BILL ANALYSIS                                                                                                                                                                                                    Ó




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          |SENATE RULES COMMITTEE            |                       SB 1265|
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                                      CONSENT 


          Bill No:  SB 1265
          Author:   Moorlach (R) 
          Introduced:2/18/16  
          Vote:     21 

           SENATE JUDICIARY COMMITTEE:  6-0, 5/3/16
           AYES:  Jackson, Moorlach, Anderson, Leno, Monning, Wieckowski
           NO VOTE RECORDED:  Hertzberg

           SUBJECT:   Marital deduction trusts


          SOURCE:   Executive Committee of the Trusts and Estates Section  
                    of the State Bar California

          DIGEST:  This bill updates provisions relating to marital  
          deduction trusts for cross-references to applicable federal laws  
          relating to qualified terminable interest property and provide  
          for a unitrust payment or other allocation of income determined  
          pursuant to a reasonable apportionment of total investment  
          return, as specified.

          ANALYSIS:  
          
          Existing law:

          1)Authorizes the value of the taxable estate to be determined by  
            deducting from the value of the gross estate an amount equal  
            to the value of any interest in property which passes or has  
            passed from the decedent to his surviving spouse, but only to  
            the extent that such interest is included in determining the  
            value of the gross estate, unless otherwise exempt as  
            specified, for purposes of tax imposed on property  
            transferrable from a decedent's estate.









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          2)Limits the application of the marital deduction in the case of  
            a life estate or other terminable interests.  

          3)Requires the formula to be applied to eliminate or to reduce  
            to the maximum extent possible the federal estate tax if an  
            instrument includes a formula intended to eliminate the  
            federal estate tax.  If an instrument includes a formula that  
            refers to a maximum fraction or amount that will not result in  
            a federal estate tax, the formula is construed to refer to the  
            maximum fraction or amount that will not result in or increase  
            the federal estate tax. 

          4)Defines "marital deduction" to mean the federal estate tax  
            deduction allowed for transfers, as specified, or the federal  
            gift tax deduction allowed for transfers, as specified.   
            Existing law also defines material deduction gift to mean a  
            transfer of property that is intended to qualify for the  
            material deduction. 

          5)Does not apply the marital deduction trust savings statute to  
            a trust that otherwise qualifies for the marital deduction  
            under federal law.

          6)Provides that if an instrument contains a marital deduction  
            gift:

                 the provisions of the instrument, including any power,  
               duty, or discretionary authority given to a fiduciary,  
               shall be construed to comply with the marital deduction  
               provisions of the Internal Revenue Code;
                 the fiduciary shall not take any action or have any  
               power that impairs the deduction as applied to the marital  
               deduction gift; and
                 the marital deduction gift may be satisfied only with  
               property that qualifies for the marital deduction.

          1)Provides that if a marital deduction gift is made in trust,  
            and does not otherwise qualify as a marital deduction trust  
            under federal law, each of the following provisions applies to  
            the marital deduction trust:

                 the transferor's spouse is the only beneficiary of  








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               income or principal of the marital deduction property as  
               long as the spouse is alive; however, this provision does  
               not preclude exercise by the transferor's spouse of a power  
               of appointment included in a trust that qualifies as a  
               general power of appointment marital deduction trust;
                 as specified, the transferor's spouse is entitled to all  
               of the income of the marital deduction property not less  
               frequently than annually, as long as the spouse is alive;
                 the transferor's spouse has the right to require that  
               the trustee of the trust make unproductive marital  
               deduction property productive or to convert it into  
               productive property within a reasonable time; and
                 notwithstanding the limitations on undistributed income  
               under the Uniform Principal and Income Act (UPIA), in the  
               case of qualified terminable interest property, as defined  
               under federal law, on termination of the interest of the  
               transferor's spouse in the trust, all of the remaining  
               accrued or undistributed income shall pass to the estate of  
               the transferor's spouse, unless the instrument provides a  
               different disposition that qualifies for the marital  
               deduction.  (Prob. Code Sec. 21524.)

          1)Requires a trust to be administered, as specified, with due  
            regard to the respective interests of defined income  
            beneficiaries and defined remainder beneficiaries.

