BILL ANALYSIS Ó
SB 1265
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Date of Hearing: June 28, 2016
ASSEMBLY COMMITTEE ON JUDICIARY
Mark Stone, Chair
SB
1265 (Moorlach) - As Introduced February 18, 2016
PROPOSED CONSENT
SENATE VOTE: 38-0
SUBJECT: MARITAL DEDUCTION TRUSTS
KEY ISSUE: IN ORDER TO BETTER PROTECT DECEDENTS AND THEIR
SURVIVING FAMILIES FROM POTENTIAL TAX LIABILITY ASSOCIATED WITH
INARTFUL DRAFTING OF ESTATE PLANS, SHOULD THE MARITAL DEDUCTION
TRUSTS SAVING STATUTE BE UPDATED to be CONSISTENT WITH FEDERAL
LAW?
SYNOPSIS
This non-controversial and technical bill updates provisions
relating to marital deduction trusts savings statute by updating
its references to federal law and deleting outdated provisions
limiting a qualified terminable interest property trust. This
bill is sponsored by the Executive Committee of the Trust and
Estates Section of the State Bar of California (TEXCOM) and has
no opposition on file.
SB 1265
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SUMMARY: Updates the marital deduction trusts savings statute
to reflect definitions used under federal law. Specifically,
this bill:
1)Provides that the term income shall be construed in a manner
consistent with subdivision (b) of Section 2056 and
subdivision (f) of Section 2523 of the Internal Revenue Code,
and shall include a unitrust payment or other allocation of
income determined pursuant to a reasonable apportionment of
total investment return that meets the requirements of Section
643 of the Internal Revenue Code and the regulations adopted
pursuant to that statute.
2)Deletes provisions relating to qualified terminable interest
property that specify that 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.
EXISTING LAW:
1)Defines a marital deduction to mean the federal estate tax
deduction allowed for transfers under Section 2056 of the
Internal Revenue Code or the federal gift deduction allowed
for transfers under Section 2523 of the Internal Revenue Code.
(Probate Code Section 21520. Unless otherwise stated, all
further statutory references are to the Probate Code.)
2)Defines a marital deduction gift as a transfer of property
that is intended to qualify for the unlimited federal estate
tax deduction or the federal gift tax deduction, as provided.
(Ibid.)
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3)Provides that if a marital deduction is made in trust, the
following must apply:
a) The transferor's spouse is the only beneficiary of
income or principal of the marital deduction property as
long as the spouse is alive. Further provides that nothing
in this requirement precludes 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.
b) 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 except as
otherwise provided.
c) The transferor's spouse has the right to require that
the trustee make unproductive marital deduction productive
or to convert it into productive property within a
reasonable time. (Section 21524.)
4)Requires a trustee to administer the trust according to the
trust or as provided by law unless the trust provides
otherwise. (Section 16000.)
5)Requires the trustee to administer the trust with reasonable
care, skill, and caution under the circumstances then
prevailing that a prudent person acting in a like capacity
would use in the conduct of an enterprise as provided.
(Section 16040.)
6)Provides that a trustee, in making and implementing investment
decisions, has a duty to diversify the investments of the
trust unless under the circumstances it is prudent not to do
so. (Section 16048.)
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FISCAL EFFECT: As currently in print this bill is keyed
non-fiscal.
COMMENTS: When it comes to estate planning, federal tax law has
a significant impact in how a decedent may transfer his or her
property. A decedent seeking to minimize estate taxes on his or
her gross estate upon death might consult an estate planner to
maximize appropriate exclusions, deductions, and other
calculations. In the other words: the lower the taxable estate,
the lower the estate tax. Although California does not have an
estate tax, federal law imposes an estate tax if a decedent's
gross estate is valued at more than the established filing
threshold for the year of the decedent's death. The filing
threshold for 2016 is $5,450,000.
The federal marital deduction can be used to shield a decedent's
estate from tax liability. Commonly, a decedent who is married
can reduce his or her gross estate by relying upon the marital
deduction under federal law. The marital deduction, which is
currently unlimited, allows a decedent to transfer all of his or
her property to a surviving spouse without being immediately
subject to wealth transfer taxes; generally, the estate tax is
deferred until the death of the surviving spouse if any tax is
applied at all. The policy reason behind this deduction is
"based on the idea that transfers between spouses should not be
subject to tax because spouses are considered one economic
unit." (See Dukeminier & Sitkoff, Wills, Trusts, and Estates
Trust (9th ed. 2013) p. 959.)
