BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Hannah-Beth Jackson, Chair
2013-2014 Regular Session
AB 296 (Wagner)
As Amended June 15, 2014
Hearing Date: June 24, 2014
Fiscal: No
Urgency: Yes
TMW
SUBJECT
Trusts: Allocation of Receipts
DESCRIPTION
This bill would provide that an allocation to principal of money
received in total or partial liquidation of an entity or money
received that is a capital gain dividend distribution, as
specified, does not include a net short-term capital gain
distribution from a regulated investment company or a real
estate investment trust.
This bill would also clarify an ambiguity in the Uniform
Principal and Income Act.
BACKGROUND
Upon recommendation of the California Law Revision Commission
(CLRC), the Legislature adopted the new Uniform Principal and
Income Act (UPAIA) in 1999 (AB 846 (Ackerman, Ch. 145, Stats.
1999)). The UPAIA, together with the Uniform Prudent Investor
Act, reconstituted the manner by which trusts are administered
for the benefit of their beneficiaries and helps trustees who
have made a prudent, modern portfolio-based investment decision
that has the initial effect of skewing return from all the
assets under management, by giving trustees the power to
reallocate the portfolio return suitably between principal and
income beneficiaries.
Under the UPAIA, a trustee is required to allocate money
received from an entity either to principal (property owned by
the trust) or income (money earned by the trust's principal)
(more)
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based upon the characterization of the money received. The
characterization of the money determines the corresponding
allocation of the money to income, which would benefit life
beneficiaries, or to principal, which would benefit remainder
beneficiaries, and when, and who will pay the taxes, when and
how much.
Existing law requires a trustee to allocate money received from
an entity to income, unless the money qualifies for a statutory
exception, in which case the trustee must allocate the money to
principal. Those exceptions include, among other things, money
received in total or partial liquidation of the entity. AB 1029
(Maienschein, Ch. 105, Stats. 2013), among other things,
clarified how the characterization of money received from a
partial liquidation of an entity is to be determined and
allocated by the trustee.
However, an ambiguity now exists with respect to the
characterization of a net short-term capital gain distribution
from a mutual fund or a real estate investment trust (REIT),
which is allocable to income, but which may be incorrectly
characterized as principal if the trustee believes the money
qualifies as either money received in total liquidation of the
entity or in partial liquidation of the entity or as money
received from an entity that is a regulated investment company
(i.e., mutual fund) or an REIT if the money distributed is a
capital gain dividend for federal income tax purposes. This
bill would clarify that ambiguity and provide that money
received in total or partial liquidation of an entity or money
received that is a capital gain dividend, as specified, does not
include a net short-term capital gain distribution.
CHANGES TO EXISTING LAW
Existing law , the Uniform Principal and Income Act (UPAIA),
establishes rules for the management by a trustee of assets held
by the trust for the benefit of the trust beneficiaries and
provides guidelines for the allocation of receipts to income or
principal. (Prob. Code Sec. 16320 et seq.)
Existing law requires the trustee, when allocating receipts and
disbursements to or between principal and income, to administer
the trust in accordance with the terms of the trust, the power
provided to the trustee under the trust, or, if the trust does
not otherwise provide, pursuant to the UPAIA. (Prob. Code Sec.
16335.)
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Existing law requires a trustee to allocate to income money
received from an entity. (Prob. Code Sec. 16350(b).)
Existing law requires a trustee to allocate to principal the
following receipts from an entity:
property other than money;
money received in one distribution or a series of related
distributions in exchange for part or all of a trust's
interest in the entity;
money received in total liquidation of the entity or in
partial liquidation of the entity, as defined; and
money received from an entity that is a regulated investment
company or a real estate investment trust if the money
distributed is a capital gain dividend for federal income tax
purposes. (Prob. Code Sec. 16350(c).)
Existing law provides that, when determining whether money
received was in partial liquidation of the entity; the money
will be treated as received in partial liquidation to the extent
the amount received from the distributing entity is attributable
to the proceeds from a sale by the distributing entity, or by
the distributing entity's subsidiary or affiliate, of a capital
asset. (Prob. Code Sec. 16350(d).)
