BILL ANALYSIS Ó ----------------------------------------------------------------- |SENATE RULES COMMITTEE | AB 296| |Office of Senate Floor Analyses | | |1020 N Street, Suite 524 | | |(916) 651-1520 Fax: (916) | | |327-4478 | | ----------------------------------------------------------------- THIRD READING Bill No: AB 296 Author: Wagner (R) Amended: 6/15/14 in Senate Vote: 27 - Urgency SENATE JUDICIARY COMMITTEE : 7-0, 6/24/14 AYES: Jackson, Anderson, Corbett, Lara, Leno, Monning, Vidak ASSEMBLY FLOOR : 73-0, 5/20/13 - See last page for vote SUBJECT : Trusts SOURCE : California Bankers Association DIGEST : This bill provides 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 also clarifies an ambiguity in the Uniform Principal and Income Act (UPAIA). ANALYSIS : Existing law: 1.Establishes, under the UPAIA, 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. CONTINUED AB 296 Page 2 2.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. 3.Requires a trustee to allocate to income money received from an entity. 4.Requires a trustee to allocate to principal the following receipts from an entity: A. Property other than money; B. 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; C. Money received in total liquidation of the entity or in partial liquidation of the entity, as defined; and D. 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. 1.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. 2.Prescribes guidelines to determine whether money is received in partial liquidation. 3.Provides that the value of the trust's interest in the distributing entity is determined as follows: A. In the case of an interest that is a security regularly traded on a public exchange or market, the closing price of CONTINUED AB 296 Page 3 the security on the public exchange or market occurring on the last business day before the date of the receipt; B. 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; C. 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 D. 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. 1.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. 2.Provides that, if the receipt was allocated between 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% of the entity's gross assets, but the amount received by the trustee did not exceed 20% of the entity's gross assets. 3.Provides that money is not received in partial liquidation, CONTINUED AB 296 Page 4 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. 4.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. 5.Defines "capital asset" to mean property held by a taxpayer (whether or not connected with his/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. This bill: 1.Clarifies 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. 2.Clarifies 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. Background Upon recommendation of the California Law Revision Commission, the Legislature adopted the new UPAIA in 1999 (AB 846, Ackerman, Chapter 145). The UPAIA, together with the Uniform Prudent Investor Act, reconstituted the manner by which trusts are CONTINUED AB 296 Page 5 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) 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, Chapter 105, Statutes of 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. FISCAL EFFECT : Appropriation: No Fiscal Com.: No Local: No SUPPORT : (Verified 6/26/14) California Bankers Association (source) CONTINUED AB 296 Page 6 ARGUMENTS IN SUPPORT : According to the Senate Judiciary Committee analysis of 6/24/14, 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." ASSEMBLY FLOOR : 73-0, 5/20/13 AYES: Achadjian, Alejo, Allen, Ammiano, Atkins, Bigelow, Bloom, Blumenfield, Bocanegra, Bonilla, Bonta, Bradford, Brown, Buchanan, Ian Calderon, Campos, Chau, Chávez, Chesbro, Conway, Cooley, Dahle, Daly, Dickinson, Donnelly, Eggman, Fong, Fox, Frazier, Beth Gaines, Garcia, Gatto, Gomez, Gordon, Gorell, Grove, Hagman, Harkey, Roger Hernández, Jones, Levine, Linder, Lowenthal, Maienschein, Mansoor, Medina, Melendez, Mitchell, Morrell, Mullin, Muratsuchi, Nazarian, Nestande, Olsen, Pan, Patterson, Perea, V. Manuel Pérez, Quirk, Quirk-Silva, Rendon, Salas, Skinner, Stone, Ting, Wagner, Waldron, Weber, Wieckowski, Wilk, Williams, Yamada, John A. Pérez NO VOTE RECORDED: Gray, Hall, Holden, Jones-Sawyer, Logue, Vacancy, Vacancy AL:e 6/26/14 Senate Floor Analyses SUPPORT/OPPOSITION: SEE ABOVE **** END **** CONTINUED AB 296 Page 7 CONTINUED