BILL ANALYSIS Ó
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2013-2014 Regular Session
AB 1029 (Maienschein)
As Amended May 24, 2013
Hearing Date: June 4, 2013
Fiscal: No
Urgency: No
TMW
SUBJECT
Trusts and Estates: Allocations of Receipts
DESCRIPTION
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.
This bill would clarify how the partial liquidation exception is
to be determined and the information on which the trustee may
rely regarding that determination.
This bill would also provide an immunity from liability for a
trustee who makes an improper allocation in reliance on the
proposed methods to determine whether or not the money received
by an entity is a partial liquidation.
BACKGROUND
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, Ch. 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 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 as between principal
(more)
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and income beneficiaries.
Under the UPAIA, a trustee is required to allocate money
received from an entity (i.e., corporation, partnership, limited
liability company, regulated investment company, real estate
investment trust, or common trust fund) 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 and 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.
This bill, sponsored by the Trusts and Estates Section of the
State Bar of California, would clarify how a partial liquidation
is to be determined and allocated by the trustee.
CHANGES TO EXISTING LAW
Existing law , the Uniform Principal and Income Act (UPAIA),
establishes 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. (Prob. Code Sec. 16320 et seq.)
Existing law 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. (Prob. Code Sec.
16335.)
Existing law requires a trustee to allocate to income money
received from an entity unless the money received may be
characterized as one of the following:
property other than money;
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;
money received in total or partial liquidation of the entity;
or
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.
If the money falls under one of the above exceptions, then the
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trustee is required to allocate the money to principal. (Prob.
Code Sec. 16350(b), (c).)
Existing law defines money received in partial liquidation to
mean money received to the extent that the entity, at or near
the time of a distribution, indicates that it is a distribution
in partial liquidation or if the total amount of money and
property received by all owners, collectively, in a distribution
or series of related distributions is greater than 20 percent of
the entity's gross assets, as shown by the entity's yearend
financial statements immediately preceding the initial receipt.
However, money is not received in partial liquidation, nor may
it be taken into account under this provision, 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. (Prob. Code Sec.
16350(d)(1), (2).)
Existing law provides that if the receipt was allocated between
December 2, 2004 and July 18, 2005, the trustee is not 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, exceeds 20 percent of the entity's
gross assets, but the amount received by the trustee does not
exceed 20 percent of the entity's gross assets. (Prob. Code
Sec. 16350(d)(1).)
Existing law authorizes the trustee to rely on a statement made
by an entity about the source or character of a distribution if
the statement is made at or near the time of distribution by the
entity's board of directors or other person or group of persons
authorized to exercise powers to pay money or transfer property
comparable to those of a corporation's board of directors.
(Prob. Code Sec. 16350(e).)
Existing federal law defines "capital asset" to mean property
held by a taxpayer (whether or not connected with his 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. (26 U.S.C. Sec. 1221.)
This bill would delete the existing definition of money received
in partial liquidation of an entity and instead provide that
money will be treated as received in partial liquidation to the
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extent the amount received from the distributing entity is
attributable to proceeds from a sale by the distributing entity,
or by the distributing entity's subsidiary or affiliate, of a
capital asset.
This bill would define "capital asset" to mean a capital asset
defined by the above federal law.
This bill would authorize the trustee, when determining whether
money is received in partial liquidation, to rely without
investigation on a written statement made by the distributing
entity regarding the receipt, or on other information actually
known by the trustee regarding whether the receipt is
attributable to the proceeds from a sale by the distributing
entity, subsidiary, or affiliate, of a capital asset.
This bill would provide that if, within 30 days from the date of
the receipt, the distributing entity does not provide a written
statement to the trustee that the receipt is a distribution
attributable to the proceeds from a sale of a capital asset by
the distributing entity, subsidiary, or affiliate, and the
trustee has no actual knowledge that the receipt is a
distribution attributable to the proceeds from a sale of a
capital asset, then the trustee would not be required to
investigate whether the receipt from the distributing entity is
in partial liquidation of the entity. However, if on the date
of receipt, the receipt from the distributing entity is in
excess of 10 percent of the value of the trust's interest in the
distributing entity, then the receipt would be deemed to be
received in partial liquidation of the distributing entity, and
the trustee would be required to allocate all of the receipt to
principal.
