.

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