D R A F T
FOR APPROVAL
AMENDMENTS TO UNIFORM PRINCIPAL AND INCOME ACT
NATIONAL CONFERENCE OF COMMISSIONERS
ON UNIFORM STATE LAWS
MEETING IN ITS ONE-HUNDRED-AND-SEVENTEENTH YEAR
BIG SKY, MONTANA
JULY 18 - JULY 25, 2008
AMENDMENTS TO UNIFORM PRINCIPAL AND INCOME ACT
Copyright ©2008
By
NATIONAL CONFERENCE OF COMMISSIONERS
ON UNIFORM STATE LAWS
The ideas and conclusions
set forth in this draft, including the proposed statutory language and any
comments or reporter’s notes, have not been passed upon by the National
Conference of Commissioners on Uniform State Laws or the Drafting
Committee. They do not necessarily
reflect the views of the Conference and its Commissioners and the Drafting Committee
and its Members and Reporter. Proposed
statutory language may not be used to ascertain the intent or meaning of any
promulgated final statutory proposal.
DRAFTING COMMITTEE ON AMENDMENTS TO UNIFORM PRINCIPAL
AND INCOME ACT
The
Committee appointed by and representing the National Conference of
Commissioners on Uniform State Laws in drafting these amendments consists of
the following individuals:
SUZANNE BROWN WALSH, P.O. Box 271820, West Hartford,
CT 06127,
Chair
TURNEY P. BERRY, 2700
PNC Plaza,
Louisville, KY 40202
DAVID M. ENGLISH,
University of Missouri-Columbia School of Law, Missouri Ave. & Conley Ave.,
Columbia, MO 65211
STANLEY C. KENT, 90
S. Cascade Ave., Suite 1210, Colorado Springs, CO 80903
MATTHEW S. RAE,
JR., 600 John St., Manhattan Beach, CA 90266
EX
OFFICIO
Martha Lee Walters, Oregon Supreme Court, 1163 State St., Salem, OR 97301-2563, President
AMERICAN
BAR ASSOCIATION ADVISOR
steven b. gorin, 20
Saint Alfred Rd., St. Louis, MO 63132-4130,
ABA Advisor
EXECUTIVE DIRECTOR
John A. Sebert, 111 N.
Wabash Ave., Suite 1010, Chicago, IL
60602, Executive
Director
Copies of this Act may be obtained from:
NATIONAL CONFERENCE OF COMMISSIONERS
ON UNIFORM STATE LAWS
111 N.
Wabash Ave., Suite 1010
Chicago, Illinois 60602
312/450-6600
www.nccusl.org
AMENDMENTS
TO UNIFORM PRINCIPAL AND INCOME ACT
AMENDMENT
1
Section 409 is amended to
read:
SECTION 409.
DEFERRED COMPENSATION, ANNUITIES, AND SIMILAR PAYMENTS.
(a) In this
section, the following definitions apply:
(1) “Payment” means a payment that a
trustee may receive over a fixed number of years or during the life of one or
more individuals because of services rendered or property transferred to the
payer in exchange for future payments. The term includes a payment made in
money or property from the payer’s general assets or from a separate fund
created by the payer, including:. For purposes of subsections (d),
(e), (f), and (g), the term also includes any payment from a separate fund, regardless
of the reason for the payment.
(2) “Separate fund” includes a private
or commercial annuity, an individual retirement account, and a pension,
profit-sharing, stock-bonus, or stock-ownership plan.
(b) To the extent
that a payment is characterized as interest, or a dividend,
or a payment made in lieu of interest or a dividend, a trustee shall allocate it
the payment to income. The
trustee shall allocate to principal the balance of the payment and any other
payment received in the same accounting period that is not characterized as
interest, a dividend, or an equivalent payment.
(c) If no part of
a payment is characterized as interest, a dividend, or an equivalent payment,
and all or part of the payment is required to be made, a trustee shall allocate
to income 10 percent of the part that is required to be made during the
accounting period and the balance to principal.
If no part of a payment is required to be made or the payment received
is the entire amount to which the trustee is entitled, the trustee shall
allocate the entire payment to principal.
