BILL ANALYSIS �
AB 2687
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ASSEMBLY THIRD READING
AB 2687 ( Revenue and Taxation Committee)
As Introduced March 12, 2012
Majority vote. Tax levy
REVENUE & TAXATION 8-0 APPROPRIATIONS 17-0
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|Ayes:|Lara, Harkey, Beall, |Ayes:|Fuentes, Harkey, |
| |Charles Calderon, | |Blumenfield, Bradford, |
| |Cedillo, Fuentes, Gordon, | |Charles Calderon, Campos, |
| |Nestande | |Davis, Donnelly, Gatto, |
| | | |Ammiano, Hill, Lara, |
| | | |Mitchell, Nielsen, Norby, |
| | | |Solorio, Wagner |
| | | | |
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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,
this bill :
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
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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
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
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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
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 :
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.
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.
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
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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.
Federal and State Taxation of CRTs . A qualified CRT is subject
to neither the federal nor state income tax, which 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: 1) ordinary income, to
the extent of the trust's undistributed ordinary income for the
current and prior years; 2) capital gains, to the extent of the
trust's undistributed capital gain for the current and prior
years; 3) other income; and, 4) 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.
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
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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 "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.
Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916)
319-2098
FN: 0003821
AB 2687
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