EGTRRA has modified the income tax rules relating to the step-up in basis discussed above be- ginning in 2010. To make up for the loss of revenue from the estate tax repeal, a new “carryover basis” regime will become effective. Under this regime, property acquired from a decedent will have a basis equal to the lesser of the decedent’s basis or the fair market value of the property on the date of the decedent’s death. A total $4.3 million of property may, however, still qualify to use the current step-up in basis rules. Up to $3 million of property passing to a surviving spouse, plus up to an ag- gregate of $1,300,000 of property passing to any beneficiaries will qualify for a step-up in basis. These new rules sunset after 2010, resulting in the modified carryover basis rules ending and the cur- rent step-up in basis rules being reinstated in 2011. So just in case, we should all start keeping better records in order to accurately reflect our tax basis in the assets we hold currently. Estates must now make quarterly estimated tax payments in the same manner as individuals, ex- cept that an estate is exempt from making such payments during its first two taxable years. Accord- ingly, the penalties for underpayment of income tax are applicable to fiduciaries. Some states also tax the income of estates, and the representative must see to it that such state statutes are complied with. 41.2 ACCOUNTING FOR ESTATES (a) GOVERNING CONCEPTS. The general concepts governing the accounting for decedent’s es- tates are for the most part similar to those applicable to trusts, but there are some differences. The un- derlying equation expressing the accounting relationship is assets ϭ accountability. However, the representative is concerned not with the long-term management of property for beneficiaries, but rather with the payment of debts and the orderly realization and distribution of the estate properties. The col- lection and the distribution of income are incidental to the main function of the estate’s fiduciary. Whenever an estate accounting is prepared, a reconciliation of the gross estate as finally deter- mined for estate tax purposes should be made with the schedule of principal received at the date by the representative. Every difference should be explainable. (i) Accounting Period. The accounting period of the estate is determined by the dates set by the fiduciary or by the court for intermediate and final accountings; nevertheless, the books must be closed at least once a year for income tax purposes. (ii) Principal and Income. Unless otherwise provided for, the rules outlined below for the trustee should generally be followed by the representative in the allocation of receipts and dis- bursements to principal and income. Such distinctions, although not called for under the will, are frequently mandated by requirements of estate, inheritance, and income tax laws and regulations. (iii) Treatment of Liabilities. The representative picks up only the inventory of assets of the decedent at the inception of the estate. Claims against the estate, after presentation and review, are paid by the representative and are recorded as “debts paid.” The payment of such debts reduces in proportion the accountability of the representative. (b) RECORD-KEEPING SYSTEM. No special type of bookkeeping system is prescribed by law, but a complete record of all transactions must be kept with sufficient detail to meet the requirements of the courts and of the estate, inheritance, and income tax returns. Much of the information may be in memorandum form outside of the formal accounting system. The federal estate tax law requires information regarding assets beyond those ordinarily under the control of the representative (e.g., real estate). Such information must be assembled in appropriate form by the representative, who has responsibility for the estate tax return. (i) Journals. A single multicolumn journal is usually sufficient. It should incorporate cash re- ceipts, cash disbursements, and asset inventory adjustments. Further, it is important to note and keep track of the distinction between principal and income. 41 • 18 ESTATES AND TRUSTS (ii) Operation of a Going Business. If the decedent was the individual proprietor of a going business and if the court or the will instructs the administrator or executor to continue the oper- ation of the business, the bookkeeping procedure becomes somewhat complicated. The books of the business may be continued as distinct from the general estate books, or the transactions of the business may be combined with other estate transactions in one set of records. The best pro- cedure, if the business is of at least moderate size, is to keep the operations of the business in a separate set of books and to set up a controlling accounting in the general books of the executor or administrator. As soon as the representative takes charge of the business, the assets should be inventoried and the books closed, normally as of the date of death. The liabilities should be transferred to the list of debts to be paid by the representative, leaving the assets, the operating expenses and income, and the subsequently incurred liabilities to be recorded in the books of the company. An account should be opened in the