For purposes of this subsection, a payment is not “required to be
made” to the extent that it is made because the trustee exercises a
right of withdrawal.
(d) If, to
obtain an estate tax marital deduction for a trust, a trustee must allocate
more of a payment to income than provided for by this section, the trustee
shall allocate to income the additional amount necessary to obtain the marital
deduction. Except as otherwise
provided in subsection (e), subsections (f) and (g) apply, and subsections (b)
and (c) do not apply, in determining the allocation of a payment made from
a separate fund to:
(1) a
trust to which an election to qualify for a marital deduction under Section
2056(b)(7) of the Internal Revenue Code of 1986 [, as amended,] has been made;
or
(2) a
trust that qualifies for the marital deduction under Section 2056(b)(5) of the
Internal Revenue Code of 1986 [, as amended].
(e) Subsections (d), (f), and (g) do not apply if
and to the extent that the series of payments would, without the application of
subsection (d), qualify for the marital deduction under Section
2056(b)(7)(C) of the Internal Revenue Code of 1986 [, as amended].
(f) A trustee shall determine the internal income of each
separate fund for the accounting period as if the separate fund were a trust
subject to this act. Upon request of the
surviving spouse, the trustee shall demand of the person administering the
separate fund that this internal income be distributed to the trust. The trustee shall allocate a payment from the
separate fund to income to the extent of the internal income of the separate
fund and distribute that amount to the surviving spouse. The trustee shall allocate the balance to
principal. Upon request of the surviving
spouse, the trustee shall allocate principal to income to the extent the
internal income of the separate fund exceeds payments made from the separate
fund to the trust during the accounting period.
(g) If a trustee cannot determine the internal income
of a separate fund but can determine the value of the separate fund, the
internal income of the separate fund is deemed to equal [insert number at least
3% and not more than 5%] of the fund’s value, according to the most recent
statement of value preceding the beginning of the accounting period. If the trustee can determine neither the
internal income of the separate fund nor the fund’s value, the internal income
of the fund is deemed to equal the product of the interest rate and the present
value of the expected future payments, as determined under Section 7520 of the
Internal Revenue Code of 1986 [, as amended,] for the month preceding the
accounting period for which the computation is made.
(e)(h)
This section does not apply to payments a payment to which
Section 410 applies.
Comment
* * *
Marital
deduction requirements. When
an IRA is payable to a QTIP marital deduction trust, the IRS treats the IRA as
separate terminable interest property and requires that a QTIP election be made
for it. In order to qualify for QTIP
treatment, an IRS ruling states that all of the IRA’s income must be
distributed annually to the QTIP marital deduction trust and then must be
allocated to trust income for distribution to the spouse. Rev. Rul. 89-89, 1989-2 C.B. 231. If an allocation to income under this Act of
10% of the required distribution from the IRA does not meet the requirement
that all of the IRA’s income be distributed from the trust to the spouse, the
provision in subsection (d) requires the trustee to make a larger allocation to
income to the extent necessary to qualify for the marital deduction. The requirement of Rev. Rul. 89-89 should
also be satisfied if the IRA beneficiary designation permits the spouse to
require the trustee to withdraw the necessary amount from the IRA and
distribute it to her, even though the spouse never actually requires the
trustee to do so. If such a provision is
in the beneficiary designation, a distribution under subsection (d) should not
be necessary.
Marital deduction requirements. When an IRA or other retirement arrangement
(a “plan”) is payable to a marital deduction trust, the IRS treats the plan as
a separate property interest that itself must qualify for the marital
deduction. IRS Revenue
Ruling 2006-26 said that, as written, Section 409 does not cause a trust
to qualify for the IRS’ safe harbors.
Revenue Ruling 2006-26 was limited in scope to certain situations
involving IRAs and defined contribution retirement plans. Without necessarily agreeing with the IRS’
position in that ruling, the revision to this section is designed to satisfy
the IRS’ safe harbor and to address concerns that might be raised for similar
assets. No IRS pronouncements have addressed
the scope of Code § 2056(b)(7)(C).