Existing law proscribes the following guidelines to determine
whether money is received in partial liquidation:
a trustee may rely without investigation on a written
statement made by the distributing entity regarding the
receipt;
a trustee may rely without investigation on other information
actually known by the trustee regarding whether the receipt is
attributable to the proceeds from a sale by the distributing
entity, or by the distributing entity's subsidiary or
affiliate, of a capital asset;
with regard to each receipt from a distributing entity, if
within 30 days from the date of the receipt the distributing
entity provides no written statement to the trustee that the
receipt is a distribution attributable to the proceeds from a
sale of a capital asset by the distributing entity or by the
distributing entity's subsidiary or affiliate and the trustee
has no actual knowledge that the receipt is a distribution
attributable to the proceeds from a sale of a capital asset by
the distributing entity or by the distributing entity's
subsidiary or affiliate, then the following apply:
o the trustee has no duty to investigate whether the
receipt from the distributing entity is in partial
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liquidation of the entity; and
o if, on the date of receipt, the receipt from the
distributing entity is in excess of 10 percent of the value
of the trust's interest in the distributing entity, then
the receipt is deemed to be received in partial liquidation
of the distributing entity, and the trustee is required to
allocate all of the receipt to principal. (Prob. Code Sec.
106350(d).)
Existing law provides that the value of the trust's interest in
the distributing entity is determined as follows:
in the case of an interest that is a security regularly traded
on a public exchange or market, the closing price of the
security on the public exchange or market occurring on the
last business day before the date of the receipt;
in the case of an interest that is not a security regularly
traded on a public exchange or market, the trust's
proportionate share of the value of the distributing entity as
set forth in the most recent appraisal, if any, actually
received by the trustee and prepared by a professional
appraiser, as defined, with a valuation date within three
years of the date of the receipt; the trustee has no duty to
investigate the existence of the appraisal or to obtain an
appraisal nor does the trustee have any liability for relying
upon an appraisal prepared by a professional appraiser;
if the trust's interest in the distributing entity cannot be
valued, as specified above, the trust's proportionate share of
the distributing entity's net assets, to be calculated as
gross assets minus liabilities, as shown in the distributing
entity's yearend financial statements immediately preceding
the receipt; or
if the trust's interest in the distributing entity cannot be
valued, as specified above, the federal cost basis of the
trust's interest in the distributing entity on the date
immediately before the date of the receipt. (Prob. Code Sec.
106350(d)(3)(B).)
Existing law provides that, if a trustee allocates a receipt to
principal using the above guidelines, or allocates a receipt to
income because the receipt is not determined to be in partial
liquidation under the above guidelines, the trustee is not be
liable for any claim of improper allocation of the receipt that
is based on information that was not received or actually known
by the trustee as of the date of allocation. (Prob. Code Sec.
106350(e).)
Existing law provides that, if the receipt was allocated between
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December 2, 2004, and July 18, 2005, a trustee shall not be
liable for allocating the receipt to income if the amount
received by the trustee, when considered together with the
amount received by all owners, collectively, exceeded 20 percent
of the entity's gross assets, but the amount received by the
trustee did not exceed 20 percent of the entity's gross assets.
(Prob. Code Sec. 106350(f)(1).)
Existing law also provides that money is not received in partial
liquidation, nor may it be taken into account under the partial
liquidation guidelines, to the extent that it does not exceed
the amount of income tax that a trustee or beneficiary is
required to pay on taxable income of the entity that distributes
the money. (Prob. Code Sec. 106350(f)(2).)
Existing law defines "entity" to mean a corporation,
partnership, limited liability company, regulated investment
company, real estate investment trust, common trust fund, or any
other organization in which a trustee has an interest other than
a trust or decedent's estate to which Section 16351 applies, a
business or activity to which Section 16352 applies, or an
asset-backed security to which Section 16367 applies. (Prob.
Code Sec. 16350(a)(1).)
Existing law defines "capital asset" to mean property held by a
taxpayer (whether or not connected with his or her trade or
business). However, capital asset does not include certain
business property, such as inventory, goods for sale to
customers, property subject to the allowance for depreciation,
accounts or notes receivable acquired for services rendered or
from the sale of property, or supplies. (Prob. Code Sec.
16350(a)(2); 26 U.S.C. Sec. 1221.)
This bill would clarify that money received in total liquidation
of the entity or in partial liquidation of the entity does not
include money received from an entity that is a regulated
investment company or a real estate investment trust if the
money distributed is a net short-term capital gain distribution.
This bill would also clarify that money received from an entity
that is a regulated investment company or a real estate
investment trust if the money distributed is a capital gain
dividend for federal income tax purposes does not include money
received from an entity that is a regulated investment company
or a real estate investment trust if the money distributed is a
net short-term capital gain distribution.
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COMMENT
1. Stated need for the bill
The author writes:
Under [Probate Code] Section 16350, money received from an
entity is allocated to income unless it falls into one of the
four enumerated exceptions. . . . Paragraph (c)(4) states
that money received from an entity that is a regulated
investment company (i.e., mutual fund) or real estate
investment trust that is a "capital gain dividend for federal
income tax purposes" is allocated to principal. The comments
in the Uniform Principal and Income Act [(UPIA)] to Section
401 state the following with respect to Paragraph (c)(4):
"Under the Internal Revenue Code and the Income Tax
Regulations, a 'capital gain dividend' from a mutual fund or
real estate investment trust is the excess of the fund's or
trust's net long-term capital gain over its net short-term
capital loss. As a result, a capital gain dividend does not
include any net short-term capital gain, and cash received by
a trust because of a net short-term capital gain is income
under this Act." (Emphasis Added.)