books of the business for the representative that will show the same amount as the con- trolling account for the business in the books of the representative. (iii) Final Accounting. The “final” accounting is the report to the court of the handling of the es- tate affairs by the representative, if required. It presents, among other things, a plan for the distribu- tion of the remainder of the assets of the estate and a computation of the commission due the representative for his services. If the court approves the report, it issues a decree putting the propos- als into effect. (c) REPORTS OF EXECUTOR OR ADMINISTRATOR. The form of the reports of the fiduciary will vary according to the requirements of the court and to the character of the estate. In general, however, the representative “charges” himself with all of the property received and subsequently dis- covered plus gains on realizations, and “credits” (or discharges) himself with all disbursements for debts paid, expenses paid, legacies distributed, and realization losses. Each major item in the charge and discharge statement should be supported by a schedule showing detailed information. At any time during the administration of the estate, the excess of “charges” over “credits” should be repre- sented by property in the custody of the fiduciary. It may be necessary to show the market value of property delivered to a legatee or trustee at the date of delivery, in which case the investment sched- ule will show the increase or decrease on distribution of assets, as well as from sales. The income schedule, when needed, should be organized to show the total income from each investment, the ex- penses chargeable against income, and the distribution of the remainder. Exhibit 41.2 is typical of the charge-and-discharge statement, each item being supported by a schedule. 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND (a) NATURE AND TYPES OF TRUSTS. The trust relationship exists whenever one person holds property for the benefit of another. The trustee holds legal title to the property for the benefit of the beneficiary, or cestui que trust. The person from whom trust property is received is known as the grantor, donor, settler, creator, or trustor. An express trust is one in which the trustee, beneficiary, subject matter, and method of administra- tion have been explicitly indicated. An implied trust may be created whether language of an instrument indicates the desirability of a trust but does not specify the details or when the trust relationship is as- sumed in order to prevent the results of fraud, breach of trust, or undue influence. The terms “con- structive,” “resulting,” and “involuntary” trust are sometimes applied to such situations. A testamentary trust is one created by a will. A living trust, or trust inter vivos, is created to take effect during the grantor’s lifetime. Trusts are sometimes created by court order, as in the case of a guardianship. A private trust is created for the benefit of particular individuals, while a public or charitable trust is for the benefit of an indefinite class of persons. Charitable trusts are discussed in Chapter 33. 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND 41 • 19 A simple trust directs the trustee to distribute the entire net income of the trust to the named benefi- ciary. A complex trust gives the trustee the discretionary authority to distribute or accumulate the trust net income to or on behalf of the named beneficiary. In some instances, the trust may start off as com- plex and then convert to a simple trust upon the happening of a specified event, that is, the beneficiary’s attainment of age 21 or 25. A grantor trust exists when both the grantor and beneficiary are the same individual. A grantor trust may be implied if the grantor retains sufficient rights or controls over disposition of trust in- come and/or principal. When a grantor establishes an irrevocable trust inter vivos and transfers assets to it, the grantor has made a completed gift of the property transferred for income, gift, and estate tax purposes. Should the grantor retain any of the rights enumerated in IRC Sections 671 to 679, however, the grantor will be continue to be treated as the grantor or owner of the trust property for income tax purposes only. The grantor will be taxed on the income of the trust instead of the trust or trust beneficiaries (even if they receive a distribution of this trust income). This is re- ferred to as an intentionally defective grantor trust (IDGT) and can be used as an effective estate and financial planning tool. 41 • 20 ESTATES AND TRUSTS ESTATE OF JOHN SMITH Charge and Discharge Statement A. L. White, Executor From April 7, 20XX, to December 15, 20XX First, as to Principal: The Executor charges himself as follows: With amount of inventory at the date of death, April 7, Schedule A $xxx With amount of assets discovered subsequent to date of death, Schedule B xxx With gain on realization of assets, Schedule C xxx $xxx The Executor credits himself as follows: With loss on realization of assets, Schedule C $xxx With amount paid for funeral and administrative expenses, Schedule D xxx With amount paid on debts of the estate, Schedule F xxx With distributions to legatees, Schedule G xxx