Magazine article The CPA Journal

New York Trust Law Offers New Planning Opportunities

Magazine article The CPA Journal

New York Trust Law Offers New Planning Opportunities

Article excerpt

In Brief

Legislative Initiatives Facilitate Trust Planning

In recognition of the enormous run-up in the value of investment securities during the 1990s, New York State amended the estates, powers, and trusts law to allow trustees to elect new allocations between income and principal interests under certain circumstances. The legislation provides a means for income beneficiaries to benefit from gains in their trust's investment portfolios that would have been allocable only to principal under prior law. The author briefly explains the public policy issues that led to the law's revision and details the major provisions that affect the new elections.

New York has just enacted two significant changes in its law concerning income and principal of trusts and estates. These changes do not abolish traditional concepts of principal and income. They do, however, authorize executors and trustees to redefine or adjust income, and trustees can now convert an "all income to beneficiary" trust into a unitrust. The changes offer exciting new opportunities for changing beneficial interests in existing trusts (with or without court proceedings). They are all the more attractive because the changeover can be made retroactively, giving the fiduciary the benefit of hindsight in making the decision.

The new legislation, coupled with federal income tax regulations proposed earlier this year by the Treasury Department that affect the definition of trust income under IRC section 643 and corresponding sections, enhances the power to adjust or create a unitrust payout. This will enable many trusts (especially income-only trusts) to implement total return investing for trust beneficiaries. The legislation's new planning alternatives may create a duty to analyze various investing options and their potential returns for trust beneficiaries. Knowledge of their purpose, the policy that led to their creation, and their operations is necessary for an informed analysis.

Background

For almost two centuries traditional legal concepts had strictly divided principal and income interests. The division was so strict that, for purposes of virtual representation (where the representor and the represented must have the "same interest") in judicial accounting proceedings, the rule was that "principal cannot represent income, and income cannot represent principal."

A relatively recent breach of the rule separating principal and income interests came in a judicial ruling on the issue of virtual representation on an accounting proceeding. Matter of Putignano [82 Misc.2d 389 (Surr. Ct. Kings Co. 1975)] redefined "same interest" as an "identity of economic interests in a particular proceeding."

The breach was significantly widened by the 1995 enactment of the Prudent Investor Act (EPTL 11-2.3, effective January 1, 1995).This law's investment philosophy focused a fiduciary to invest for "expected total return of the portfolio (including both income and appreciation of capital) ... for present and future distributions."

This total return investment philosophy mirrored the then current investment philosophy, but created an unbearable tension in many trusts that were prepared and administered under the old principal, and income dichotomy. Income-only trusts, with an income for life to one individual, the remainder to another, and no power to invade principal, were affected most adversely by the new law. Trustees were now told by law to invest one way, but told by the trust instrument to administer another way. Because of the run-up in the stock market, a demand arose for income beneficiaries to enjoy a fair share of the increases in the principal value of trusts invested for their benefit.

Accounting Income Distributable to Beneficiaries

Under the new law, two options are available to redefine trust income:

* the fiduciary's power to adjust, and

* a unitrust option. …

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