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 of 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 14:59:00
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