Can states tax trust income if the trust is in another state?

The Supreme Court of the United States (SCOTUS) has agreed to hear a case that questions whether the due process clause prohibits states from taxing trusts based on the trust beneficiaries’ in-state residency. It is important to note this case addresses the taxation of the trust income itself, not distributions. In most cases, it is legal for a state to require the payment of taxes on distributions made to a resident of the state.

The issue is controversial: 11 states in the country have state laws that allow for the taxation of trust income based on a trust beneficiary’s residence within the state. Whether or not this practice is legal is controversial, with the answer split across the country. Of the nine states that have litigated the issue in their highest courts, four states have said yes, a state can tax an out-of-state trust if a beneficiary lives within its bounds.

The case headed to SCOTUS involves a trust set up in New York. One of the beneficiaries moved to North Carolina. North Carolina attempted to tax the undistributed income of the trust. This led the trust to file suit against the North Carolina Department of Revenue, demanding a refund of the $1.3 million tax bill. The state refused. The issue will now be addressed by the highest court in the country.

Big money translates to broad implications: As noted in a recent Forbes publication, the holding in the case will have a broad impact throughout the country. Trusts can hold massive amounts of wealth and some states depend on the income taxes taken from these accounts to help meet budgetary needs.