BILL ANALYSIS Ó AB 296 Page 1 CONCURRENCE IN SENATE AMENDMENTS AB 296 (Wagner) As Amended June 15, 2014 2/3 vote. Urgency ----------------------------------------------------------------- |ASSEMBLY: | |(May 20, 2013) |SENATE: |36-0 |(June 30, | | | | | | |2014) | ----------------------------------------------------------------- (vote not relevant) Original Committee Reference: JUD. SUMMARY : 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 (REIT). The Senate amendments delete the Assembly version of this bill, and instead: 1)Clarify that money received in total or partial liquidation of an entity, as defined, that a trustee is required to allocate to principal does not include money received from an entity that is a regulated investment company or a REIT if the money distributed is a net short-term capital gain distribution. 2)Clarify that a trustee must allocate to principal money received from an entity that is a regulated investment company or a REIT if the money distributed is a capital gain dividend for federal income tax purposes, but that does not include money that is distributed as a net short-term capital gain distribution. EXISTING LAW : 1)Establishes, under the Uniform Principal and Income Act (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. 2)Requires the trustee, when allocating receipts and AB 296 Page 2 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)Proscribes the specified guidelines to determine whether money is received in partial liquidation. Provides that, when determining whether money received was in partial liquidation of an 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. 4)Provides that, if a trustee allocates a receipt to principal using the specified 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. 5)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. 6)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. FISCAL EFFECT : None COMMENTS : 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), Chapter 145). 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 AB 296 Page 3 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 that money determines who receives the benefit of that money and when and who has to pay taxes on that money. An allocation to income generally benefits the trust's life beneficiaries, while an allocation to principal generally benefits the remainder beneficiaries. Current 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. Last year's 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, the author argues that an ambiguity now exists with respect to the characterization of a net short-term capital gain distribution from a mutual fund or a 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 clarifies that ambiguity and provides 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. 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 AB 296 Page 4 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 REIT should be allocated to principal or income. This bill clarifies that the new partial liquidation guidelines do not apply to net short-term capital gain distributions. Accordingly, these distributions would be allocated to income. The author notes that "of the 46 states and District of Columbia that have enacted the UPAIA, 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 UPAIA. 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 UPAIA 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." Analysis Prepared by : Leora Gershenzon / JUD. / (916) 319-2334 FN: 0004138