BILL ANALYSIS Ó
AB 1029
Page 1
Date of Hearing: April 23, 2013
ASSEMBLY COMMITTEE ON JUDICIARY
Bob Wieckowski, Chair
AB 1029 (Maienschein) - As Amended: April 18, 2013
PROPOSED CONSENT
SUBJECT : Trust Distributions: Allocations to Principal or
Income
KEY ISSUE : IN ORDER TO INCREASE THE LIKELIHOOD OF A JUST
OUTCOME, SHOULD THE RULES FOR MAKING A TRUST ALLOCATION BETWEEN
PRINCIPAL AND INTEREST BE REVISED?
FISCAL EFFECT : As currently in print this bill is keyed
non-fiscal.
SYNOPSIS
This non-controversial bill, sponsored by the Trust and Estates
Section of the State Bar, deals with the characterization of
money, whether principal or interest, received by a trust from a
business entity. 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 when, and who, will pay the taxes.
This bill establishes new rules for determining when an
allocation of money received by a trust is attributable to the
sale of a capital asset and thus allocated to principal and when
the allocation is attributable to income. This bill also helps
ensure that trustees can use information they may have to
appropriately allocate between principal and income. The author
and sponsor believe that this bill adds greater clarity and
fairness to the categorization of assets received from a
business entity and, in the absence of information, provides an
improved bright line test to follow. There is no reported
opposition to the bill.
SUMMARY : Clarifies how a distribution to a trust is allocated
between income and principal. Specifically, this bill :
1)Clarifies that money received by a trust from an entity (such
as a corporation, partnership, limited liability company,
trust or real estate investment trust) is received in partial
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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.
2)In determining whether money is received in partial
liquidation, permits 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.
3)If no written information is received from the distributing
entity, as provided, and the trustee has no actual knowledge,
provides that the trustee has no duty to inquire or
investigate whether the money received is in partial
liquidation of the entity. Provides that if a receipt is in
excess of 10 percent of the trust's net interest in the
entity, as defined, the receipt is deemed to be in partial
liquidation of the entity. Provides rules for determining the
value of the trust's interest in the distributing entity to
determine if a receipt is in excess of 10 percent of the
trust's interest in the entity.
4)Provides that a trustee is not liable for an allocation
between principal and interest done in accordance with the
provisions of this bill.
EXISTING LAW :
1)Establishes, through the Uniform Principal and Income Act,
rules for the management by a trustee of assets held by the
trust for the benefit of the trust beneficiaries. (Probate
Code Section 16320 et seq.)
2)Provides that money received in total or partial liquidation
of an entity shall be allocated by the trustee to principal.
Provides that if the total amount of money received by all
owners from a distribution or a series of related
distributions by an entity is greater than 20 percent of the
entity's gross assets, it is received in partial liquidation
of the entity and must be allocated to principal. (Probate
Code Section 16350.)
3)Permits a trustee to rely on a statement made by a
distributing entity that indicates that the distribution is in
partial liquidation of the entity, as provided. (Id.)
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COMMENTS : California adopted the Uniform Principal and Income
Act (UPAIA) in 2000. (AB 846 (Ackerman), Chap. 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. 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.
This bill, sponsored by the Trusts and Estates Section of the
State Bar, deals with the characterization of money, whether
principal or interest, received by a trust from an entity (such
as a corporation or partnership). 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
when, and who, will pay the taxes.
Current law provides that money received by a trust is deemed to
be in partial liquidation of an entity - and thus allocated to
principal and the remainder beneficiaries - if either (1) the
distributing entity indicates that the distribution is in
partial liquidation, or (2) the total amount of money received
by all owners from a distribution or a series of related
distributions is greater than 20 percent of the entity's gross
assets. According to the author, these rules "can lead to
inconsistent and arguably unfair results."
Case law demonstrates need for the bill . The need for this bill
is best exemplified, according to the sponsor, by a 2007 case.
In Hasso v. Hasso (2007) 148 Cal.App.4th 329, an entity
distributed millions of dollars to a trust and advised that the
distribution represented return of capital and that most of the
distribution would result in capital gains. However, this
characterization did not specifically mention that the
distribution was the result of a "partial liquidation." Thus,
the appellate court concluded that under the first test as to
whether a distribution was in partial liquidation, the
distribution did not qualify as a partial distribution. The
appellate court then determined that the entity's distribution
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to all owners was not more than 20 percent of its gross assets.
This was particularly true since the distributing entity was
very highly leveraged. Thus while the distribution might
represent more than 20 percent of the entity's net value, it was
not more than 20 percent of its gross value. As a result, the
distribution was treated as income and went entirely to the
income beneficiary and not the remainder beneficiaries.
While not changing the results in this case, this bill would
change the result in future cases in two ways. First, it would
loosen the language regarding what a business entity has to call
a distribution from the precise language of "partial
liquidation" to "a written statement made by the distributing
entity regarding the receipt." This would help ensure that even
if the exact words "partial liquidation" are not used, money can
still be characterized as that if it truly is. Second the bill
changes the standard from 20 percent of the entity's gross value
to 10 percent of the trust's net interest in the entity. The
author and sponsor believe that this new test better captures
distributions that constitute a return of the trust's underlying
investment in the business entity.
Allows a trustee to rely on actual knowledge in making an
allocation . The bill also allows the trustee to rely on
information actually known to the trustee concerning
characterization of a distribution. While the trustee has no
duty to inquire or investigate, this provision allows the
trustee to rely on actual knowledge in making the
characterization. Since the trustee is a fiduciary, the trustee
retains his or her fiduciary duty to make reasonable decisions
for the trust beneficiaries and not to rely on unreasonable
information when making the characterization.
Bill protects a trustee who follows the rules . This bill
specifically states that a trustee is not liable for any claim
of improper allocation between principal and interest if the
trustee, at the time of allocation, allocates a receipt to
principal in accordance with the terms of the bill, or allocates
a receipt to income because it is not determined to be in
partial liquidation under the bill. This provision reasonably
protects trustees who correctly follow the statutory scheme.
REGISTERED SUPPORT / OPPOSITION :
Support
AB 1029
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Trusts & Estates Section of the State Bar (sponsor)
Opposition
None on file
Analysis Prepared by : Leora Gershenzon / JUD. / (916) 319-2334