xxx Leaving a balance of principal, Schedule C, of $xxx Second, as to Income: The Executor charges himself as follows: With amount of income received, Schedule H $xxx The Executor credits himself as follows: With amount of administrative expenses chargeable to income, Schedule D $xxx With distribution of income to legatees, Schedule I xxx xxx Leaving a balance of income, Schedule J xxx Leaving a balance of principal and income of $xxx Balance of principal and income to be distributed to those entitled thereto, subject to the deduction of the Executor’s commissions, legal fees, and the expenses of this accounting, Schedule K. Exhibit 41.2 Sample charge and discharge statement. A trust may include a spendthrift clause that prohibits the beneficiary from assigning his interest before receiving it or prevents creditors from enforcing their claims against the income or principal of a trust fund, or both. Trusts are often used for business purposes, as when property is transferred by a deed of trust instead of a mortgage, when trustees are appointed to hold title and perform other func tions under a bond issue, or when assets are assigned to a trustee for the benefit of creditors. Bankruptcy and insolvency are discussed in Chapter 43. (i) Limitations on Private Trusts. A public trust may be established for an indefinite period, but a trust may not suspend indefinitely the power of anyone to transfer the trust property. The common law rule, otherwise known as the Rule against Perpetuities, limits the duration of a private trust to 21 years after the death of some person who is living when the trust is created. Another common limita- tion in certain states is “two lives in being” at the origin of the trust. Accumulation of the income of a trust is also restricted by state law. A common provision, for ex- ample, is that in the case of a trust created for the benefit of a minor, the income can be accumulated only during the minority of the beneficiary. Even the income of a charitable trust cannot be accumu- lated for an “unreasonable” period. (ii) Revocation of Trusts. A completed trust cannot be revoked without the consent of all the ben- eficiaries unless the right to revoke has been expressly reserved by the grantor. Trusts are therefore sometimes classified as “revocable” or “irrevocable.” (b) APPOINTMENT AND REMOVAL OF TRUSTEES. In general, anyone competent to make a will or a contract is competent to create a trust. The trustee must be one who is capable of taking and holding property and who has the legal capacity and natural ability to execute the trust. (i) Choice of Trustee. The decedent’s will usually names the trustee for a testamentary trust. A grantor who is establishing an inter vivos trust will usually appoint one or more of the following to act as trustee: a relative; his professional adviser, that is, attorney, accountant, broker; a business as- sociate; or an institutional entity, such as a bank or trust company. Each type of trustee has its pros and cons; however, the most important concern is not to choose a trustee that will cause adverse in- come tax consequences. (ii) Methods of Appointment. Seven of the means by which trustees are appointed are: 1. By deed or declaring of trust. The creator of the trust names the trustees in the instrument. 2. By will. The same person may be both executor and trustee under a will, but this dual capacity should be clearly indicated. 3. By agreement. 4. By the court. The court will appoint a trustee when a trust may fail for lack of a trustee, when a trustee refuses to serve or has died, or when a vacancy from any cause exists and no other means have been provided for filing the vacancy. 5. By implication of law. 6. By self-perpetuating boards. When vacancies occur, they are filed by the remaining members of the board. 7. B y the exercise of a power of appointment. The instrument creating the trust may give the remaining trustees, beneficiaries, or any other person the power to appoint a trustee to fill a vacan cy. Specific instructions should be included in the instrument as to the situation establishing a vacancy, the persons who may be appointed, and the manner of making the appointment. 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND 41 • 21 (iii) Acceptance or Disclaimer. Acceptance of an appointment as trustee may be made by posi- tive statement, by qualifying as executor if the appointment is by will, by the acceptance of property of the trust, or by other acts from which acceptance may be presumed. An individual may refuse to accept an appointment as a trustee and should execute and deliver a disclaimer expressing rejection of the appointment. (iv) Resignation of Trustee. According to the Restatement of the Law of Trusts 2d (1 Trusts A.L.I. 234): A trustee who has accepted the trust cannot resign except (a) with the permission of a proper court; or (b) in accordance with the terms of the trust; or (c) with the consent of all the beneficiaries, if they have capacity to give such consent. (v) Removal of Trustee. The court has power to remove a trustee and appoint a successor under certain circumstances. Scott cites, among others, the following six grounds upon which trustees have been removed: 1. Failure to exercise discretion 2. Self-dealing 