Where’s the Income Distribution?

Where’s the Income Distribution?


In today’s economy, income beneficiaries are suffering because the income distributions they relied on have diminished significantly. The prudent approach in drafting a trust that seeks to maintain an income beneficiary’s standard of living should include provisions which: (1) vest in the beneficiary the authority to require that investments be altered if they are not producing reasonable income; and/or (2) provide the trustee the authority to invade principal if the net income is insufficient to maintain the standard of living of the income beneficiary. However, in practice, these provisions may be overlooked or a situation may exist where the trustee, the remainder persons and the income beneficiary have differing interests. In these situations, New York’s Estates, Powers & Trust Law (“EPTL”) can be the appropriate remedy.
 
The optional unitrust provisions provided under EPTL §11-2.4 require that a trust provide income distributions of 4% of the net fair market value of the trust assets regardless of whether income is actually being generated by the trust assets. Following the first year, the calculation “smoothes” distributions by taking 4% of the average fair market value of the trust according to the prior years net fair market values. Pursuant to EPTL §11-2.4(e), a trust may be treated as a unitrust under the following three scenarios: (1) the governing instrument provides that the statute applies to the trust; (2) the trustee makes an election to have the unitrust statute apply; or (3) the court, pursuant to a judicial proceeding, directs that the unitrust statute applies to the trust. Importantly, EPTL §11-2.4(e)(5)(B) provides that there shall be a rebuttable presumption that the unitrust statute applies. See Matter of Ives, 745 N.Y.S.2d 904, 905-06 (Broome County Sur. Ct. 2002) (stating that “[t]he presumption favoring unitrust is analogous to the presumption . . . favoring the right of survivorship in joint accounts” and that such a presumption can only be rebutted by “substantial evidence to the contrary.”); Matter of Hyde, 10/17/03N.Y.L.J., at 25, col. 1 (New York County Sur. Ct.) (stating that “conversion of a trust to a unitrust is presumptively reasonable”). Also, Treasury Regulations §1.643(b)-1, §20.2056(b)-5(f)(1) and §20.2056(b)-7(d)(1) have made it clear that a trust making unitrust distributions to a surviving spouse will continue to qualify for the estate tax marital deduction as long as the unitrust distribution is between 3% and 5%of the annual fair market value of the trust assets. 
 
As an alternative to converting to a unitrust, the trustee may exercise the power to adjust between income and principal pursuant to EPTL§11-2.3(b)(5), where the rules relating to the Uniform Principal and Income Act apply to the trust. This power enables the trustee to make a fair and reasonable adjustment between principal and income in an effort to balance the competing interests of income and remainder beneficiaries. For example, in today’s economy, a trustee may convert value traditionally reserved for principal, such as the appreciation of a trust asset, to income in order to satisfy the income beneficiary. In determining the extent to which this power is exercised, the EPTL sets forth a number of factors for the trustee to consider and specific situations when the adjustment is prohibited. If a court determines that the trustee has abused its discretion, EPTL 11-2.3-A(c) provides that the court may restore the beneficiaries to the position they held prior to such abuse.
 
The good news is that between the trust in question and the EPTL, it is likely that an income beneficiary will have some ability to force greater income distributions. Thus, income distributions can often be increased despite these difficult financial times.