Things that may surprise you about Florida's Principal and Income Act and related accounting law.

• Author: Carroll, William C.
• Position: Part 2

Part one of this two-part article introduced the reader to the provisions of the Florida Uniform Principal and Income Act. (1) In part two, the authors continue using examples to explore the more complex workings of the act and how those provisions allocate trust and estate receipts and disbursements between income and principal of an estate or trust. As in part one, these examples assume that the will or trust is silent as to allocating the receipt or disbursement at issue to either income or principal, and does not give the personal representative and/or trustee a discretionary power of administration.

Example One: Life Estate in Real Property

Decedent's will devises a vacation condominium (subject to a mortgage) to Spouse for life with the remainder to Child. In the first year after death, the condominium has the following expenses: monthly mortgage payments of $1,000; quarterly (regular) condominium association maintenance assessments of $400; real property taxes of $2,500; and routine repairs of $2,000. Also, as a result of hurricane damage to the building, each unit is specially assessed $30,000 for repairs.

Section 738.801 provides that the provisions of [subsection]738.701 through 738.705 shall govern the apportionment of expenses between tenants and remainder beneficiaries when no trust has been created. A tenant (i.e., the holder of the life estate) must pay the income charges and the remainder beneficiary pays the principal charges. In this example, no trust was created. Accordingly, as required by [section]738.701(3), Spouse pays the interest portion of the mortgage payments, the quarterly association maintenance assessments, the property taxes, and the routine repairs. Under [section]738.702(1)(c), Child pays the principal portion of mortgage payments. Assuming the hurricane damage repairs are reasonably expected to outlast Spouse's actuarial life expectancy, the cost of the special assessment is allocated between Spouse and Child based on an actuarial formula set forth in [section]738.801(2). If the special assessment repairs are not reasonably expected to last beyond Spouse's life expectancy, [section]738.801(2) charges this expense to Spouse. (2) Significantly, under [section]738.701(4), homeowner's and windstorm insurance premiums must be paid by the life tenant.

Example Two: Mutual Fund Capital Gain Distributions

A trustee purchases 20,000 units in QZ mutual fund for $200,000. Shortly after the purchase, QZ mutual fund makes a $1 per unit ($20,000) distribution to the trust, representing short-term and long-term capital gains realized within the mutual fund. Pursuant to [section]738.401(3)(d), the distribution constitutes principal.

Example Three: Bond Discounts and Premiums

Example 3a (bond discount): On January 1, 2007, a trustee purchases 100,000 units of Edsel Motor Co. ("junk") bond for $76,000. Bond has a coupon rate of 7.45 percent, paid annually, with a maturity date in 30 years. Because the bond was purchased at a discount, it yields approximately 9.8 percent annually. Every year $7,450 of interest is received by the trust from Edsel Motor Co. and, as provided in [section]738.503(1), the interest constitutes trust income. Five years after the bond purchase, Edsel Motor Co. merged with another car manufacturer and, pursuant to the terms of the merger, the trust's 100,000 units of the bond were redeemed for $90,000. A, the income beneficiary of the trust, complains to the trustee that he should have received annually $9,800 (an amount equal to the yield on the bond). A argues that, because he was short-changed by a total of $11,750, the trustee should pay him that amount from the redemption proceeds. The trustee correctly responds that Florida law does not specifically authorize the accretion of bond discounts and that the $90,000 redemption amount constitutes trust principal pursuant to [section]738.503(2) of which $14,000 represents capital gain to the trust.

Example 3b (bond premium): On January 1, 2007, a trustee purchases 100,000 units of DEF Corp. bond for $105,000. The bond has a coupon rate of seven percent paid annually and it matures in five years. Each...