by Steven B. Gorin, Esq.
Thompson Coburn LLP
St. Louis, MO
At the request of the American Bar Association's Real Property, Trust & Estate Law Section (the “Section”) and the American College of Trust & Estate Counsel, the Uniform Law Commission has revised sections 409 and 505 of the Uniform Principal and Income Act (“UPIA”).
UPIA Section 409
Revenue Ruling 2006-26 (the “Ruling”) provides a safe harbor for IRAs and defined contribution retirement plans (either of which was referred to as a “fund”) that are payable to a marital deduction trust to qualify for the marital deduction, but only if the trust satisfies two requirements. First, the surviving spouse must be entitled to withdraw the fund's income. Second, the fund's income must be determined as if the fund itself were a trust. The Ruling criticized UPIA section 409 for the way it determined the marital trust's income (which criticism could also apply to some states that have not adopted UPIA section 409). In response to the Ruling's criticism of section 409, the Uniform Law Commission has amended that provision to make it comply with the Ruling's safe harbor requirements. The Section has formally requested that the IRS modify the Ruling to provide that the new version of UPIA Section 409 satisfies the Ruling's safe harbor.
UPIA Section 505
It is not uncommon for trusts that are required to pay income to a beneficiary to own an interest in a partnership (including an LLC) or other entity where the owners are taxed on the entity's income whether or not the owners receive the income. Many such entities distribute to their owners only enough income to enable the owners to pay their tax obligations and reinvest the rest of the income in business operations.
This strategy works well when the owners are individuals, but it can cause problems when the owners are mandatory income trusts, as described below. Suppose a trust has a 40% combined federal and state income tax rate and receives a Schedule K-1 reporting $100x of the entity's income. The entity distributes $40x to the trust to fund the tax obligation. If the trust is required to distribute the full $40x to the beneficiary, the trust will be taxed on $60x of income ($100x minus the $40x that was distributable to the beneficiary), but the trustee will have no money remaining to pay its income taxes. The beneficiary would be liable for the taxes on the $40x distribution. How should the trust and beneficiary share the money that the entity distributed to pay its owners' taxes?
Before amendment, UPIA section 505 provided rules for calculating how much the trust needs to distribute and how much it can use to pay taxes. The language was ambiguous and led to litigation. The proposed change clarifies that the trust will keep enough money to pay its taxes and distribute the balance of the income to the mandatory income beneficiary.
The individual at the Uniform Law Commission who tracks enactments and can help those interested in having their states enact these changes is:
Kieran P. Marion, Legislative Counsel
Uniform Law Commission (NCCUSL)
111 N. Wabash Avenue, #1010
Chicago, IL 60602
The ABA Advisor who worked on these amendments from start until finish is the author of this column, Steven B. Gorin. He is continuing to work with the Joint Editorial Board for Uniform Trust & Estate Laws on possibly extending the changes to UPIA section 409 so that they apply in all situations involving retirement plans, annuities, and similar funds, not just where funds are payable to a marital trust.
All Bloomberg BNA treatises are available on standing order, which ensures you will always receive the most current edition of the book or supplement of the title you have ordered from Bloomberg BNA’s book division. As soon as a new supplement or edition is published (usually annually) for a title you’ve previously purchased and requested to be placed on standing order, we’ll ship it to you to review for 30 days without any obligation. During this period, you can either (a) honor the invoice and receive a 5% discount (in addition to any other discounts you may qualify for) off the then-current price of the update, plus shipping and handling or (b) return the book(s), in which case, your invoice will be cancelled upon receipt of the book(s). Call us for a prepaid UPS label for your return. It’s as simple and easy as that. Most importantly, standing orders mean you will never have to worry about the timeliness of the information you’re relying on. And, you may discontinue standing orders at any time by contacting us at 1.800.960.1220 or by sending an email to firstname.lastname@example.org.
Put me on standing order at a 5% discount off list price of all future updates, in addition to any other discounts I may quality for. (Returnable within 30 days.)
Notify me when updates are available (No standing order will be created).
This Bloomberg BNA report is available on standing order, which ensures you will all receive the latest edition. This report is updated annually and we will send you the latest edition once it has been published. By signing up for standing order you will never have to worry about the timeliness of the information you need. And, you may discontinue standing orders at any time by contacting us at 1.800.372.1033, option 5, or by sending us an email to email@example.com.
Put me on standing order
Notify me when new releases are available (no standing order will be created)