Subsection (e)
requires the trustee to demand certain distributions if the surviving spouse so
requests. The safe harbor of Revenue
Ruling 2006-26 requires that the surviving spouse be separately entitled to
demand the fund’s income (without regard to the income from the trust’s other
assets) and the income from the other assets (without regard to the fund’s
income). In any event, the surviving
spouse is not required to demand that the trustee distribute all of the fund’s
income from the fund or from other trust assets. Treas. Reg. § 20.2056(b)-5(f)(8).
Subsection (e)
also recognizes that the trustee might not control the payments that the
trustee receives and provides a remedy to the surviving spouse if the distributions
under subsection (d)(1) are insufficient.
Subsection (f)
addresses situations where, due to lack of information provided by the fund’s
administrator, the trustee is unable to determine the fund’s actual
income. The bracketed language is the
range approved for unitrust payments by Treas. Reg. § 1.643(b)‑1. In determining the value for purposes of
applying the unitrust percentage, the trustee would seek to obtain the value of
the assets as of the most recent statement of value immediately preceding the
beginning of the year. For example,
suppose a trust’s accounting period is January 1 through
December 31. If a retirement plan
administrator furnishes information annually each September 30 and
declines to provide information as of December 31, then the trustee may
rely on the September 30 value to determine the distribution for the
following year. For funds whose values
are not readily available, subsection (f) relies on Code section 7520
valuation methods because many funds described in Section 409 are
annuities, and one consistent set of valuation principles should apply whether
or not the fund is, in fact, an annuity.
* * *
AMENDMENT
2
Section 505 is amended to read:
SECTION 505.
INCOME TAXES.
(a) A tax required
to be paid by a trustee based on receipts allocated to income must be paid from
income.
(b) A tax required
to be paid by a trustee based on receipts allocated to principal must be paid
from principal, even if the tax is called an income tax by the taxing
authority.
(c) A tax required
to be paid by a trustee on the trust’s share of an entity’s taxable income must
be paid proportionately:
(1) from income to the extent that receipts
from the entity are allocated only to income; and
(2) from principal to the extent that:
(A) receipts from the
entity are allocated only to principal; and
(B) the trust’s share of the
entity’s taxable income exceeds the total receipts described in paragraphs (1)
and (2)(A).
(3) proportionately
from principal and income to the extent that receipts from the entity are
allocated to both income and principal; and
(4) from principal to
the extent that the tax exceeds the total receipts from the entity.
(d) For
purposes of this section, receipts allocated to principal or income must be
reduced by the amount distributed to a beneficiary from principal or income for
which the trust receives a deduction in calculating the tax. After applying
subsections (a) through (c), the trustee shall adjust income or principal
receipts to the extent that the trust’s taxes are reduced because the trust
receives a deduction for payments made to a beneficiary.
Comment
Electing Small
Business Trusts. An Electing
Small Business Trust (ESBT) is a creature created by Congress in the Small
Business Job Protection Act of 1996 (P.L. 104-188). For years beginning after 1996, an ESBT may
qualify as an S corporation stockholder even if the trustee does not distribute
all of the trust’s income annually to its beneficiaries. The portion of an ESBT that consists of the S
corporation stock is treated as a separate trust for tax purposes (but not for
trust accounting purposes), and the S corporation income is taxed directly to
that portion of the trust even if some or all of that income is distributed to
the beneficiaries.
A trust normally
receives a deduction for distributions it makes to its beneficiaries. Subsection (d) takes into account the
possibility that an ESBT may not receive a deduction for trust accounting
income that is distributed to the beneficiaries. Only limited guidance has been issued by the
Internal Revenue Service, and it is too early to anticipate all of the
technical questions that may arise, but the powers granted to a trustee in
Sections 506 and 104 to make adjustments are probably sufficient to enable a
trustee to correct inequities that may arise because of technical problems.
Taxes
on Undistributed Entity Taxable Income. When a trust owns an interest in a
pass-through entity, such as a partnership or S corporation, it must report its
share of the entity’s taxable income regardless of how much the entity
distributes to the trust. Whether the entity distributes more or less than the
trust’s tax on its share of the entity’s taxable income, the trust must pay the
taxes and allocate them between income and principal.
