BILL ANALYSIS                                                                                                                                                                                                    Ó



                                                                  AB 296
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          CONCURRENCE IN SENATE AMENDMENTS
          AB 296 (Wagner)
          As Amended June 15, 2014
          2/3 vote.  Urgency 
           
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          |ASSEMBLY:  |     |(May 20, 2013)  |SENATE: |36-0 |(June 30,      |
          |           |     |                |        |     |2014)          |
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               (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  








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            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  








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          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  








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          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 


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