BILL ANALYSIS �
AB 2687
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Date of Hearing: May 14, 2012
ASSEMBLY COMMITTEE ON REVENUE AND TAXATION
Henry T. Perea, Chair
AB 2687 (Committee on Revenue and Taxation) - As Introduced:
March 12, 2012
VOTE ONLY
Majority vote. Tax levy. Fiscal committee.
SUBJECT : Income taxes: charitable remainder trusts.
SUMMARY : Allows a charitable remainder trust (CRT), in modified
conformity with the federal income tax law, to retain its
tax-exempt status when it has an unrelated business taxable
income (UBTI) by paying tax on that income. Specifically, this
bill :
1)Modifies California tax law, for taxable years beginning on or
after January 1, 2011, to generally conform to the federal tax
treatment of CRTs that have unrelated UBTI. Specifically :
a) Provides that Internal Revenue Code (IRC) Section
664(c)(2), relating to excise tax, shall not apply.
b) States that, in lieu of a 100% excise tax imposed under
IRC Section 664(c)(2) on UBTI, California UBTI of a CRT
will be subject to tax under the graduated personal income
tax rates that range from 1% to 10.3% �Revenue and Taxation
Code (RT&C) Section 17651].
2)Contains legislative findings and declarations stating that
this bill serves a public purpose by preventing the loss of a
tax exemption for charitable remainder annuity trusts and
charitable remainder unitrusts (collectively referred to as
'CRTs').
3)Takes effect immediately as a tax levy but will be operative
for taxable years beginning on or after January 1, 2011.
EXISTING FEDERAL LAW :
1)Defines a CRT as a trust that is (a) funded by a donor's
irrevocable contribution of cash or property, (b) provides a
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donor's or other designated beneficiaries with an income
stream for a specified period, commonly for the life of one or
more beneficiaries, and (c) contributes the remainder of the
trust to charity.
2)Provides that the remainder to be contributed to charity must
be at least 10% of the value of the assets contributed to the
trust. Allows the donor a charitable-contribution deduction
in the year of the contribution for the present value of the
remainder.
3)Exempts a CRT from federal income tax, which means that income
that otherwise would be taxable is not taxable until
distributed to a beneficiary. Prior to 2007, a CRT that had
UBTI in any taxable year lost its tax-exempt status for that
year, and the CRT was taxed as a regular complex trust.
4)Imposes, for taxable years beginning on or after January 1,
2007, a 100% excise tax on the UBTI of a CRT, but allows the
CRT to retain its tax-exempt status. �Tax Relief and Health
Care Act of 2006 (TRHCA)]. The excise tax is treated as paid
from corpus of the trust, and the UBTI is considered income of
the trust for purposes of determining the character of the
distribution made to the beneficiary.
5)Allows a regular complex trust, in computing its taxable
income, to deduct amounts required to be distributed in a
taxable year, not to exceed the amount of the trust's
distributable net income for the year.
EXISTING STATE LAW :
1)Conforms to the federal rules for CRTs, but specifically does
not conform to the UBTI rule change made by the TRHCA. Thus,
a CRT that has UBTI in any taxable year loses its tax-exempt
status for that year and is taxed as a regular complex trust.
Such a CRT is allowed a deduction in computing taxable income
for amounts required to be distributed in a taxable year, not
to exceed the amount of the trust's distributable net income
for the year.
2)Applies the UBTI rule on an annual basis.
3)Provides that a CRT, which has UBTI, loses its general tax
exemption for the taxable year, but continues to be exempt
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from tax in subsequent years in which it has no UBTI.
FISCAL EFFECT : The Franchise Tax Board staff estimates that
this bill will result in an annual revenue loss of $400,000 in
the fiscal year (FY) 2011-12, $300,000 in FY 2012-13, and
$300,000 in FY 2013-14.
COMMENTS :
1)The Purpose of This Bill . AB 2687 is intended to conform
California law to the federal tax treatment of CRTs that have
UBTI, in order to allow such trusts to retain their tax-exempt
status for California tax purposes.
2)Arguments in Support . The proponents of this bill state that
"California follows the pre-2006 federal law, which creates an
extreme hardship for CRTs, precisely the hardship that the
federal legislation was designed to alleviate." The
proponents argue that the loss of tax exempt status under
California law is particularly burdensome: "it is a real trap
for the unwary because California almost always follows
federal tax-exempt treatment, especially in the area of
charitable organizations," "CRTs must pay income tax on all
income, not just on the UBTI," and compliance burdens are
increased.
3)Charitable Remainder Trusts: Background. A CRT is an
irrevocable trust that is created under IRC Section 664.