Subsection (c)
requires the trust to pay the taxes on its share of an entity’s taxable income
from income or principal receipts to the extent that receipts from the entity
are allocable to each. This assures the trust a source of cash to pay some or
all of the taxes on its share of the entity’s taxable income. Subsection 505(d)
recognizes that, except in the case of an Electing Small Business Trust (ESBT),
a trust normally receives a deduction for amounts distributed to a beneficiary.
Accordingly, subsection 505(d) requires the trust to increase receipts payable
to a beneficiary as determined under subsection (c) to the extent the trust’s
taxes are reduced by distributing those receipts to the beneficiary.
Because the trust’s
taxes and amounts distributed to a beneficiary are interrelated, the trust may
be required to apply a formula to determine the correct amount payable to a
beneficiary. This formula should take into account that each time a
distribution is made to a beneficiary, the trust taxes are reduced and amounts
distributable to a beneficiary are increased. The formula assures that after
deducting distributions to a beneficiary, the trust has enough to satisfy its
taxes on its share of the entity’s taxable income as reduced by distributions
to beneficiaries.
Example (1) – Trust T receives a Schedule K-1 from
Partnership P reflecting taxable income of $1 million. Partnership P
distributes $100,000 to T, which allocates the receipts to income. Both Trust T
and income Beneficiary B are in the 35 percent tax bracket.
Trust T’s tax on $1 million of taxable income is $350,000. Under
Subsection (c) T’s tax must be paid from income receipts because receipts from
the entity are allocated only to income. Therefore, T must apply the entire
$100,000 of income receipts to pay its tax. In this case, Beneficiary B
receives nothing.
Example (2) - Trust T receives a Schedule K-1 from
Partnership P reflecting taxable income of $1 million. Partnership P
distributes $500,000 to T, which allocates the receipts to income. Both Trust T
and income Beneficiary B are in the 35 percent tax bracket.
Trust T’s tax on $1 million of taxable income is $350,000. Under
Subsection (c), T’s tax must be paid from income receipts because receipts from
P are allocated only to income. Therefore, T uses $350,000 of the $500,000 to
pay its taxes and distributes the remaining $150,000 to B. The $150,000 payment
to B reduces T’s taxes by $52,500, which it must pay to B. But the $52,500
further reduces T’s taxes by $18,375, which it also must pay to B. In fact,
each time T makes a distribution to B, its taxes are further reduced, causing
another payment to be due B.
Alternatively, T
can apply the following algebraic formula to determine the amount payable to B:
D =
(C-R*K)/(1-R)
D
= Distribution to income beneficiary
C
= Cash paid by the entity to the trust
R
= tax rate on income
K
= entity’s K-1 taxable income
Applying the
formula to Example (2) above, Trust T must pay $230,769 to B so that after
deducting the payment, T has exactly enough to pay its tax on the remaining
taxable income from P.
Taxable
Income per K-1 1,000,000
Payment
to beneficiary 230,769
Trust
Taxable Income $
769,231
35
percent tax 269,231
Partnership
Distribution $ 500,000
Fiduciary’s
Tax Liability (269,231)
Payable
to the Beneficiary $
230,769
In addition, B will
report $230,769 on his or her own personal income tax return, paying taxes of
$80,769. Because Trust T withheld $269,231 to pay its taxes and B paid $80,769
taxes of its own, B bore the entire $350,000 tax burden on the $1 million of
entity taxable income, including the $500,000 that the entity retained that
presumably increased the value of the trust’s investment entity.
If a trustee
determines that it is appropriate to so, it should consider exercising the
discretion granted in UPIA section 506 to adjust between income and principal.
Alternatively, the trustee may exercise the power to adjust under UPIA section
104 to the extent it is available and appropriate under the circumstances,
including whether a future distribution from the entity that would be allocated
to principal should be reallocated to income because the income beneficiary
already bore the burden of taxes on the reinvested income. In exercising the
power, the trust should consider the impact that future distributions will have
on any current adjustments.