Depending on the intent of the decedent, different trusts may be
created. Since California is a community property state, joint
trusts are common. According the sponsor, it is also common for
a joint trust to have various subtrusts to help manage the
assets upon the death of one of the spouses. To maximize the
federal marital deduction benefit described above, a joint trust
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may include a marital deduction trust as a subtrust.
Practically speaking, upon death of the decedent, the decedent's
property in the joint trust is divided, and the marital
deduction gift flows to a marital deduction trust,
where-depending on the type of marital deduction trust-income
and/or principal may be distributed to support the surviving
spouse during his or her life. One of the most common marital
deduction trusts is a qualified terminable interest property
trust (QTIP). Under a QTIP trust, income is paid to the
surviving spouse for life and any remainder is directed to the
other beneficiaries.
To protect decedents from problems arising out of inartful
estate drafting, California has enacted a backstop to federal
law for marital deduction trusts. Generally, the federal
Internal Revenue Code establishes the tax rules on transferring
property between spouses during life and at death. (See 26
U.S.C. Sections 2056, 2523.) Accordingly, estate planners will
look to federal law to ensure that estate plans are correctly
drafted to help their clients. However, since the risk of tax
liability caused by potential inartful drafting is significant,
California has enacted a statutory backstop that mirrors federal
law aimed at guarding decedents, surviving spouses, and their
families from significant tax liabilities. Consequently,
Probate Code Section 21524 establishes default provisions for
marital deduction gifts made in trust. However, this savings
clause becomes ineffective if it is inconsistent with federal
law.
In support of the bill, the author writes:
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
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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. However, this backstop is only effective
if the marital deduction trust savings statute mirrors the
requirements under federal law.
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. However, 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 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.
Summary of this bill: Essentially, this bill adopts the
definition of income as it is defined under federal law, and
also defines it to include income from a unitrust payment or
other allocation of income determined to be a reasonable
apportionment of total investment return under the Internal
Revenue Code. This bill also deletes an unnecessary provision
of law relating to qualified terminable interest property that
has been recognized under common law.
This bill adopts the definition of income to include income from
a unitrust payment. A unitrust is a type of trust that
distributes a fixed amount or percentage of the trust property
to the income beneficiary. Because a unitrust does not
distinguish between income and principle, it provides more
flexibility to a trustee to diversify and invest for a total
return. In addition to adopting the definition of income
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adopted under the Internal Revenue Code, this bill reasonable
includes a unitrust payment or other allocation of income
determined to be a reasonable apportionment of total investment
return that meets the requirements of Section 643 of the
Internal Revenue Code as income. Given that this definition is
already recognized under federal law, this adoption would
improve the state's marital deduction savings clause.
This bill seeks to conform the current marital deduction savings
statute to existing law by deleting outdated provisions.
Probate Code Section 21524 (d) provides that in the case of a
QTIP trust, upon the termination of the interest of the
surviving spouse, all remaining accrued or undistributed income
shall pass to the estate of the surviving spouse unless the
instrument provides a different disposition that qualifies for
the marital deduction. According to TEXCOM, when the statute
was enacted in 1990, federal tax law was unsettled as to whether
undistributed income that had accrued prior to the surviving
spouse's death had to flow to the surviving spouse's estate in
order for a trust to qualify for the marital deduction. TEXCOM
states that it is now well-settled that a trust qualifies for
the marital deduction without mandating distribution of that
income. (See Estate of Howard v. Commissioner (9th Cir. 1990)
910 F.2d 633.) Accordingly, this bill justifiably deletes the
outdated reference and removes the unnecessary limitations on a
QTIP trust.
REGISTERED SUPPORT / OPPOSITION:
Support
Executive Committee of the Trusts and Estates Section of the
State Bar of California (sponsor)
SB 1265
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Opposition
None on file
Analysis Prepared by:Eric Dang / JUD. / (916)
319-2334