3. Failure to keep proper accounts, and mingling with trustee’s own funds 4. Incompetency and neglect of duty 5. Conversion of trust property 6. Refusal to obey orders of the court 5 (c) POWERS AND DUTIES OF TRUSTEES. The powers of trustees are obtained both from the provisions and implications of the instrument creating the trust and from the general laws pertain- ing to the trust relationship. The instrument may either expand or restrict the general powers, ex- cept that it may not relieve the trustee from liability for gross negligence, bad faith, or dishonesty. The powers of a trustee may be either (1) imperative or mandatory or (2) permissive or discre- tionary. In other words, they must either be exercised definitely and positively within a given length of time or upon the occurrence of some contingency, or they may be exercised at the dis- cretion of the trustee. (i) General Powers. The nine general powers of a trustee, which include all necessary incidental powers, are: 1. To take and retain possession of the trust property 2. To invest trust funds so as to yield a fair income 3. To sell and reinvest when necessary 4. To sell and convey real estate when necessary to carry out the provisions of the trust 5. To release real estate so that it may earn income 6. To pay for repairs, taxes, and other such expenses in connection with trust property 7. To sue or defend suits when necessary 8. To make contracts that are necessary to carry out the purposes of the trust 9. To pay over and distribute the trust property to those entitled to it 41 • 22 ESTATES AND TRUSTS 5 A. W. Scott, The Law of Trusts, 4th ed. (Little Brown, 1987), 1995 Supplement. The trustee secures possession of the trust property and holds title in his own name. All debtors should be notified of the change in ownership of claims against them in order to hold them directly liable to the trustee. All debts due the trust estate should be collected promptly. T r ust property must be kept separate from the property of anyone else. The trustee will be liable for any loss occurring as a re- sult of their mingling of funds or other property. An exception is usually made when a trust company is acting as trustee; it may deposit cash in trust funds with itself or may mingle various trust funds and de- posit same with designated depositories. (ii) Duties. The 14 duties of the trustee are outlined by Scott as follows: 1. To administer the trust as long as he continues as trustee 2. To administer the trust solely in the interest of the beneficiary (the duty of loyalty as a fiduciary) 3. Not to delegate to others the performance of acts which the trustee sought personally to perform 4. To keep clear and accurate accounts 5. To give to beneficiaries upon their request complete and accurate information as to the admin- istration of the trust 6. To exercise such care and skill as a man of ordinary prudence would exercise in dealing with his own property; and if the trustee possesses greater skill than that of an ordinary prudent man, he must exercise the skill he has 7. To take reasonable steps to secure control of trust property and to keep control of it 8. To use care and skill to preserve the trust property. The standard of care and skill is that of a man of ordinary prudence 9. To take reasonable steps to realize on claims which he holds in trust and to defend claims of third persons against the trust estate 10. To keep the trust property separate from his own property and separate from property held upon other trusts; and to designate trust property as property of the trust 11. To refrain in ordinary circumstances from lending trust money without security 12. To invest trust funds so that they will be productive of income 13. To pay the net income of the trust to the beneficiary at reasonable intervals; and if there are two or more beneficiaries he must deal with them impartially 14. Where there are several trustees, it is the duty of each of them, unless otherwise provided by the trust instrument, to participate in the administration of the trust, and each trustee must use reasonable care to prevent the others from committing a breach of trust 6 (d) PROPER TRUST INVESTMENTS. The trustee is under a duty to invest funds in such a way as to receive an income without improperly risking the loss of the principal. The only general rule as to investment is that the trustee is under a duty to make such investments as a prudent man (the “pru- dent man” rule or “Massachusetts” rule) would make of his own property, having primarily in view the preservation of the estate and the amount and regularity of the income to be derived. In some states (“legal-list” states), the legislatures tell trustees in what they must or may invest funds unless the terms of the trust otherwise provide. Eight kinds of investments that are almost universally condemned are summarized by Scott as follows: 1. Purchase of securities on margin 2. Purchase of speculative shares of stock 3. Purchase of bonds selling at large discount because of uncertainty of repayment at maturity 4. Purchase of securities in new and untried enterprises 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND 41 • 23 6 Id. 5. Use of trust property in the carrying on of a trade or business, even though