June 20, 2013
Authored by: Kathy Sherby and Stephanie Moll
Many states base trust income taxation on the domicile or residence of the settlor at the time the trust became irrevocable. Some of these states have taken the position either by statute or case law that the residence or domicile of the settlor provides sufficient contacts with the state for the state to impose its income tax burden on the trust. However, the Court in New Jersey recently expressly rejected that view and held in Residuary Trust A u/w/o Fred E. Kassner v. Director, Division of Taxation, 2013 N.J. Tax LEXIS 1 (January 3, 2013), that constitutional due process requires additional minimum contacts to subject a trust to state income taxation.
Residuary Trust A u/w/o Fred E. Kassner (“Trust”) was created under the will of a New Jersey domiciliary. However after Kassner’s death, the sole Trustee of the Trust was a resident of New York. The Trust owned S corporation stock, with a portion of the S corporation income produced in New Jersey. The Trustee filed a New Jersey income tax return for 2006, a year in which it made no distributions to beneficiaries, to report the income from the S corporation stock that was allocated to New Jersey. The Trust did not report income from the S corporation stock that was allocated to other states nor did it report its ordinary dividend and interest income. The New Jersey Director of Revenue (“Director”) audited the Trust’s 2006 return and assessed a deficiency, taking the position that 100% of the Trust’s income was subject to New Jersey state income taxation. The Trustee protested the deficiency, but the Director issued a Final Deficiency based on 100% of the Trust’s income. The Trustee then appealed the deficiency.
1. The Director first argued that no further contacts with New Jersey were required in order to constitutionally impose state income taxation, other than that set out in the statute defining a resident trust as a trust created by a NJ domiciliary. The Director invited the Court to adopt this position based on rulings of the Connecticut court (Chase Manhattan Bank v. Gavin, 249 Conn. 172, 733 A. 2d 782 (Ct. 1999) and of the District of Columbia court (District of Columbia v. Chase Manhattan Bank, 689 A. 2d 539 (D.C. App. 1997), both of which held that no further contacts are required of a trust created by a domiciliary or resident of the state.
The Court expressly rejected that position, relying on two older New Jersey cases, Pennoyer v. Taxation Div. Dir., 5 N.J. Tax 386 (Tax 1983) Potter v. Taxation Div. Dir., 5 N.J. Tax 399 (Tax 1983), and ruled that, even though a trust is a resident trust as defined in the N.J. statute, further minimum contacts were required to tax a trust.
2. The Director then argued that the Trust met the required minimum contacts when it filed its NJ income tax return using a N.J. address.
The Court summarily dismissed this argument, ruling that merely using a N.J. address on the tax return was insufficient to expose the Trust to N.J. income taxation.
3. Finally, the Director argued that the Trust had NJ situs property in that the Trust owned S corporation stock that owned New Jersey assets and as a flow through entity the New Jersey assets owned by the S corporation should be attributed to the Trust.
The Court ruled that the ownership of S corporation stock did not result in a transfer of ownership of the underlying assets of the corporation to the Trust.
Having failed to establish sufficient minimum contacts with New Jersey, the Trust was not subject to taxation in New Jersey on anything other than the income from the S corporation allocated to New Jersey.