This bill would require the trustee, if applicable, to apply one
of the following methods to determine the value of the trust's
interest in the distributing entity:
in the case of an interest that is a security regularly traded
on a public exchange or market, the closing price of the
security on the public exchange or market occurring on the
last business day before the date of the receipt;
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 actually received by
the trustee and prepared by a professional appraiser with a
valuation date within three years of the date of the receipt;
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if the trust's interest in the distributing entity cannot
otherwise be valued, the trust's proportionate share of the
distributing entity's net assets (gross assets minus
liabilities) as shown in the distributing entity's yearend
financial statements immediately preceding the receipt; or
if the trust's interest in the distributing entity cannot be
valued pursuant to the above provisions, the federal cost
basis of the trust's interest in the distributing entity on
the date immediately before the date of the receipt.
This bill would provide that the trustee has no duty to
investigate the existence of the appraisal or to obtain an
appraisal nor shall the trustee have any liability for relying
upon an appraisal prepared by a professional appraiser.
This bill would define "professional appraiser" to mean an
appraiser who has earned an appraisal designation for valuing
the type of property subject to the appraisal from a recognized
professional appraiser organization.
This bill would provide that if a trustee allocates a receipt to
principal in accordance with the above procedures for
determining a partial liquidation or allocates a receipt to
income because the receipt is not determined to be in partial
liquidation, then the trustee would 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.
This bill would also make technical and conforming revisions to
the above provisions.
COMMENT
1. Stated need for the bill
The author writes:
This bill would bring greater clarity and fairness to the
categorization of amounts received from business entities as
between principal and income. This bill seeks to achieve this
by permitting the trustee to act on facts concerning
distributions actually known to the trustee, and by providing
an improved bright line test that would operate in the absence
of the trustee having any information about the character of a
receipt. This bill would also provide protection from
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liability to trustees who rely on [Probate Code] Section 16350
to make allocations of income and principal.
2. Determination of partial liquidation receipts
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
principal. Existing law provides that money received by the
trustee is a partial liquidation if: (1) the distributing
entity indicates it is a distribution in partial liquidation
(the entity indication exception); or (2) if the total amount of
money and property received by all owners, collectively, in a
distribution or series of related distributions is greater than
20 percent of the entity's gross assets (the 20 percent
exception), as shown by the entity's yearend financial
statements immediately preceding the initial receipt. (Prob.
Code Sec. 16350(d)(1).) The author argues that two recent cases
demonstrate the need to clarify the methods to be used by a
trustee to properly determine when money received from an entity
is a partial liquidation.
a. Twenty percent exception
In the first case, Hasso v. Hasso (2007) 148 Cal.App.4th 329,
the issue raised was whether money received by a trust, as a
shareholder, from an entity constituted a partial liquidation
either based on whether information received from the entity
constituted an "indication" that the money was a partial
liquidation, or whether the money distributed by the entity to
all shareholders was more than 20 percent of the gross assets
of the entity.
With respect to the 20 percent exception, the Hasso court
analyzed which of the two numbers of gross assets indicated on
the yearend financial statement should be used as the
denominator of the distribution amount. The court held that
the "special purpose" gross assets number was not the correct
denominator as asserted by the principal beneficiaries. (Id.
at p. 339.) Accordingly, using the larger gross assets number
on the yearend financial statement, the distribution was less
than 20 percent of the total gross assets, so the distribution
would be allocated to income.
