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Opinion analysis: Presence of in-state beneficiaries alone insufficient for state to assert jurisdiction to tax trust income

June 22, 2019 by admin Leave a Comment

In a unanimous opinion, the Supreme Court on Friday held that North Carolina’s efforts to tax the income of a trust based on the trust beneficiary’s residence in the state violated the Constitution’s due process clause.

The case arose when North Carolina attempted to tax the income earned by the Kimberley Rice Kaestner 1992 Family Trust from 2005 to 2008. During this period, the Kaestner trust’s beneficiaries were all residents of North Carolina, but the trust’s grantor was a resident of New York, and the trust was governed by New York law, where its documents and records were kept. The trust’s asset custodians were in Massachusetts. At no point during the relevant tax period was the trustee a North Carolina resident. Moreover, the trust earned no income in North Carolina.

The trust alleged that North Carolina’s imposition of its tax violated the due process clause because the trust lacked the necessary minimum contacts with the state. North Carolina argued that the presence of in-state beneficiaries was sufficient to satisfy the minimum-contacts requirement under the court’s modern jurisprudence.

The Supreme Court rejected the state’s arguments in an opinion written by Justice Sonia Sotomayor. The opinion begins its analysis by observing that tax due process cases are analyzed under a two-step framework that requires (1) “some minimum connection” between the taxpayer and the state and (2) a rational relationship between the income the state seeks to tax and the state. The opinion focuses on the first part of this test, which is determined under the same framework, derived from the court’s 1945 decision in International Shoe Co. v. Washington, used to analyze questions of personal jurisdiction.

In applying the International Shoe framework to trust cases, the opinion remarks on the legal complexity of trusts, which are not themselves legal entities but rather a fiduciary relationship between a settlor, a trustee and a beneficiary. In cases like this one, the hard question is not whether the beneficiary’s contacts are sufficient, but rather whether they matter at all for the minimum-contacts analysis. Drawing on two seminal cases about the taxation of trusts, Safe Deposit & Trust Co. of Baltimore v. Virginia and Brooke v. Norfolk, the opinion suggests that whether a beneficiary’s in-state contacts are relevant depends on “the extent of the in-state beneficiary’s right to control, possess, enjoy, or receive trust assets.”

Applying this test to the Kaestner trust, the court concludes that the in-state beneficiaries lack the requisite control or possession for their contacts with North Carolina alone to establish jurisdiction. The beneficiaries neither received money from the trust during the relevant period nor had any right to demand trust distributions. Furthermore, because the trust gave the trustee sole discretion over distributions, there was not even a guarantee that a particular beneficiary would ever receive a distribution.

In addressing the state’s concerns about existing tax regimes and tax avoidance, the court repeatedly emphasizes the narrowness of its holding. Furthermore, the opinion notes that if settlors wish to provide more certainty to beneficiaries, rather than entrusting distributions to the sole discretion of the trustee, tax-avoidance opportunities will be more limited. The opinion concludes that “mere speculation about negative consequences cannot conjure the ‘minimum connection’ missing between North Carolina and the object of its tax.”

When the Supreme Court agreed to review this case, many observers hoped that the court might use it as an opportunity to address tax jurisdiction and provide guidance to taxpayers and states, especially in the wake of last summer’s decision in South Dakota v. Wayfair to allow states to impose a sales tax obligation on vendors who lack a physical presence in the state. Oral argument made clear that the justices were more interested in the particularities of trust law, and this opinion is decided quite narrowly. At multiple points within the opinion and its footnotes, the opinion explicitly withholds judgment, both about states’ claims of jurisdiction over trusts on other bases and about states’ jurisdiction over trusts whose distribution regimes differ from that of the Kaestner trust.

In a concurrence, Justice Samuel Alito, joined by Chief Justice John Roberts and Justice Neil Gorsuch, attempts to clarify that the narrowness of this holding does not mean there is no governing standard. Alito writes, “The Court’s discussion of the peculiarities of this trust does not change the governing standard, nor does it alter the reasoning applied in our earlier cases.” Although this concurrence suggests more certainty for trust cases going forward, it remains to be seen how the court will deal with other due process challenges to state tax regimes.