it is not an untried enterprise 6. Purchase of land or other things for the purpose of resale, unless authorized by the terms of the trust 7. Purchase of second and other junior mortgages 8. Making unsecured loans to individuals or firms or corporations 7 Three types of investments that are almost universally permitted include: 1. Bonds of the United States or of the state or of a municipality thereof 2. First mortgages on land 3. Corporate bonds of a high investment grade In 1990, the American Law Institute adopted the Uniform Prudent Investor Act (the UPIA) and published it in the Restatement of the Law of Trusts, 3rd ed. The UPIA incorporates a new Prudent Investor Rule that has since been adopted by a significant majority of the states in a form that is sim- ilar to, or somewhat comparable to, the scope of these new rules. The Restatement embodies three main themes: 1. Although it is thought that a trustee may not delegate any of his duties, other than certain minis- terial duties, this position is relaxed in that a trustee should, or even must, delegate investment authority to skilled professionals should they lack the required expertise or experience to properly manage the assets within the trust. 2. The costs incurred by the trustee in performing his duties must be reasonable. 3. A trustee is now charged with the responsibility for maintaining the trust portfolio so as to keep pace with inflation. In other words, trustees should invest for the maximum total return on investment without regard for distinctions between principal and income. This is referred to as modern portfolio theory, permitting trustees to invest for capital appreciation as well as current income in the form of interest, dividends, rents, and so forth. (e) TRUSTEE’S PERSONAL LIABILITIES AND LIABILITY FOR ACTS OF CO-TRUSTEE. A trustee is liable to the beneficiary for failure to fulfill his duties under the statutes, general rules of eq- uity, or the provisions of the trust indenture. A trustee must be particularly circumspect in all matters affecting his own property or benefit. He is personally liable for torts committed by himself or his agents and, unless his agreement states otherwise, is personally liable on all contracts made on behalf of the trust. A trustee is not responsible for loss by theft, embezzlement, or accident if he has taken all the pre- cautions that a careful businessman takes in guarding his own property, and if he is strictly following his line of duty as a trustee. If a trustee is not insolvent and mixes trust property with his own, the beneficiary may take the whole, leaving the trustee to prove his own part. If the trustee is insolvent, the beneficiary shares with the other creditors unless definite property can be identified as belonging to the trust. Interest will be charged against a trustee who has mingled trust funds with his own. If bank deposits are made in the individual name of the trustee, he will be treated as a guarantor of the solvency of the bank, even though he uses care in his choice of the bank and has not in any way misused the funds. In general, a trustee is not liable for losses caused by the default or negligence of a co-trustee un- less he has cooperated with the trustee who is at fault, or has known of the trustee’s misconduct and has not taken any steps to prevent it. If, however, each trustee should have interested himself in the matter in question, such as the proper investment of funds, each would be responsible even though he took no part in or knew nothing of the misconduct. All trustees should act together in handling the trust property and should apply to the court for instructions in case they cannot agree. Unanimity is 41 • 24 ESTATES AND TRUSTS 7 Id. usually required for all important decisions in the case of private trusts, but a majority of a board of trustees may act for a charitable trust. In certain circumstances, a trustee may become personally liable for the unpaid estate taxes of a decedent under the theory of transferee liability. Ordinarily, the beneficiary of an estate or trust is ultimately liable for any unpaid estate or gift taxes due on the transfer. The liability is equal to the value of the property received by the recipient as of the date of transfer. A review of IRC Sections 6324 and 6901, primarily, is in order. For example, the trustee of an inter vivos trust that is included in the gross estate for estate tax purposes could result in the trustee being personally liable, as opposed to the beneficiaries, for payment of any attributable estate taxes. Certain trust distributions trigger the GSTT, discussed in Subsection 41.1(l), requiring the trustee to pa y this tax. As a result of this possibility, a trustee should consider maintaining a reserve until he is satisfied that all such taxes are satisfied. Upon making distributions, the trustee should also consider requesting that the beneficiaries indemnify him for any taxes that may be assessed against him. (f) GUARDIANS. If a person is incompetent to manage his own property because of a disability such as infancy or mental incompetency, a guardian will be appointed by the probate or other appro- priate court. The court must approve the appointment of a guardian by will. A guardian is a trustee in the