Imagine you’ve been named as the beneficiary of a trust, but you haven’t received a dime from the trust and it’s not certain that you ever will – yet your state tax collector bills you $1.3 million. A North Carolina woman thought that was unfair, and the United States Supreme Court agreed with her.

In North Carolina Department of Revenue v. Kimberly Rice Kaestner 1992 Family Trust, the Supreme Court unanimously found that North Carolina violated the Due Process Clause of the Fourteenth Amendment when it taxed Mrs. Kaestner for undistributed trust income on the basis of just one contact: that she lived there.

That Clause says, “No State shall…deprive any person of life, liberty or property without due process of law.” Previous cases have held that the Clause means states can only impose taxes that “bear fiscal relation to protection, opportunities and benefits given by the state.” If they don’t, they are not taxes but “mere unjustified ‘confiscation,’” courts have said.

In the North Carolina case, there were no other contacts that might have affected taxability. The Kaestner trust was created (by her father, John Rice) in New York; the trustee and settlor were not residents of North Carolina; the assets were located in Massachusetts; the trust was administered in New York and Massachusetts; and the beneficiaries did not reside in North Carolina when the trust was created.

Mrs. Kaestner and the other beneficiaries never had a right to demand trust income, or to dictate handling of the trust assets. In fact, the New York trustee had absolute discretion over distribution and termination of the trust, and the beneficiaries could not be sure they would receive any specific amount of income from the trust in the future.

The Court ruled that North Carolina, or any state, must demonstrate that a resident has “some degree of possession, control, or enjoyment of the trust property or a right to receive that property” before the State can tax the asset.

Otherwise, the State’s relationship to the asset or income it plans to tax is “too attenuated to create the ‘minimum connection’ that the Constitution requires,” Justice Sotomayor wrote in the Court’s opinion.

This decision is narrow and limited to facts similar to Kaestner, but it will likely give states pause before they tax undistributed income and thus risk violating the Constitution.

If you have questions about how the Kaestner decision could affect your estate planning or your potential tax liability as a beneficiary, please contact any member of the Tax and Wealth Planning Group here at Valensi Rose.

By Susan Sabry