Unitrust provisions: trustees, advisers: be aware of changes to California Probate Code.

• Author: Reggiardo, Sil
• Position: Estate planning

The California Uniform Principal and Income Act (California Probate Code (CPC) secs. 16320 et seq.) gives trustees the power to "adjust" the allocation of total return on trust assets between income and principal (CPC Sec. 16336).

Gov. Schwarzenegger recently signed SB 754, which adds "unitrust" conversion provisions to the act. Beginning next year, trustees may treat an annual percentage (at least 3 percent, but not more than 5 percent) of a trust's asset value as trust income (CPC secs. 16328, 16336.4).

The adjustment and unitrust provisions, which must comply with detailed notice and beneficiary consent requirements, will prove important to trustees and their advisers.

Principal Income Rules

The act makes an important distinction between trust principal and income, and almost every document creating a trust also makes this distinction.

For example, marital deduction trusts must normally distribute all income to the surviving spouse [IRC Sec. 2056(b)(7)]. Credit shelter trusts normally subject principal distributions to some need-based standard, such as "health, education, support or maintenance" [IRC Sec. 2041(b)(1)(A)].

These and many other trusts often have non-tax objectives of providing for a lifetime beneficiary's support and also preserving assets for the remainder beneficiaries.

Trust accounting income rules are based on state law and do not necessarily track income tax rules (e.g., capital gains are taxable income generally allocated to trust accounting principal rather than income). The act allocates trust receipts and disbursements between principal and income (CPC secs. 16370, 16371).

The trustee makes the allocation, nets receipts and disbursements in a trust accounting, and then distributes or withholds principal and income as permitted or directed in the governing document.

The act's principal and income allocation provisions constitute default rules a trust settler may override through specific instructions or trustee discretionary powers (CPC Sec. 16335). Overrides can be useful, especially in connection with seemingly arbitrary rules in the act, like those allocating 90 percent of certain "wasting asset" receipts to trust principal (CPC Sec. 16363).

Examples

The traditional rules, the adjustment power, and the unitrust operate in different ways.

For example, if a trust sells real estate for a $1,025,000 gain before $50,000 of sales costs and commissions--and the trust also has $75,000 of rental income with $50,000 of...