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Justices send cake sequel back to state court

June 18, 2019 by admin Leave a Comment

Just over a year ago, the justices issued a narrow ruling in the case of Jack Phillips, a Colorado baker and devout Christian who refused to create a custom cake for a same-sex couple’s wedding festivities. The Supreme Court’s decision for Phillips rested primarily on the rationale that the Colorado administrative agency that ruled against Phillips treated him unfairly, because it was too hostile to his religious faith. Today the court declined to take up a question that it left open in Phillips’ case: Can sincerely held religious beliefs trump neutral laws that apply to everyone? Instead, the justices sent the case of an Oregon couple who refused to bake a cake for a same-sex wedding celebration back to the state court for another look in light of Phillips’ case.

The couple, Melissa and Aaron Klein, owned a bakery in the Portland suburbs. Six years ago, Rachel Bowman-Cryer and her mother, Cheryl, visited the bakery to order a wedding cake for Rachel’s upcoming marriage. But the Kleins wouldn’t take the order, explaining that the bakery did not make cakes for same-sex ceremonies because they believe that a marriage is limited to the union between a man and a woman.

Rachel and her fiancée complained to a state administrative agency. They argued that the Kleins’ refusal to make a cake for them violated state laws that prohibit businesses that serve the public from discriminating based on sexual orientation. The agency agreed and awarded them $ 135,000. A state appeals court upheld that ruling. The state court rejected the Kleins’ argument that applying the state’s anti-discrimination laws to them violates the First Amendment by compelling them to “express a message—a celebration of same-sex marriage—with which they disagree.”

Last fall the Kleins went to the Supreme Court, asking the justices to take up their case. After considering the Kleins’ case at 10 consecutive conferences, the justices today sent the case back to the Oregon Court of Appeals, for that court to reconsider it in light of the Supreme Court’s decision in Phillips’ case. The court’s order was a terse one that did not indicate exactly how Phillips’ case might affect the ruling in the Kleins’ case or why it had taken so long for the justices to act on the Kleins’ case. The order may have allowed the justices to avoid tackling this contentious issue for now, but they may not be able to dodge the question forever: Earlier this month, the Washington Supreme Court reaffirmed its ruling against a florist who refused to provide flowers for a same-sex wedding. The U.S. Supreme Court had sent that case back to the state court last year in the wake of its ruling in Phillips’ case; lawyers for the florist have already announced that they intend to appeal to the U.S. Supreme Court.

The justices did not act on the three petitions for review filed by the Trump administration, seeking review of decisions by lower courts blocking the federal government from ending the program known as “Deferred Action for Childhood Arrivals,” which allows undocumented immigrants who came to the United States as children to apply for protection from deportation and (among other things) for permission to work in this country. The petitions, which the justices had considered at their conference last week for the first time since January, have already been distributed for the justices to consider again at their conference on Thursday.

We expect orders from Thursday’s conference on Monday, June 24, at 9:30 a.m.

This post was originally published at Howe on the Court.

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Opinion analysis: Court carves out narrow role for state law on the outer continental shelf

June 11, 2019 by admin Leave a Comment

In a broad, unanimous and unsurprising decision, the Supreme Court yesterday held that the Outer Continental Shelf Lands Act only incorporates state law when federal law’s silence on a particular issue creates a “gap” for state law to fill. The decision is a defeat for Brian Newton, a former employee of Parker Drilling Service, Ltd., who sought compensation under California’s more labor-friendly wage-and-hours law for hours that he spent on standby but not working on oil-drilling platforms miles off the coast of California.