There are two general types of CRTs: a charitable remainder
annuity trust and a charitable remainder unitrust. A CRT is
established when a donor irrevocably contributes cash or
property to the trust. The donor will be allowed a charitable
contribution deduction in the year of the contribution in the
amount equal to the present value of the remainder. To
qualify as a CRT, the trust must distribute, at least
annually, a fixed percentage of the value of its assets to a
non-charitable beneficiary and, at the expiration of a
specified time (commonly after one or more beneficiaries die),
the remaining balance of the trust's assets must be
contributed to a charity. The remainder of the trust must be
at least 10% of the original fair market value of the assets
contributed to the trust.
4)Federal and State Taxation of CRTs . A qualified CRT is
subject to neither the federal nor state income tax, which
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means that its income that, otherwise, would be taxable is not
taxable, until it is distributed to a beneficiary.
Distributions from a CRT are treated in the following order:
a) ordinary income, to the extent of the trust's undistributed
ordinary income for the current and prior years, b) capital
gains, to the extent of the trust's undistributed capital gain
for the current and prior years, c) other income, and d)
corpus. In general, distributions characterized as income are
includible in the beneficiary's income for the year in which
the CRT amount is required to be distributed, even if the
actual distribution does not occur until later.
While a qualified CRT is exempt from the federal income tax,
it may still be subject to tax on its UBTI. Generally, UBTI
is defined as income from a trade or business regularly
conducted by an exempt organization and not substantially
related to the performance by the organization of its exempt
purpose or function. For example, an investment in an active
trade or business through a partnership, a working interest in
an oil and gas well, or unrelated debt-financed income from
trading on the margin would be considered UBTI. Often, an
otherwise tax-exempt entity may generate UBTI in a particular
tax year.
Currently, a CRT that has UBTI is treated differently under
the federal and California tax laws. Under federal law, such
a CRT will be subject to the 100% excise tax on its UBTI, but
it will retain its tax-exempt status, which means other types
of income generated by the CRT will continue being exempted
from the federal income tax. In contrast, under California's
law, which was federal law prior to 2007, the CRT will lose
its tax-exempt status and all of its income, including UBTI,
will be subject to the income tax in California.
5)Should California Conform to the Federal Tax Treatment of
CRTs ? Generally, a tax-exempt organization must pay tax on
its UBTI. The original provision denying the income tax
exemption for CRTs with UBTI was enacted because Congress did
"not believe that it is appropriate to allow the unrelated
business income tax to be avoided by the use of a charitable
remainder trust rather than a tax-exempt organization." (T.D.
9403, Guidance Under Section 664 Regarding the Effect of
Unrelated Business Taxable Income on Charitable Remainder
Trusts, 2008-32 I.R.B., p. 285, citing P.L. 91-172, Senate
Report 91-552, C.B. 1969-3, P. 481-2). However, the
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"sanctions imposed under prior law on a charitable remainder
trust investing in UBTI-producing asset(s), specifically the
loss of tax-exempt status, was generally viewed as
particularly onerous." (Ibid.) Thus, Congress revised those
provisions, i.e. IRC Section 664(c), by adopting the TRHCA of
2006, which was signed into law on December 20, 2006. While
the revision alleviated the severity of the sanction, it did
not change the long-standing policy of discouraging
investments by CRTs in UBTI-producing assets. (Ibid.) The law
became effective for tax years beginning after December 31,
2006.
California law conforms to the federal rules for CRTs, but
specifically does not conform to the UBTI rule change made by
the TRHCA. A CRT is used as a tax planning technique to
reduce income, gift, or estate tax, but non-conformity to the
federal tax treatment of CRTs may inadvertently frustrate this
purpose. For example, a CRT that receives even a small amount
of UBTI in a year when it realizes substantial gain from the
sale of an appreciated asset would lose its tax-exempt status
in California under existing law.
As a result, the CRT will be taxed as a complex trust,
potentially on the realized gain, thus nullifying a
significant tax benefit otherwise afforded to CRTs. By
allowing a CRT to retain its tax-exempt status by paying an
income tax on the UBTI, this bill would alleviate the hardship
for the CRT but would still reinforce the policy of
discouraging investments in UBIT-producing assets, in line
with the Congressional action.
6)Related Legislation .
SB 401 (Wolk), Chapter 14, Statutes of 2010, changed
California's "specified" date of conformity to the IRC from
January 1, 2005, to January 1, 2009, and modified California
law to specifically not conform to the CRT-UBTI rule change
that was made by the TRHCA.
REGISTERED SUPPORT / OPPOSITION :
Support
California Taxpayers Association
Opposition
AB 2687
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None on file
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098