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) ------------------------------------------------------------------------ |COMMITTEE VOTE: |9-0 |(August 12, 2014) |RECOMMENDATION: |concur | |(Jud.) | | | | | ------------------------------------------------------------------------ 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, which is allocated to principal, does not include money received from a regulated investment company or a REIT if the money distributed is a net short-term capital gain distribution. 2)Clarify that money received from a regulated investment company or a REIT, which is allocated to principal if the money distributed is a capital gain dividend for federal income tax purposes, does not include money distributed as a net short-term capital gain distribution. 3)Add an urgency clause, allowing this bill to take effect immediately upon enactment. EXISTING LAW : AB 296 Page 2 1)Establishes, through 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. 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 (such as a corporation, partnership, limited liability company, trust or real estate investment trust) as specified. 4)Requires a trustee to allocate to principal specified receipts from an entity. 5)Clarifies that money received by a trust from an entity is received in partial liquidation of the entity (and thus treated as principal and not income) to the extent the money is attributable to sale of a capital asset. Permits, in determining whether money is received in partial liquidation, a trustee to rely, without investigation, on a written statement from the distributing entity. Also allows a trustee to rely, again without investigation, on other information known by the trustee. 6)Provides that a trustee is not liable for an allocation between principal and interest done in accordance with the stated provisions. FISCAL EFFECT : None COMMENTS : California adopted the UPAIA in 2000. (AB 846 (Ackerman), Chapter 145, Statutes of 1999.) The UPAIA, together with the Uniform Prudent Investor Act, reconstituted the manner by which trusts are administered for the benefit of their beneficiaries. At the time it was adopted, the UPAIA was said to deal conservatively with the tension between modern investment theory and the traditional income allocation, and to help a trustee who has made a prudent, modern portfolio-based investment decision that has the initial effect of skewing return from all the assets under management, by giving the trustee the power to reallocate the portfolio return suitably as between principal and income beneficiaries. AB 296 Page 3 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. Whether money is characterized as principal or income determines who will get the benefit of the distribution - income to the income or life beneficiaries, principal to the remainder beneficiaries - and who will pay the taxes, and when. 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. 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, AB 296 Page 4 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." This bill is urgency legislation that will take effect immediately. The author states that it is necessary to enact this bill this year before trustees follow the new partial liquidation guidelines and mistakenly allocate this year's net short-term capital gain distributions to principal instead of income. Analysis Prepared by : Leora Gershenzon / JUD. / (916) 319-2334 FN: 0004528