Justice Thomas with opinion in Parker Drilling v. Newton (Art Lien)

The case turned on what Justice Clarence Thomas’ opinion for the court candidly called “a close question of statutory interpretation.” Under the OCSLA, structures attached to the continental shelf more than three nautical miles from the coast are deemed to be under exclusive federal control and are governed solely by federal law. However, because federal law does not contain a full code of behavior to regulate human interaction, 43 U.S.C. § 1333(a)(2)(A) provides that “the civil and criminal laws” of the adjacent states are incorporated into the prevailing federal law “[t]o the extent that they are applicable and not inconsistent with” other provisions of federal law. The U.S. Court of Appeals for the 5th Circuit — which is responsible for over 90 percent of the cases arising under the OCSLA — has generally interpreted that statutory provision to spring to life only when a “gap” exists in federal law that requires a rule of decision. The Supreme Court’s few prior opinions interpreting the OCSLA have hinted at the same construction, applying state law because such a gap existed, albeit without ever saying that a gap was required. In this case, the district court followed the 5th Circuit’s approach, but the U.S. Court of Appeals for the 9th Circuit reversed, holding that the plain language of the statute required an approach receptive to the application of state-law rules on the outer shelf, as long as such rules are relevant to the subject matter of the litigation and do not violate ordinary pre-emption principles.

Though the justices found many factual and legal points difficult during oral argument, as I wrote for this blog, the Supreme Court ultimately found it unnecessary to engage those peripheral issues in order to resolve this case. After acknowledging that the question of statutory interpretation is “close,” Thomas’ opinion immediately explained that the court found the 5th Circuit’s approach advocated by Parker Drilling “more persuasive” in the context of the full statutory scheme. That argument had two parts. First, the court somewhat perfunctorily cited to a series of contemporaneous dictionaries suggesting that the word “inconsistent” had multiple meanings when the OCSLA was adopted and that those meanings pointed in different directions in this case. Second, the court with a bit more gusto concluded that the OCSLA’s focus on establishing exclusive federal control over and supervision of the outer continental shelf and its insistence that state law only applies to the shelf as “surrogate federal law” show that Congress wanted state law to play a much more limited role on the outer shelf than it does in the contiguous states. Because traditional pre-emption law balances the interests of two geographic sovereigns, it implicates federalism concerns that are absent when — as here — there is only one governing authority.

Perhaps in order to establish unanimity, the opinion went on to list a variety of other factors and reasons that also support the Supreme Court’s narrow interpretation. First, the broader reading of the statute advocated by Newton and the 9th Circuit, under which state law would apply unless pre-empted by federal law, would render the bulk of the statutory language superfluous. Second, the role given to state law under the court’s interpretation is broadly consistent with the limited role state law plays in other federal enclaves (such as national parks and military bases). Finally, the court’s reading is consistent with settled expectations as established by its earlier dicta and, to a lesser extent, the 5th Circuit’s holdings.

After providing its authoritative construction of the relevant statutory provision, the Supreme Court briefly applied its rule to the facts of this case, vacating the 9th Circuit’s judgment and ruling against Newton on his core claims but remanding for resolution of some peripheral claims that were not briefed before the court. In rejecting Newton’s central claims (involving whether he should be paid for his time on standby and whether the California minimum wage is applicable on the outer continental shelf), the court concluded that they are addressed and defeated by the federal Fair Labor Standards Act and that there is, therefore, no relevant gap for state law to fill.

In practice, this decision changes little, as almost all of the cases involving the OCSLA arise in the 5th Circuit, which has always applied a rule similar to the one the Supreme Court adopted. However, it does close off one avenue that coastal states might potentially have relied upon to gain greater control over offshore oil drilling, a potential flashpoint in future debates over energy and environmental policy. And on a doctrinal level it has the potential to become a convenient citation for the proposition that textualism is not literalism but instead requires careful contextual analysis.

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Academic highlight: The need for transparency in state attorneys general amicus briefs

June 6, 2019 by admin Leave a Comment

Lisa F. Grumet is Visiting Associate Professor of Law and Director of the Diane Abbey Law Institute for Children and Families at New York Law School.

