By Michael Penza and Timothy Gustafson

The California Franchise Tax Board (FTB) issued an information letter explaining that a trust is taxable in California if any of the following three conditions are met: (1) the trust has income from California sources; (2) a trustee is a resident of California; or (3) a non-contingent beneficiary is a resident of California. The letter elaborated that where a trust accumulates income from both California and foreign sources, California taxes 100% of the California source income, plus a percentage of the foreign source income reflecting the proportion of trustees and beneficiaries residing in California to trustees and beneficiaries residing outside of California. California FTB Information Letter No. 2015-02 (April 21, 2015).

The information letter is consistent with the California Supreme Court’s ruling in McCulloch v. Franchise Tax Board, 390 P.2d 412 (Cal. 1964), which held that California could tax a foreign trust’s undistributed income based on a beneficiary’s California residence without violating the federal Constitution. A North Carolina Superior Court, however, reached the opposite conclusion in The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue. In Kaestner, the trust’s only connection to the state was through its beneficiary, a North Carolina resident. The trust did not hold any real or personal property in North Carolina; it did not generate any income from direct investments in North Carolina; it did not maintain any records in North Carolina; and its sole trustee did not reside in North Carolina. Accordingly, the court held that the federal Due Process Clause prevented North Carolina from taxing the trust’s undistributed income because: (1) the trust did not have a physical presence in the state, or derive any income from sources within the state; and (2) the trust did not receive any benefits from the state that could justify the tax imposed. Similarly, the court held that the Commerce Clause prevented the state from taxing the trust because: (1) the trust did not have substantial nexus with the state; and (2) the tax was not fairly related to the services provided by the state. The Kimberley Rice Kaestner 1992 Family Trust v. North Carolina Department of Revenue, Docket No. 12 CVS 8740 (N.C. Super. Ct., April 23, 2015).