BILL NUMBER:S5620

TITLE OF BILL:

An act to amend the estates, powers and trusts law, in relation to
trust accounting income and principal

This is one in a series of measures being introduced at the request of
the Chief Administrative Judge upon the recommendation of her
Surrogate's Court Advisory Committee.

Recent increases in tax rates applicable to realized capital gains and
the enactment of the new 3.8% tax on undistributed net investment
income (which includes realized capital gains) have made it
increasingly important that, in order to achieve results which are
reasonable and impartial to all beneficiaries, a trustee be able to
effectively determine whether the realized capital gains of a trust
are taxed to the current beneficiaries or to the trust (i.e., in
essence to the remainder beneficiaries).

Accordingly, this measure would amend the New York Principal and
Income Act (EPTL Article 11-A) to make clear that, unless the
instrument provides otherwise, a trustee has the powers set forth in
the regulations which would permit a reasonable and impartial
allocation of realized capital gains to income and thereby permit the
trustee to determine the incidence of such gains in a reasonable and
              

impartial manner.

Whether the trust or the current beneficiaries are taxed on the
capital gains turns on whether such gains are "excluded" vs.
"included" in what is called "distributable net income" (DNI) under
IRC § 643(a). If they are excluded from DNI, they will be taxed to the
trust. If they are included in DNI, then amounts distributed (or
required to be distributed) to the current beneficiaries will be
considered, partially or fully, to "carry out" such gains and cause
them to be taxed to such beneficiaries.

The relevant statutory provisions and regulations are as follows:

(a) The statute (unamended since the 1954 Code). § 643(a)(3)

(a) Distributable net income

For purposes of this part, the term "distributable net income" means,
with respect to any taxable year, the taxable income of the estate or
trust computed with the following modifications-

Capital gains and losses

Gains from the sale or exchange of capital assets shall be excluded to
the extent that such gains are allocated to corpus and are not

(A) paid, credited, or required to be distributed to any beneficiary
during the taxable year ...., or

(b) The regulations (last amended in 2004)


§ 1.643(a)-3

(b) Capital gains ... are included in distributable net income to the
extent they are, pursuant to the terms of the governing instrument and
applicable local law, or pursuant to a reasonable and impartial
exercise of discretion by the fiduciary (in accordance with a power
granted to the fiduciary by applicable local law or by the governing
instrument if not prohibited by applicable local law)--

(1) Allocated to income (but if income under the state statute is
defined as, or consists of, a unitrust amount, a discretionary power
to allocate gains to income must also be exercised consistently and
the amount so allocated may not be greater than the excess of the
unitrust amount over the amount of distributable net income determined
without regard to this subparagraph § 1.643(a)-3(b)h

(2) Allocated to corpus but treated consistently by the fiduciary on
the trust's books, records, and tax returns as part of a distribution
to a beneficiary; or

(3) Allocated to corpus but actually distributed to the beneficiary or
utilized by the fiduciary in determining the amount that is
distributed or required to be distributed to a beneficiary.  The above
regulations, proposed in 2001 and finalized in 2004, were the result
of the Treasury's decision to accommodate changes in state laws
(spearheaded by New York) designed to facilitate total return
investing by trustees.

As stated in the introduction to the proposed and final regulations.

(Proposed)

The prudent investor standard for managing trust assets has been
enacted by many states and encourages fiduciaries to adopt an
investment strategy designed to maximize the total return on trust
assets. Under this investment strategy, trust assets should be
invested for total positive return, that is, ordinary income plus
appreciation, in order to maximize the value of the trust. Thus, under
certain economic circumstances, equities, rather than bonds, would
constitute a greater portion of the trust assets than they would under
traditional investment standards....To ensure that the income
beneficiary is not penalized if a trustee adopts a total return
investment strategy, many states have made, or are considering making,
revisions to the definitions of income and principal. Some state
statutes permit the trustee to make an equitable adjustment between
income and principal if necessary to ensure that both the income
beneficiary and the remainder beneficiary are treated impartially,
based on what is fair and reasonable to all of the beneficiaries.
Thus, a receipt of capital gains that previously would have been
allocated to principal may be allocated by the trustee to income if
necessary to treat both parties impartially. Conversely, a receipt of
dividends or interest that previously would have been allocated to
income may be allocated by the trustee to principal if necessary to
treat both parties impartially. Other states are proposing legislation
that would allow the trustee to pay a unitrust amount to the income
beneficiary in satisfaction of that beneficiary's right to the income
from the trust. This unitrust amount will be a fixed percentage,


sometimes required to be within a range set by state statute, of the
fair market value of the trust assets determined annually.

(Final)

The IRS and the Treasury Department recognize that state statutes are
in the process of changing traditional concepts of income and
principal in response to investment strategies that seek total
positive return on trust assets. These statutes are designed to ensure
that, when a trust invests in assets that may generate little
traditional income (including dividends, interest, and rents), the
income and remainder beneficiaries are allocated reasonable amounts of
the total return of the trust (including both traditional income and
capital appreciation of trust assets) so that both classes of
beneficiaries are treated impartially. Some statutes permit the
trustee to pay to the person entitled to the income a unitrust amount
based on a fixed percentage of the fair market value of the trust
assets. Other statutes permit the trustee the discretion to make
adjustments between income and principal to treat the beneficiaries
impartially. Under the proposed regulations, a trust's definition of
income in conformance with applicable state statutes will be respected
for federal tax purposes when the state statutes provide for a
reasonable apportionment of the total return of the trust.

In New York, total return investing by trustees is facilitated
statutorily by the power to adjust provisions of EPTL 11 -2.3(b)(5)
and the optional unitrust provisions of EPTL 11-2.4.1{1}

In addition to these statutes, the provisions of the trust itself may
permit total return investing. E.g., a trustee who has unlimited
discretion to distribute principal to a beneficiary to whom income
must or may be paid is substantially free to invest without regard to
the form of return because the power to distribute principal can be
used in much the same manner as the power to adjust.

This measure, which would have no fiscal impact, would take effect
immediately.

Legislative History:

None.  New proposal.

{1} As stated by the Court of Appeals in In Re Heller, 6 NY3d 649
(2006) "The Prudent Investor Act encourages investing for total return
on a portfolio ... The 2001 legislation allows trustees to pursue this
strategy uninhibited by a constrained concept of trust accounting
income A trustee investing for a portfolio's total return under the
Prudent Investor Act may now adjust principal and income to compensate
for the effects of the investment decisions on distribution to income
beneficiaries Alternatively, the optional unitrust provision lets
trustees elect unitrust status for a trust (EPTL 11-2 4) by which
income is calculated according to a fixed formula