BILL ANALYSIS �
AB 296
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Date of Hearing: August 12, 2014
ASSEMBLY COMMITTEE ON JUDICIARY
Bob Wieckowski, Chair
AB 296 (Wagner) - As Amended: June 15, 2014
FOR CONCURRENCE
SUBJECT : Trust Distributions: Allocations to Principal or
Income
KEY ISSUE : SHOULD THE LAW BE CLARIFIED, ON AN URGENCY BASIS, TO
ENSURE THAT SHORT-TERM CAPITAL GAIN DISTRIBUTIONS ARE
CHARACTERIZED AS INCOME RATHER THAN PRINCIPAL FOR PURPOSES OF
MAKING A TRUST ALLOCATION?
SYNOPSIS
Under the Uniform Principal and Income Act (UPAIA), which
California adopted in 2000, a trustee is required to allocate
money received from an entity either to principal (property
owned by the trust) or income (money earned by the trust's
principal) based upon the characterization of the money
received. Whether money is characterized as principal or income
determines who will get the benefit of the distribution - income
to the income or life beneficiaries, principal to the remainder
beneficiaries - and who will pay the taxes. Last year's AB 1029
(Maienschein) clarified how the characterization of money
received from a partial liquidation of an entity is to be
determined and allocated by the trustee. This non-controversial
urgency bill, sponsored by the California Bankers Association,
clarifies that a short-term capital gain distribution from a
regulated investment company or a real estate investment trust
should not be distributed as principal. This bill is supported
by the Trusts & Estates Section of the State Bar and there is no
reported opposition.
SUMMARY : Clarifies, on an urgency basis, how a specific
distribution to a trust is allocated between income and
principal. Specifically, this bill :
1)Clarifies that money received in total or partial liquidation
of an entity, which is allocated to principal, does not
include money received from a regulated investment company or
a real estate investment trust if the money distributed is a
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net short-term capital gain distribution.
2)Clarifies that money received from a regulated investment
company or a real estate investment trust, which is allocated
to principal if the money distributed is a capital gain
dividend for federal income tax purposes, does not include
money distributed as a net short-term capital gain
distribution.
3)Takes effect immediately as urgency legislation.
EXISTING LAW :
1)Establishes, through the Uniform Principal and Income Act
(UPAIA), rules for the management by a trustee of assets held
by the trust for the benefit of the trust beneficiaries.
(Probate Code Section 16320 et seq. Unless stated otherwise,
all further statutory references are to that code.)
2)Requires the trustee, when allocating receipts and
disbursements to or between principal and income, to
administer the trust in accordance with the terms of the
trust, the power provided to the trustee under the trust, or,
if the trust does not otherwise provide, pursuant to the
UPAIA. (Section 16335.)
3)Requires a trustee to allocate to income money received from
an entity (such as a corporation, partnership, limited
liability company, trust or real estate investment trust) as
specified. (Section 16350(b).)
4)Requires a trustee to allocate to principal specified receipts
from an entity. (Section 106350(c).)
5)Clarifies that money received by a trust from an entity is
received in partial liquidation of the entity (and thus
treated as principal and not income) to the extent the money
is attributable to sale of a capital asset. Permits, in
determining whether money is received in partial liquidation,
a trustee to rely, without investigation, on a written
statement from the distributing entity. Also allows a trustee
to rely, again without investigation, on other information
known by the trustee. (Section 16350(d).)
6)Provides that a trustee is not liable for an allocation
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between principal and interest done in accordance with the
stated provisions. (Section 16350(e).)
FISCAL EFFECT : As currently in print this bill is keyed
non-fiscal.
COMMENTS : California adopted the Uniform Principal and Income
Act (UPAIA) in 2000. (AB 846 (Ackerman), Chap. 145, Stats.
1999.) The UPAIA, together with the Uniform Prudent Investor
Act, reconstituted the manner by which trusts are administered
for the benefit of their beneficiaries. At the time it was
adopted, the UPAIA was said to deal conservatively with the
tension between modern investment theory and the traditional
income allocation, and to help a trustee who has made a prudent,
modern portfolio-based investment decision that has the initial
effect of skewing return from all the assets under management,
by giving the trustee the power to reallocate the portfolio
return suitably as between principal and income beneficiaries.
Under the UPAIA, a trustee is required to allocate money
received from an entity either to principal (property owned by
the trust) or income (money earned by the trust's principal)
based upon the characterization of the money received. Whether
money is characterized as principal or income determines who
will get the benefit of the distribution - income to the income
or life beneficiaries, principal to the remainder beneficiaries
- and who will pay the taxes, and when.
Current law requires a trustee to allocate money received from
an entity to income, unless the money qualifies for a statutory
exception, in which case the trustee must allocate the money to
principal. Those exceptions include, among other things, money
received in total or partial liquidation of the entity. Last
year's AB 1029 (Maienschein), Chap. 105, Stats. 2013, among
other things, clarified how the characterization of money
received from a partial liquidation of an entity is to be
determined and allocated by the trustee.
The author states that, as a result of last year's legislation,
an ambiguity now exists with respect to the characterization of
a net short-term capital gain distribution from a mutual fund or
a real estate investment trust, which is allocable to income,
but which may be incorrectly characterized as principal if the
trustee believes the money qualifies as either money received in
total or partial liquidation of the entity if the money
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distributed is a capital gain dividend for federal income tax
purposes. This bill clarifies that ambiguity and provides that
money received in total or partial liquidation of an entity or
money received that is a capital gain dividend, as specified,
does not include a net short-term capital gain distribution.
In support of the bill, the author writes that it is appropriate
"to rectify the unintended result of having distributions
allocated to principal instead of to income so that when the
distributions are received by trusts in December of 2014, unless
otherwise provided in the trust instrument, the distributions
are allocated to income, consistent with the [UPAIA] and the
expectations of the trust beneficiaries."
The author notes that "of the 46 states and District of Columbia
that have enacted the UPAIA, only Florida has changed the
allocation rule for distributions to require that such
distributions be allocated to principal." As a result, the
failure to correct this ambiguity regarding a net short-term
capital gain distribution will result in California's allocation
rule being inconsistent with the allocation rule of all but one
other state that has enacted the UPAIA. The author also notes
that, in most cases, a trust instrument will require that the
trust's net income be distributed to the income beneficiaries,
who have the expectation, based on the UPAIA model laws enacted
by California, that these distributions will continue to be
allocated to income. As such, the author asserts that "to now
allocate distributions to principal and deny income
beneficiaries those funds will, in some cases, cause undue
hardship for the income beneficiaries."
This bill is urgency legislation that will take effect
immediately. The author and supporters state that it is
necessary to enact this bill this year before trustees follow
the new partial liquidation guidelines and mistakenly allocate
this year's net short-term capital gain distributions to
principal instead of income.
REGISTERED SUPPORT / OPPOSITION :
Support
California Bankers Association (sponsor)
Trusts and Estates Section of the State Bar
AB 296
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Opposition
None on file
Analysis Prepared by : Leora Gershenzon / JUD. / (916) 319-2334