strictest sense of the term. He is directly under the supervision of the court. If possible, only the income from the property should be used for the maintenance and education of the beneficiary; per- mission must be granted by the court before the principal can be used for this purpose. Any sale of real estate must be authorized by the court. A guardian should have the authorization of the court or the direction of a will before paying money to a minor or to anyone for the minor; otherwise he may be compelled to pay the amount again when the minor becomes of age. (g) TESTAMENTARY TRUSTEE. The work of the trustee appointed by a will begins when the ex- ecutor sets aside the trust fund out of the estate assets. One person may serve as both executor and trustee under a will. The testamentary trustee has slightly more freedom in handling the funds than does the executor, and his responsibility may be made less rigorous by provisions of the will. He holds, invests, and cares for the property, and disposes of it or its income as directed by the will. A trustee should have specific authority of a will or the court, or the consent of everyone inter- ested, before carrying on a business. If there are several executors, one can act alone, but trustees must act jointly. (h) COMPENSATION OF TRUSTEES. Trustees are usually allowed compensation for their work, either by provision of the trust instrument or by statute. The statutory provision is usually a graduated percentage of the funds handled. A trustee is entitled to be repaid expenditures reasonably and properly incurred in the care of trust property. The compensation is usually allocated to principal and income in accordance with the spe- cific provision of the indenture or as provided by statute or rules of law. (i) RIGHTS OF BENEFICIARY. The beneficiary has an equitable title to the trust property, that is, he can bring suit in a court of equity to enforce his rights and to prevent misuse of the property by the trustee. Unless the instrument by which the trust is created provides otherwise, the beneficiary, if of age, can sell or otherwise dispose of his equitable estate in the property. The beneficiary has the right to inspect and take copies of all papers, records, and data bearing on the administration of the trust property and income that are in the hands of the trustee. The benefi- ciary may have an accounting ordered whenever there is any reason for suspicion, or any failure to allow inspection or to make satisfactory reports and statements. Whenever it seems advisable, a court of equity will order an accounting. The beneficiary may have an injunction issued to restrain the trustee from proceeding with any unauthorized action, if such action will result in irremediable damage. The beneficiary may present a 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND 41 • 25 petition to the court for the removal of a trustee but must be able to prove bad faith, negligence, lack of ability, or other such cause for the removal. The trustee is entitled to a formal trial. The beneficiary can, if it is possible to do so, follow the trust property and have it subjected to the trust, even if a substitution has been made for the original property, unless it comes into the hands of an innocent holder for value. If the trust property cannot be traced or is in the hands of an innocent holder for value, the beneficiary may bring action against the trustee in a court of equity for breach of trust. If the beneficiary is of age and mentally competent, he may approve or ratify acts of the trustee that would otherwise be a violation of the trustee’s duties or responsibilities. (j) DISTINCTION BETWEEN PRINCIPAL AND INCOME. Probably the most difficult problem of the trustee is to differentiate between principal (corpus) and income. The intention of the creator of the trust is binding if it can be ascertained, but in the absence of instructions to the contrary the general legal rules must be followed. The life tenant (the present beneficiary) is entitled to the net income and the remainderman (the fu- ture beneficiary) to the principal, as legally determined. The principal is the property itself that consti- tutes the trust fund, and the income is the accumulation of funds and other property arising from the investment or other use of the trust principal. Increases or decreases in the value of the assets that con- stitute the trust fund affect only the principal. The income determined under these rules is not always the same as taxable income or income as determined by generally accepted accounting principles (GAAP). The life tenant is entitled to receive only the net income from all sources for the entire term of his tenancy. He is not allowed to select the income from only those investments that are lucrative. The existing rules regarding principal and income are based on the Uniform Principal and In- come Act of 1962 (UPAIA). These rules are, to a great extent, at odds with a trustee’s ability to comply with the modern portfolio theory contained in the Uniform Prudent Investor Act described earlier. As one commentator noted, 8 the incompatibility of the UPIA and UPAIA were reconciled in 1997 by the National Conference of Commissioners on Uniform State Laws. The revised