How to accomplish a Private Total Return Unitrust conversion for a trust.

March 28th, 2016

The power of a trustee to adjust receipts and disbursements between principal and income was recognized under Section 104 of the 1997 Uniform Principal and Income Act (“UPIA”).

Most states have recently enacted enabeling legislation setting forth the various steps required to convert a net income trust to a private unitrust. State statutes may typically include many of the following provisions:

  • Definitions – Terms used in the statute.
  • Fiduciary duties and general principals – requirement for a fiduciary allocating receipts and disbursements between principal and income.
  • Fiduciary power to adjust between principal and income to the extent the fiduciary considers it necessary.
  • Total return unitrust definitions.
  • Indication that the trustee may in it’s sole discretion and without judicial approval convert an income trust to a total return unitrust if the trustee adopts a policy for the trust stating that future distributions from the trust will be unitrust amounts not net income.
  • The trustee will send notice of its intention to take such action along with copies of such written policies to the grantor, if living, qualified trust beneficiaries, and trust advisors and protectors.
  • No person receiving such notice shall object within a stated time period.
  • The fair market value of the trust shall be determined at least annually.
  • The percentage used in determining the unitrust amount shall be either a stated fixed amount or within a certain range.
  • If the trustee desires to convert an income trust to a unitrust, but does not want to do so under the statutory provisions, the trustee may in many cases petition the appropriate court for an order to do so.

See Internal Revenue Service (“IRS”) Regulation Section 1.643(b)-1 (“643 Regs.”) redefining a safe harbor income amount of between 3% and 5% of the fair market value of the trust assets as being a “reasonable apportionment” of the total return of the trust. A switch using the method authorized by state statute will not constitute a recognition event under Internal Revenue Code Section 1001 and will not result in a taxable gift from the trust’s grantor or any of the trust’s beneficiaries. The 643 Regs clarify circumstances under which capital gains are included in the Distributable Net Income (“DNI”) of the trust. See, “Drafting to Allow for the Inclusion of Capital Gains in DNI under the 643 Regulations”, by Timothy A. Nordgren, North Carolina Bar Association, 2014.

Summary

Hopefully, this report will provide useful information on the advisability of the potential investment and administrative benefits of converting a trust from an income trust to a private total return unitrust.

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