Today, the Supreme Court will, for the ninth time, consider whether to grant certiorari in Klein v. Oregon Bureau of Labor and Industries. Similar to Masterpiece Cakeshop, Ltd. v. Colorado Civil Rights Commission, Klein concerns enforcement against a bakery that refused to provide a wedding cake to a same-sex couple of a state law prohibiting discrimination in public accommodations.

An important consideration for the Supreme Court is the potential impact that a ruling against Oregon could have on states’ abilities to enforce their own civil rights laws. Forty-five states have laws prohibiting discrimination in public accommodations. Many local jurisdictions also have anti-discrimination laws. These laws generally define “public accommodation” more broadly than federal law, and they often cover protected categories not specified in federal law.

Nevertheless, state attorneys general (SAGs) from nine states with anti-discrimination laws have joined an amicus brief — filed on their states’ behalf — that effectively supports the bakery’s right to discriminate. The brief fails to mention that the nine states have their own public-accommodation laws. It does not acknowledge that arguments made in the brief could undermine enforcement of those laws, laws the SAGs are otherwise generally responsible to defend. In Masterpiece Cakeshop, 18 Republican SAGs and two Republican governors filed a similar brief, while 20 Democratic SAGs filed an amicus brief supporting the Colorado Civil Rights Commission. Increasing partisanship in SAG amicus briefs deserves new focus in light of another, more troubling phenomenon: SAGs taking positions in amicus briefs that may contradict their own states’ laws, without saying so.

I call this phenomenon “hidden nondefense,” and I discuss it in more detail in my recent Fordham Law Review article. “Nondefense” occurs when a SAG declines to defend, or attacks, a law in the SAG’s state on the ground that it is unconstitutional. “Hidden” nondefense occurs when the SAG takes a position in an amicus brief before the Supreme Court that may undermine a law in the SAG’s own state, without affirmatively disclosing this information to the court or the public. For the article I reviewed cases from the 2017-18 Supreme Court term that involved challenges to state laws or practices, in which partisan groups of SAGs filed amicus briefs on both sides of the case. In addition to Masterpiece Cakeshop, the cases included Gill v. Whitford, Husted v. A. Philip Randolph Institute, Janus v. AFSCME and National Institute of Family & Life Advocates v. Becerra (NIFLA). The table below shows the number of SAGs from each party who participated in amicus briefs filed on each side of the case, as well as the number of participating states with related laws specifically cited and discussed in the briefs.

Click to enlarge.

As indicated in the chart, there was a complete partisan divide in amicus participation in these cases. Furthermore, only one of the briefs discussed laws specific to the states of all participating SAGs.

The SAG amicus brief opposing Oregon in Klein does not mention that nine of the 11 participating states — Arizona, Arkansas, Louisiana, Nebraska, Nevada, Oklahoma, South Carolina, Utah and West Virginia — have laws that define public accommodation more broadly than federal law, to include businesses that provide goods or services to the general public. In fact, Nevada specifically prohibits discrimination in “baker[ies].” The brief argues in part that “public-accommodation concerns of past eras are not present here; customized pieces of art are not public accommodations (like restaurants and hotels).” It suggests that states could “define ‘public accommodations’ like the federal government,” to encompass only “establishments such as hotels, restaurants, and stadiums.” The only SAGs whose state laws are not potentially at issue are those from Texas (the lead participant) and Alabama, because neither state has its own public-accommodation laws. However, certain municipalities within those two states do have laws prohibiting discrimination, so the problem remains.

Hidden nondefense raises serious questions of accountability and separation of powers. By appearing in front of the Supreme Court and attacking another state’s law, a SAG may seek and achieve results that could not be obtained politically within their own state. For example, any of the legislatures in the states joining the Klein brief could, in theory, adopt the brief’s proposal to narrow the scope of their public-accommodation laws. They have not done so. Similarly, in the Janus v. AFSCME litigation last term, which concerned whether public employees who did not belong to unions could be required to pay union “agency fees,” the Michigan and Wisconsin SAGs successfully argued to invalidate a law similar to laws in their own states, without informing the court of the connection. Of course, SAGs sometimes do publicly decline to defend laws; one example is pre-Obergefell v. Hodges prohibitions on same-sex marriage. But the problem with “hidden nondefense” is that it is hidden. In this time of increasingly partisan SAG coalitions, transparency and accountability are especially critical to ensuring that SAGs truly represent the interests of their states.