UPAIA accomplishes: this result by way of an adjustment power conferred upon trustees, pursuant to which the trustee is empowered to allocate traditional trust accounting income (e.g., interest, dividends, rents) to prin- cipal and perhaps more importantly, to allocate to income what is typically considered principal. Thus, a trustee can increase the amount currently distributable to a beneficiary, for example, by al- locating capital appreciation to income. Some states (New York, New Jersey, Delaware, and Mis- souri) added an alternative approach to their respective adoptions of the new UPAIA: an optional unitrust provision. Instead of being limited to the annual accounting income actually realized by the trust in any year, the current beneficiary of a unitrust is entitled to an amount equal to a fixed percentage of the value of the trust’s assets determined annually. As a result, the trustee is free to invest for total return absent the need to produce sufficient income to satisfy the current benefi- ciary. By adopting the unitrust alternative, the trustee is relieved of the obligation to determine each year whether an equitable adjustment is warranted. In addition, the unitrust approach pro- vides the current beneficiary with the certainty of knowing what he or she is entitled to each year instead of having to await the trustee’s possible exercise of its discretionary adjustment power. All of the statutes give testators and grantors the ability to opt out of the statutory language by defining how they want principal and income to be recognized and charged. The UPAIA in effect in a given state is operative only if the trust document or will is silent. The U.S. Treasury Depart- ment and Internal Revenue Service have recognized this new trend in trust accounting and have is- sued Proposed Treasury Regulation Section 1.643(a) through (d). 41 • 26 ESTATES AND TRUSTS 8 The commentator is Linda B. Hirschon, Esq., of Greenberg Tauig LLP, New York, in an updated ver- sion of her article “The Unitrust Alternative, A Framework for Total Return Investing,” Tax Manage- ment Memorandum, Vol. 42, No. 23 (November 5, 2001). The updated version of the article appeared in a NYS Bar Association CLE publication entitled, “New York’s New Principal and Income Act, the Power of Adjustment Between Principal and Income and the New 4% Unitrust Option.” The following describes the principal and income rules under the UPAIA of 1962. Trustees are advised to seek to professional counseling to determine whether the 1962 or 1997 revised rules are in effect in their respective state. (i) Receipts of Principal. The following ten receipts of cash or other property have been held to be part of the corpus of the trust and therefore to belong to the remainderman or persons entitled to the corpus: 1. Interest accrued to the beginning of the trust. Bond coupons are not apportioned in the ab- sence of a statute providing for such a division. 2. Rent accrued to the beginning of the trust. Under the common law, rent was not apportioned according to the time expired. 3. Excess of selling price of trust assets over their value in the original inventory or over its pur- chase price. Appreciation, in general, belongs to the trust corpus. 4. The value of assets existing at the time the original inventory was taken but not included in the inventory. 5. Dividends (see discussion below). 6. Proceeds of the sale of stock rights. 7. Profit from the completion of executory contracts of a decedent. 8. Profits earned prior to the beginning of the trust on the operations of a partnership or sole proprietorship. 9. Insurance money received for a fire that occurred prior to the date of the beginning of the trust, or after that date if the property is in the hands of the trustee for the benefit of the trust in general. 10. If trust property is mortgaged, the proceeds may be said to be principal assets, although there is no increase in the equity of the remainderman. (ii) Disbursements of Principal. The following 12 payments, distribution, and exhaustion of as- sets have been held to be chargeable to the corpus: 1. Excess of the inventory value or purchase price of an asset over the amount realized from its sale. 2. Payment of debts owed, including accruals, at the date of the beginning of the trust. 3. Real estate taxes assessed on or before the date of the beginning of the trust. In the case of special assessments made during the administration of the trust, the remainderman may pay the assessment and the life tenant may be charged interest thereon annually during the life of the trust, or else some other equitable adjustment will be made between them. 4. Any expenditures that result in improvements of the property, except those made voluntarily by a life tenant for his own benefit, and all expenditures on newly acquired property that are necessary to put it into condition to rent or use. 5. Wood on the property that the life tenant uses for fuel, fences, and other similar purposes. The life tenant may operate mines, wells, quarries, and so on, that have been opened and op- erated on the property. 6. Losses due to casualty and theft of general trust assets. 