Therefore, with respect to Paragraph (c)(4), because money
received as a short-term capital gain distribution from a
mutual fund or real estate investment trust ("Distributions")
is not a capital gain dividend for federal income tax
purposes, the distributions are allocated to income in
accordance with the general rule of Section 16350.
Distributions are received annually each December. This
allocation rule applies unless the trust instrument expressly
provides otherwise.
The [recent] amendment [to California's Uniform Principal and
Income Act (UPAIA)] redefined the meaning of a partial
liquidation. Prior to the . . . amendment, money received by
a trust from an entity constituted a partial liquidation if
either (1) the entity itself indicated at or near the time of
the distribution that the money was in partial liquidation of
the entity or (2) the total amount of the distribution
received by all owners of the entity exceeded 20 percent of
the entity's gross assets on the entity's immediately
preceding yearend statement. Under the new definition, as set
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forth in subdivision (d) of Section 16350, a distribution by
an entity that is attributable to the sale of a capital asset
is allocated to the principal of the trust. We believe it is
appropriate to amend Section 16350, on an urgency basis, to
rectify the unintended result of having distributions
allocated to principal instead of to income so that when the
distributions are received by trusts in December of 2014,
unless otherwise provided in the trust instrument, the
distributions are allocated to income, consistent with the
UPIA and the expectations of the trust beneficiaries.
2. Clarifying characterization of net short-term capital gain
distributions
A trustee is required to allocate money received from an entity
to income, unless the money falls under a specified exception.
For money received as a partial liquidation of an entity,
existing law requires the trustee to allocate the money to
principal. Last year's clarification of partial liquidation
guidelines created an unintended ambiguity in the UPAIA about
whether a net short-term capital gain distribution received by
the trustee from a regulated investment company or real estate
investment trust (REIT) should be allocated to principal or
income. This bill would clarify that the new partial
liquidation guidelines do not apply to net short-term capital
gain distributions. Accordingly, these distributions would
properly be allocated to income.
In the comments to the Uniform Principal and Income Act, Section
1401, a net short-term capital gain, and cash received by a
trust because of a net short-term capital gain is income because
a "capital gain dividend" is the excess of the fund's or trust's
net long-term capital gain over its net short-term capital loss.
(See Uniform Principal and Income Act (Feb. 9, 2009)
[as of June 15, 2014] p. 36.)
Notably, because the new partial liquidation guidelines specify
that money received from an entity that is a regulated
investment company or REIT if the money distributed is a capital
gain dividend for federal income tax purposes might otherwise be
confused by the trustee to include a net short-term capital gain
distribution from a regulated investment company or REIT.
Further, because money received as a net short-term capital gain
is the result from the sale of a capital asset (such as shares
of corporate stock), the trustee may improperly characterize the
distribution as a total or partial liquidation of the entity and
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allocate the distribution to principal.
The author notes that "of the 46 states and District of Columbia
that have enacted the UPIA, only Florida has changed the
allocation rule for distributions to require that such
distributions be allocated to principal." As a result, the
failure to correct this ambiguity regarding a net short-term
capital gain distribution will result in California's allocation
rule to be inconsistent with the allocation rule of all but one
of the states that have enacted the UPIA. The author also notes
that, in most cases, a trust instrument will require that the
trust's net income be distributed to the income beneficiaries,
who have the expectation, based on the UPIA model laws enacted
by California, that these distributions will continue to be
allocated to income. As such, the author asserts that "to now
allocate distributions to principal and deny income
beneficiaries those funds will, in some cases, cause undue
hardship for the income beneficiaries."
As noted by the author, it is necessary to enact this bill this
year before trustees mistakenly follow the new partial
liquidation guidelines and mistakenly allocate this year's net
short-term capital gain distributions to principal instead of
income.
Support : None Known
Opposition : None Known
HISTORY
Source : California Bankers Association
Related Pending Legislation : None Known
Prior Legislation :
AB 1029 (Maienschein, Ch. 105, Stats. 2013) See Background.
SB 296 (Campbell, Ch. 51, Stats. 2005) clarified that money is
received in partial liquidation if the total amount of money and
property received by all owners, collectively, in a distribution
or series of related distributions is greater than 20 percent of
the entity's gross assets.
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AB 846 (Ackerman, Ch. 145, Stats. 1999) See Background.
Prior Vote : Prior votes not relevant
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