There is a simple solution to the problem of hidden nondefense. Rule 37(4) of the Supreme Court’s rules currently allows SAGs to file amicus briefs “on behalf of a State” without seeking leave of the court. However, the rules do not require SAGs to identify state laws relevant to the brief’s position.

The rules could be changed to require that SAGs filing amicus briefs identify laws within their states that could be adversely impacted by the position they take in a brief. Requiring disclosure would help to ensure that the court, other government officials and the public are fully advised of the reasons for the SAGs’ participation in the litigation and the implications of the ruling. It would encourage SAGs to carefully consider how the case might affect their own states’ laws, possibly influencing the content of the brief or even the decision of whether to participate in it. And finally, it would help to ensure that nondefense is not “hidden” but rather discussed in the open, consistent with the SAGs’ role to represent the interests of the people in their states.

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Argument analysis: Court worries that state trust tax may tax trust income that is never distributed to in-state beneficiary

April 18, 2019 by admin Leave a Comment

On Tuesday, the Supreme Court heard oral argument in North Carolina Department of Revenue v. Kimberley Rice Kaestner 1992 Family Trust. North Carolina hopes to convince the court that its method of taxing trusts, with jurisdiction based on an in-state beneficiary, passes constitutional muster. The court greeted the state’s arguments with significant skepticism.

As a quick recap, North Carolina’s Department of Revenue is defending tax liability imposed on income earned by the Kimberley Rice Kaestner 1992 Family Trust between 2005 and 2008. During this period, the trust’s beneficiaries were all North Carolina residents, but the trust itself was administered in New York by trustees who were not North Carolina residents, and the trust made no distributions in the relevant period. (The trust concedes, as it must, that distributions actually paid to a North Carolina beneficiary would be taxable in that state as income to the beneficiary.)

North Carolina Solicitor General Matthew Sawchak, representing the Department of Revenue, opened his argument by emphasizing that the trust beneficiaries are the “true owners of trust income” and “the benefits and protections” provided by the state to its residents provided sufficient ground for the state to tax a beneficiary’s income, even while held in trust.

Several justices, however, seemed unpersuaded by Sawchak’s true-ownership argument. Sawchak conceded that the trustee had complete discretion over both the timing of distributions and their allocation among beneficiaries. As Justice Sonia Sotomayor asked Sawchak, “What makes it your right under any circumstance to tax all of the trust income where there’s no guarantee that she is going to receive all of it at any point?”

Justice Stephen Breyer also questioned the fairness of the state’s pro-rata approach, which assumed trust beneficiaries would split trust income equally, even if the trust document granted the trustee discretion as to how to allocate distributions. Breyer was concerned with the possibility that a nonresident would end up with the lion’s share of trust distributions. In that case, North Carolina’s pro-rata division of trust income would overstate the income appropriately attributed to the state. Breyer, somewhat quixotically, also seemed to believe that the state should offer a present-value discount on trust income to reflect the fact that the beneficiary did not immediately receive the benefit of the income.

Finally, the justices also seemed concerned about how North Carolina’s tax would affect other states’ efforts to tax the trust income based on in-state administration or the residence of a trustee. Sawchak argued that North Carolina’s credit system solved any problems of multi-state taxation and tried to pivot to the state’s argument that jurisdiction based on beneficiary residence prevented tax avoidance. Sawchak’s point was that worries about multiple tax burdens on trust income were misguided given the ease with which trusts could move to avoid taxes based on other characteristics.