The author argues that Hasso demonstrates that using gross
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assets for the 20 percent exception is an inaccurate method of
measuring value because the entity may be highly leveraged
with debt. Presumably, the concept of "partial liquidation"
was meant to capture distributions that returned a portion of
the capital or principal of a trust's investment in an entity,
as opposed to distributions that constitute interest or
dividends received on that underlying investment. The author
asserts that utilizing a net assets valuation test would more
closely track this intention.
The author provides the following example of when the current
20 percent exception, based on gross assets, produces
different results in situations which are relatively the same.
The A Trust owns 20 parcels of real property, all of equal
value. The B Trust owns the same identical properties,
except that the settlor transferred the 20 real properties
into a family limited partnership, so that the trust only
owns an interest in the partnership rather than direct
ownership of the real properties. During 2006 the A Trust
sells two parcels; the proceeds are properly allocated to
principal. In the same year the B Trust sells two
properties. If the partnership then distributes the sale
proceeds to Trust B, under [Probate Code Section] 16350 the
distributions of the sale proceeds must be allocated to
income because the distributions are less than 20 [percent]
of the value of the family limited partnership's gross
assets.
This bill would change the existing 20 percent exception (the
total money and property received by all owners, collectively,
is greater than 20 percent of the entity's gross assets) to a
10 percent exception (the receipt is greater than 10 percent
of the value of the trust's interest), in order to arrive at
the proper value of the assets that a portion of which has
been distributed to shareholders. To determine the value of
the trust's interest, this bill would require the trustee to
apply one of the following methods:
in the case of an interest that is a security regularly
traded on a public exchange or market, the closing price of
the security on the public exchange or market occurring on
the last business day before the date of the receipt;
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
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distributing entity as set forth in the most recent
appraisal actually received by the trustee and prepared by
a professional appraiser with a valuation date within three
years of the date of the receipt;
if the trust's interest in the distributing entity
cannot otherwise be valued, the trust's proportionate share
of the distributing entity's net assets (gross assets minus
liabilities) as shown in the distributing entity's yearend
financial statements immediately preceding the receipt; or
if the trust's interest in the distributing entity
cannot be valued pursuant to the above provisions, the
federal cost basis of the trust's interest in the
distributing entity on the date immediately before the date
of the receipt.
By providing specified methods for determining the value of
the distribution, this bill would provide clarity in order to
properly characterize the distribution as a partial
liquidation.
a. Entity indication exception
The Hasso court next analyzed whether the "entity indication
exception" applied to the money received by the trustee. The
Hasso court noted that the California Law Revision Commission
comment on the partial liquidation exception "implies at least
some degree of specificity is necessary to advise the
shareholders the entity is being partially liquidated. (Hasso
v. Hasso, supra, 148 Cal.App.4th at p. 340.) Having found no
degree of specificity that the distribution was a partial
liquidation, the court held that the entity's announcement
that it was selling its stock in an affiliate did not
constitute a sufficient indication that the money received
from the sale was a partial liquidation. (Id.)
On the other hand, in Manson v. Shepherd (2010) 188
Cal.App.4th 1244, the information provided by the distributing
entity was a resolution indicating that the distribution was
paid out as a dividend, and, as argued by the
trustee/surviving spouse, there was no indication given by the
entity that the distribution was a partial liquidation. In
analyzing the Hasso holding requiring some degree of
specificity to advise the trust that the distribution is a
partial liquidation, the Manson court determined that the
partial liquidation exception to principal allocation does not
rely on an express statement by the entity that the
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distribution is a partial liquidation, and will apply "where
the entity has made known in some manner that the distribution
to a trust was the result of the entity selling an asset or
assets in order to achieve a better cash position, and not to
terminate the business." (Id. at pp. 1263-64.) Instead of
only relying on the resolution, the court held that the
entity's indication of partial liquidation was implied based
on the board minutes documenting the entity's board meeting,
which the trustee attended as the board of directors and
therefore had personal knowledge of the entity's distribution
strategy of selling assets to achieve a better cash position.
(Id. at p.1265-66.)