          2)Defines "undistributed income" to mean net income received  
            before the date on which income interest ends; however, the  
            term does not include an item of income or expense that is due  
            or accrued or net income that has been added or is required to  
            be added to principal by the trust. 

          This bill:

          1)Requires the income from a marital deduction trust to which  
            the transferor's spouse is entitled to be construed in a  
            manner consistent with the federal limitations on life estate  
            or other terminable interest, as specified, and include a  
            unitrust payment or other allocation of income determined  
            pursuant to a reasonable apportionment of total investment  
            return that meets the requirements of federal laws and  
            regulations, as specified.








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          2)Deletes provisions made inoperative pursuant to changes in the  
            Internal Revenue Code.

          Background
          
          Although California does not currently have an estate tax,  
          current federal law imposes an estate tax on all the assets of  
          United States citizens and residents.  An estate tax at the rate  
          of 40 percent is assessed on the value of assets above the  
          estate exclusion ($5,340,000 for year 2014, indexed annually for  
          inflation).  Federal law allows a decedent's estate an unlimited  
          estate tax marital deduction for property that passes to a  
          surviving spouse.  Qualifying for the estate tax marital  
          deduction is a primary goal of many estate plans because that  
          qualification may reduce or eliminate the estate tax due on the  
          death of the first spouse, and defers payment of that tax, if at  
          all, until the death of the surviving spouse.  Gifts in trust  
          for the surviving spouse may qualify for the estate tax marital  
          deduction, subject to the requirements in federal tax  
          regulations. 

          Probate Code Section 21524 (marital deduction trust savings  
          statute) was enacted as a statutory backstop to marital  
          deduction trusts drafted under California law.  That statute  
          grafts the federal regulatory requirements onto marital  
          deduction trusts that may not otherwise qualify due to unartful  
          drafting.  The purpose of the statute is to rescue possibly  
          defective marital deduction trusts and ensure their  
          qualification for the federal estate tax marital deduction, and,  
          thereby, reduce or eliminate the estate tax on a decedent's  
          estate.  To accomplish this rescue mission, the marital  
          deduction trust savings statute should mirror the requirements  
          for marital deduction trusts in federal tax regulations. 

          Federal law regarding marital deduction gifts has changed in the  
          nearly 25 years since the enactment of the marital deduction  
          trust savings statute, without any substantive change to that  
          statute.  Two important changes have been made to federal tax  
          regulations in the interim:  (1) a revised definition of income  
          for a qualifying marital deduction trust that reflects modern  
          portfolio theory and investment approaches; and (2) evolving  








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          case law and government announcements regarding income of a  
          marital deduction trust that is accrued, but undistributed,  
          prior to the death of the surviving spouse. 

          Federal regulations now allow a marital deduction trust to pay a  
          unitrust amount, which may be less than actual net income, but  
          still qualify for the estate tax marital deduction.  This bill  
          updates the marital deduction trust savings statute in  
          accordance with federal tax laws and regulations.

          Comments
          
          The author writes:

            Probate Code [S]ection 21524 was originally enacted in  
            1990 as a savings clause.  If a marital trust in a  
            document fails to meet the federal requirements, perhaps  
            due to outdated or unartful drafting, [S]ection 21524 will  
            import those requirements and give the surviving spouse  
            this important tax benefit.

            Since 1990 changes in federal law have made qualification  
            for the [marital] trust more flexible.  This bill updates  
            Probate Code [S]ection 21524 for two changes in federal  
            law since the time of its enactment.  The first change is  
            to allow trusts that give the surviving spouse a unitrust  
            payment to qualify for the marital deduction.  The bill  
            makes a second technical change to conform [S]ection 21524  
            to existing federal law.  Subsection (d) regarding the  
            payment of undistributed income is deleted because it does  
            not reflect current federal estate tax law and the  
            California Principal and Income Act.  This change will  
            clarify the law and bring the statute up to date.