He was not allowed to linger on this point, however, because Justice Neil Gorsuch and Sotomayor both wanted to know how North Carolina’s position squared with existing precedent. Both justices suggested that the state’s position required the court to overrule prior decisions on state jurisdiction over trusts. Sawchak tried to distinguish two of these cases, Safe Deposit Trust Co. v. Virginia and Brooke v. Norfolk, as property tax cases. Gorsuch made clear that he was not persuaded, observing that Sawchak was “slicing the baloney a little too thinly.” Sawchak then fell back on the argument that the cases had been implicitly overruled by the court’s modern due process jurisprudence. Addressing questions about the court’s decision in Hanson v. Denckla, Sawchak argued that Hanson was about adjudicative and not tax jurisdiction. Sawchak returned to this point in his rebuttal, though Gorsuch seemed to remain skeptical.

David O’Neil, representing the trust, began by arguing that trust income does not belong to the beneficiary. As he observed, Kimberley Kaestner “didn’t possess it or control it. She didn’t access it. She couldn’t use it. … She didn’t receive any of it, and she had no guarantee that she would ever receive a penny of it in North Carolina or anywhere else.”

Justice Elena Kagan emerged as the justice most skeptical of the trust’s position. She flatly rejected O’Neil’s argument that the beneficiary does not benefit from undistributed trust income, noting that “a person in North Carolina who’s making $ 100,000 a year and a person in North Carolina who’s making that exact same amount of income and has a $ 20 million trust are really in two different positions.” As a result, Kagan suggested that as among establishing jurisdiction based on trust administration, trustee residence and beneficiary residence, beneficiary residence had the most compelling claim. As she noted, “all the benefit of this trust is going to this person who lives down in North Carolina.”

Other justices expressed far less skepticism, and O’Neil took several opportunities to rebut the state’s claims. For example, in response to Chief Justice John Roberts’ questions about the taxation of trust distributions, O’Neil addressed North Carolina’s concern that a taxpayer victory here would open the doors to tax abuse. O’Neil suggested that states already have a constitutional mechanism to solve this problem: throwback statutes that allow states to tax “income that had accumulated in previous years and that the trustee did not pay tax on.”

At one point, several justices engaged O’Neil in a colloquy about the constitutional limits of a state wealth tax, before Breyer concluded that “I can’t reach [this] really interesting legal question” because it wasn’t presented in this case.

O’Neil concluded by addressing the state’s argument that last year’s decision in South Dakota v. Wayfair, in which the court ruled that states can require retailers who don’t have a physical presence in the state to collect tax on sales to state residents, changes the result in this case. Noting that Wayfair focused on the taxpayer’s own conduct in the state, he suggested the proper analogy to that case would be the claim of jurisdiction over Wayfair’s income based on the residence of a beneficial shareholder.

Prior to the oral argument, court observers (including me) had suggested that this case offered the court an opportunity to clarify its due process doctrine in state tax cases. The court’s questions, focused as they were on the particular problems of trust taxation, suggest interest in a narrower opinion. And states hoping the court would bless the taxation of trust income based on in-state beneficiaries should probably start considering other ways of taxing this income. Now, about the state wealth tax …

Editor’s Note: Analysis based on transcript of oral argument.

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Supreme Court says state Medicaid payments not open to private lawsuits

April 3, 2015 by admin Leave a Comment

Supreme Court says state Medicaid payments not open to private lawsuits
The Supreme Court narrowly ruled Tuesday that health-care providers cannot sue states in order to bump up Medicaid reimbursement rates they say are unlawfully low. The justices ruled 5 to 4 that neither the Constitution nor federal law authorizes …
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Forward Motions: Doral Financial, ProNerve Seek Court-Supervised Sales
On Thursday in Manhattan, Doral Financial Corp.DRLCQ -9.30% will seek court permission to sell its insurance arm to Anglo-Puerto Rican Insurance Corp. for $ 10.75 million, subject to higher bids at an auction. Before the sale can proceed, Judge Shelley …
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NBA playoff picture: Trail Blazers still in 4th, but lose home court advantage
The Trail Blazers have already clinched a playoff berth, but after losing to the Los Angeles Clippers on Wednesday Portland has lost home court advantage. Here's a look at the Western Conference playoff picture with two weeks remain in the regular season.
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