BILL NUMBER: S4866A

SPONSOR: BONACIC
 
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 his Surro-
gate's Court Advisory Committee.

This measure would amend section 11-2.3(b) (5)(A) of the Estates, Powers
and Trusts Law (part of the State's Prudent Investor Act) and
11-A-4.4(2) of such Law (part of the State's Principal and Income Act)
to clarify that, unless a trust instrument otherwise provides, a trustee
has the powers set forth in regulations under the Internal Revenue Code
permitting a reasonable and impartial allocation of realized capital
gains to income and thereby permitting the trustee to determine the
incidence of such gains in a reasonable and impartial manner.

Recent increases in the 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, to achieve results that are reasonable and impartial to
all beneficiaries, a trustee be able effectively to determine whether
the realized capital gains of a trust are taxed to the current benefici-
aries or to the trust (i.e., in essence to the remainder beneficiaries).

Briefly put, whether the trust or the current beneficiaries are taxed on
the capital gains turns on whether such gains are "excluded" or
"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 consid-
ered, 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));

(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 foregoing regu-
lations, 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 strate-
gy 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 princi-
pal. Some state statutes (like those of New York) 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 allo-
cated to income may be allocated by the trustee to principal if neces-
sary to treat both parties 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 princi-
pal 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 stat-
ute, of the fair market value of the trust assets determined annually.
(Emphasis and bracketed material added.)
(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 statuto-
rily by the power to adjust provisions of EPTL 11-2.3(b)(5) and the
optional unitrust provisions of EPTL 11-2.4.*

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.

In light of the foregoing, and as noted above, it is recommended that
the New York statutes be amended to make clear that, unless the instru-
ment provides otherwise, a trustee has the powers set forth in the regu-
lations 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.

This measure revises a prior legislative proposal submitted by this
Office. Specifically, this measure adopts the recommendation of certain
members of the New York State Bar Association and the Association of the
Bar of the City of New York that (1) the provisions affecting New York's
Power-to-Adjust be made directly within the present Power-To-Adjust
provisions of EPTL 11-2-3(b), and

(2) those provisions preclude any unintended and undesirable negative
implications by clarifying the breadth of a trustee's power under EPTL
11-2.3(b)(5)(A).

This measure, which would have no-fiscal impact on the State, would take
effect immediately and apply to all trusts whenever established.

 
2017-18 LEGISLATIVE HISTORY:

OCA 2017-31


Senate 4866 (Sen. Bonacic) (PASSED in 2017; referred to Judiciary in
2018)

 
2015-16 LEGISLATIVE HISTORY:

OCA 2015-15 Senate 5620 (Sen. Bonacic) (PASSED)

*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 benefici-
aries.... 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."