7. Expenses of administration except those directly pertaining to the administration of income. For example, legal expenses incurred in defending the trust estate are chargeable to princi- pal; however, the expenses of litigation in an action to protest only the income are payable out of income. 8. Trustee’s commissions in respect to the receipts or disbursements out of principal. Commis- sions computed on income are ordinarily payable out of income. 9. Brokerage fees and other expenses for changing investments should generally be chargeable to principal, since they are a part of the cost of purchase or sale. 41.3 TRUSTS AND TRUSTEES—LEGAL BACKGROUND 41 • 27 [...]... 8 Losses due to casualty and theft of income assets (k) PRINCIPAL AND INCOME SPECIAL PROBLEMS The distinction between principal and income also involves a consideration of such problems as unproductive property, accruals, dividends, bond premium and discount, and depreciation and depletion (i) Unproductive Property When the trustee is required to sell unproductive property and the sale is delayed,... by TV and radio and, to a lesser extent, by billboards Promotions normally account for 2.5% of sales No single customer accounts for more than 5% of sales The analysis indicated that ABC was growing somewhat faster than both the potato chip and the popcorn industries Both the potato chip and popcorn businesses are marked by fairly intense competition in terms of price, promotions, distribution, and advertising... interest and amortization of bond premium and discount Ordinarily it is sufficient to keep one account for cash and one for each type of investment, and to indicate the claims of the principal and income in the total Accounts should be kept with the beneficiaries to show the amounts due and paid to each The trustee should keep records that will meet both the requirements of the income tax law and regulations... industry, including the identity of existing competitors, barriers to entry and exit, and the bargaining position of customers and suppliers Obtain information on the sales force, including its size, structure, methods of compensation, and radius of distribution Information on markets, including principal industries served and 42.2 GENERAL PROCEDURE FOR VALUATION 42 3 • principal customers served,... The standard of value may not be clear from the statutes or the case law It is imperative that the appraiser get guidance from the attorney with regard to the standard of value and the ways in which that standard can be applied to the case at hand 42 16 • VALUATION OF NONPUBLIC COMPANIES The date as of which the marital estate is to be valued frequently is not clear from the statutes or case law and. .. is a producer of potato chips, tortilla and corn chips, and popcorn The company has two plants, one of 205,000 sq ft in Houston, Texas, and a second of 100,000 sq ft in Amarillo, Texas, which was opened in 20XX Products are distributed through 350 routes, of which 225 are company owned and 125 are independent distributors In each of its major markets ABC is either the first or second brand Advertising,... principal and income accounts In addition, a statement showing the changes in the investments, an inventory of the property at the date of the report, and supporting schedules of various items will be required A reconciliation of cash receipts and disbursements is also often prepared 41.5 SOURCES AND SUGGESTED REFERENCES Denhardt, J.G., Jr., and Denhardt, J.W., Complete Guide to Trust Accounting and Trust... manufactures and distributes potato chips, fried pork skins, peanut butter crackers, and popcorn Products are sold throughout the South Hudson Foods Corp., produces meat sticks and beef jerky under the names Slim Jim and Pemmican Distribution is national Interlaken Foods Corp is primarily a producer of chocolate and confectionary products distributed nationally King Foods Inc produces and markets soft pretzels,... Principal and Income Act (Uniform Laws Annotated, Vol 7B, § 5) follows the essence of the Massachusetts rule in treating cash and other property dividends as income and stock dividends as principal (iv) Premium and Discount on Bonds The necessity of accumulating bond discount or amortizing bond premium in order to determine the correct interest income still gives rise to a great deal of confusion in trust and. .. Background information can usually be obtained from trade sources The analyst should understand the growth and cyclical characteristics of the industry He should review the performance of the company relative to its industry, and he should understand the reasons for any pronounced differences in trends between the company and its industry (b) COMPILE FINANCIAL INFORMATION REGARDING THE COMPANY The appraiser . receipts and dis- bursements to principal and income. Such distinctions, although not called for under the will, are frequently mandated by requirements of estate, inheritance, and income tax laws and. re- ceipts, cash disbursements, and asset inventory adjustments. Further, it is important to note and keep track of the distinction between principal and income. 41 • 18 ESTATES AND TRUSTS (ii) Operation. intentionally defective grantor trust (IDGT) and can be used as an effective estate and financial planning tool. 41 • 20 ESTATES AND TRUSTS ESTATE OF JOHN SMITH Charge and Discharge Statement A. L. White,