          A unitrust is a type of trust in which a fixed percentage of the  
          trust property is paid annually to the trust's income  
          beneficiary.  The California Uniform Principal and Income Act  
          (UPIA) provides trust accounting rules regarding distributions  
          of principal and income to trust beneficiaries and, among other  
          things, provides limitations on unitrust conversions and  
          payouts.  (Prob. Code Sec. 16320 et seq.)  Under California's  
          marital deduction trust savings statute, the surviving spouse is  








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          entitled to all of the income of the marital deduction property  
          transferred from the deceased spouse at least once a year.   
          (Prob. Code Sec. 21524(b).)  This bill would define "income" to  
          include a unitrust payment or other allocation of income  
          determined pursuant to a reasonable apportionment of total  
          investment return, as specified, and require the income to be  
          construed in a manner consistent with federal law, as specified.

          As noted by the author, Treasury Regulation Section  
          20.2056(b)-5(f) defines when the surviving spouse is deemed to  
          be entitled to the entire income of a trust, thereby qualifying  
          that trust or interest in a trust for the estate tax marital  
          deduction.  The author further notes that regulation was  
          modified on January 2, 2004, by Treasury Decision 9102 to  
          reflect changes in the definition of trust accounting income  
          under state laws, and the concurrent change in federal income  
          tax law under Internal Revenue Code Section 643 and applicable  
          federal regulations.  That modified regulation allows the income  
          payment determined under the trustee's adjustment power or a  
          unitrust payment to qualify as a marital deduction gift.

          Existing law, with respect to qualified terminable interest  
          property and subject to limitations on undistributed income  
          under the UPIA, requires all of the remaining accrued or  
          undistributed income to pass to the surviving spouse's estate,  
          unless the transferring spouse's testamentary instrument  
          provided for a different disposition that qualifies for the  
          marital deduction.  This bill repeals those provisions.

          A qualified terminable interest property trust (QTIP trust) is  
          one established by the transferring spouse for the benefit of  
          beneficiaries (other than the surviving spouse) to receive  
          assets from a marital deduction trust after the surviving spouse  
          dies.  An example of the use of a QTIP trust is where the  
          transferor spouse is married to a second spouse, who is the  
          surviving spouse.  The transferor spouse had children from his  
          or her first marriage.  The transferor spouse wants to provide  
          for the surviving spouse, as well as the transferor's children  
          from the first marriage.  The transferor spouse establishes a  
          marital deduction trust for the benefit of the surviving spouse  
          until his or her death, at which time the assets in the marital  
          deduction trust are transferred to a QTIP trust for the benefit  








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          of the children.

          Related/Prior Legislation
          
          AB 846 (Ackerman, Chapter 145, Statutes of 1999) enacted the  
          Uniform Principal and Income Act, and, among other things,  
          revised the cross-reference to the new Act under the marital  
          deduction trust savings statute.

          AB 759 (Friedman, Chapter 79, Statutes of 1990) revised and  
          recast the Probate Code, and, among other things, continued the  
          marital deduction gifts and trust provisions under prior law.


          FISCAL EFFECT:   Appropriation:    No          Fiscal  
          Com.:NoLocal:    No


          SUPPORT:   (Verified5/5/16)


          Executive Committee of the Trusts and Estates Section of the  
            State Bar of California (source)


          OPPOSITION:   (Verified5/5/16)


          None received


          ARGUMENTS IN SUPPORT:     The Executive Committee of the Trusts  
          and Estates Section of the State Bar (TEXCOM), sponsor, contends  
          that since the original intent of the marital deduction trust  
          savings statute appears to be to preserve the marital deduction,  
          it should mirror the definition of income in current federal tax  
          regulations.  The marital deduction trust savings statute  
          currently provides a default rule that a trustee must distribute  
          all of the income, without reference to unitrust payments.   
          TEXCOM asserts that without specific reference to unitrust  
          payments, "income" under the existing statute may be construed  
          in accordance with the definition of income in Probate Code  








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          Section 16324, or traditional notions of income.  Accordingly,  
          this bill, by incorporating unitrust payments and other  
          allocations of income into the meaning of "income" under the  
          marital deduction trust savings statute, seeks to harmonize the  
          savings statute with current federal tax regulations and the  
          UPIA.



          Prepared by:Margie Estrada / JUD. / (916) 651-4113
          5/6/16 14:26:31


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