To provide for either information received from the entity or
the trustee's actual knowledge of the characterization of the
money received as being a partial liquidation of the entity,
this bill would delete the entity indication exception and
instead provide that the trustee may rely on a written
statement made by the distributing entity or rely on
information actually known by the trustee regarding the
receipt. In this way, both of the Hasso and Manson decisions
are incorporated so that either a statement or actual
knowledge of the trustee may be used to identify a
distribution as a partial liquidation. In addition to the
written statement and actual knowledge methods of determining
a partial liquidation, this bill would also provide for
instances when no statement is received by the trustee within
30 days of receipt of the distribution, in which cases the
trustee would defer to the 10 percent exception described
above.
3. Immunity from liability
This bill would provide that if a trustee allocates a receipt to
principal in accordance with the above procedures for
determining a partial liquidation or allocates a receipt to
income because the receipt is not determined to be in partial
liquidation, then the trustee would 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.
The author argues that this provision "gives the trustee
protection from liability based upon subsequently discovered
information. The trustee is only responsible for making the
allocation based on information available at the time when the
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allocation is made." This bill provides for instances when the
entity expressly characterizes the distribution as a partial
liquidation, but also provides protection to income and
principal beneficiaries when a trustee has personal information,
not found in the written statement, as to the proper
characterization of the distribution. This bill further
provides for methods to calculate the trust's interest in the
distribution in order to arrive at the appropriate
characterization of the distribution. As such, the trustee is
required to exhaust all possibilities of characterizing the
money received. Having exhausted all other possibilities, it is
arguably appropriate to provide immunity protection to the
trustee who allocates the distribution incorrectly based on
information that subsequently changes through no fault of the
trustee.
Furthermore, the sponsor, Trusts and Estates Section of the
State Bar of California (TEXCOM), states that the intent of this
bill is to encourage trustees to allocate money received from
the entity rather than holding on to the distribution, waiting
for a year or more for information to be sent to the trustee
upon which the trustee may utilize as specified under existing
law. In furtherance of this purpose, the immunity conferred in
this bill would provide trustees with a limited protection for
allocating a receipt in reliance on the information and
knowledge provided under this bill. However, this immunity is
limited to those instances when the trustee has utilized the
information received from the entity or known to the trustee and
the methods provided in this bill, the trustee has allocated
accordingly, but subsequently, it is discovered that the
allocation was improper because the trustee did not have the
information or knowledge that was later discovered that properly
characterized the money. For trustees who allocate the money
improperly and do so in bad faith, existing probate provisions
regarding the trustee's breach of duties (i.e., duty of
impartiality, conflict of interest, loyalty, and standard of
care) to the beneficiaries would apply. This immunity language
does not specifically require the trustee to act in "good faith"
when making the allocation because, arguably, inserting a good
faith standard would potentially weaken the higher level of duty
that exists concurrently with other probate statutes.
It is important to note that recent amendments, taken at the
request of the California Bankers Association, include a request
by staff to strike the relief of the duty of the trustee to
inquire about the proper characterization of the distribution.
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Although the trustee should not be required to investigate into
the entity's strategy or reasoning behind making the
distribution, the trustee is in the best position to discover
that information necessary for the trustee to make the
allocation may have not be sent by the entity. In these
instances, it could be appropriate for the trustee to make an
inquiry of the entity as to whether the entity considered the
distribution to be a partial liquidation of the entity's assets.
Support : None Known
Opposition : None Known
HISTORY
Source : Trusts and Estates Section of the State Bar of
California
Related Pending Legislation : None Known
Prior Legislation : SB 296 (Campbell, Ch. 51, Stats. 2005)
clarified that money is received in partial liquidation if the
total amount of money and property received by all owners,
collectively, in a distribution or series of related
distributions is greater than 20 percent of the entity's gross
assets.
Prior Vote :
Assembly Committee on Judiciary (Ayes 10, Noes 0)
Assembly Floor (Ayes 77, Noes 0)
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