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G.         ALLOCATION OF RECEIPTS AND EXPENSES
BETWEEN INCOME AND PRINCIPAL ACCOUNTS


Assets
        a) received by the trustee

1) must be allocated to either
        a) principal or
        b) income.

For example,  suppose a trust is created for A for life, remainder to B.

        A is to receive the income for life; at A's death, B is to receive possession of the principal.

The trustee will usually
        a) credit the assets received
                i) to principal, and
        b) credit all income earned
                i) to income.

However,

1) certain receipts are of a mixed nature (both income and principal),
        a) depending upon how they are viewed, and
2) certain expenses are made
        a) to protect both income and principal.

Thus, allocation problems occur.

1.         Uniform Principal and Income Act

As previously noted,

1) the majority of states have enacted the UPIA
        a) to enable a trustee
                i) to make prudent investment decisions
                ii) without having to realize a particular portion of the portfolio's total return
                        (a) in the form of traditional trust accounting income.

To implement adoption
        a) of this new investment regime,

1) the majority of states have also enacted the Uniform Principal and Income Act ("UPAIA'').

The Act,
        a) which
                i) applies to all
                        (a) trusts and
                        (b) estates
                ii) unless the governing instrument provides otherwise [UPAIA ��103(a)],

1) gives
        a) the trustee or
        b) personal representative
                i) an adjustment power
                        (a) to reallocate investment portfolio return [UPAIA ��104].

This adjustment power authorizes the trustee
        a) to characterize items
                i) such as
                        (a) capital gains,
                        (b) stock dividends, etc.,
        b) as income

1) if the trustee deems it
        a) appropriate or
        b) necessary
                i) to carry out the trust purposes,

2) e.g., where the income component
        a) of a portfolio's total return

   is
        a) too small
        b) (or too large)
                i) because of the investment decisions
                        (a) made by the trustee.

a.         Duty of Fairness to All Beneficiaries

The trustee is
        a) under a duty
                i) to administer the trust
                        (a) impartially
                ii) "based on what is fair and reasonable
                        (a) to all of the beneficiaries,"

1) except to the extent that
        a) the trust or
        b) the will
                
           manifests an intent that
                 i) one or more of the beneficiaries is to be favored over the others.
[UPAIA ��103(b)]

b.         Adjustment Power

If the trust describes the amount
        a) that may be distributed to a beneficiary
                i) as "income,"

1) the starting point is that
        a) the trustee must follow traditional trust accounting rules
                i) by distributing
                        (a) interest and
                        (b) dividend income, etc.,
                                (i) to the beneficiary.

If the resulting distribution effectuates
        a) the settlor's
                i) intent and
                ii) the purposes
                        (a) of the trust,

1) then nothing further needs to be done.

If, however, the trustee determines that
        a) by distributing only the trust's "income"
        b) she is unable to comply with the requirement that
                i) all beneficiaries be treated fairly,

1) the trustee may adjust
        a) between
                i) principal and
                ii) income
        b) to the extent
                i) the trustee considers necessary. [UPAIA ��104]

Example:   1) If a trustee decides that the investment portfolio should be composed primarily of financial assets whose total return will result primarily from capital appreciation rather than dividends and interest,

        the trustee can satisfy its duty of fairness to the beneficiaries by allocating capital gains to the income account.

        2) On the other hand, if the trustee decides that the risk and return objectives for the trust are best achieved by a portfolio whose total return includes interest and dividend income that will provide the income beneficiary with an appropriate level of beneficial enjoyment,

        the trustee can decide that it is unnecessary to exercise the power to adjust.

c.         Factors to Be Considered

In deciding
        a) whether and
        b) to what extent
                i) to exercise the adjustment power,

1) the trustee is to consider the following factors:

        (i) The nature, purpose, and expected duration
                i) of the trust;
        (ii) The intent
                i) of the settlor;
        (iii) The identity and circumstances
                i) of the beneficiaries;

        (iv) The needs for
                i) liquidity, regularity
                        (a) of income, and
                ii) preservation and appreciation of
                        (a) capital;

        (v) The nature of
                i) the trust's assets;

        (vi)
                i) The net amount
                        (a) allocated to income
                                (i) under the other sections of this Act and
                ii) the increase or decrease
                        (a) in the value of
                                (i) the principal assets;

        (vii)
                i) Whether and
                ii) to what extent
                        (a) the trust
                                (i) gives or
                                (ii) denies
                                        (a) the trustee the power to
                                                (I) invade principal or
                                                (II) accumulate income;

        (viii)
                i) The actual and
                ii) anticipated
                        (a) effect of economic conditions on
                                (i) principal and
                                (ii) income and

                        (b) effects of
                                (i) inflation and
                                (ii) deflation; and

        (ix) The anticipated tax consequences
                i) of an adjustment. [UPAIA ��104(b)]


d.         Adjustment Not Permitted If Result Would Be Adverse Tax Consequences

The trustee may not make an adjustment

1) if the trustee is a beneficiary of the trust,
2) as
        a) this would give
                i) the beneficiary
                ii) a general power of appointment
                        (a) for estate tax purposes, and
        b) the trust assets would be taxed
                i) in the beneficiary's estate.

Also, an adjustment cannot be made
1) if the adjustment power would
        a) disqualify the trust
                i) for a federal estate tax
                        (a) marital or
                        (b) charitable deduction or
        b) cause the trust's income
                i) to be taxed
                        (a) to the trustee
                        (b) under the Internal Revenue Code's "grantor trust" rules. [UPAIA ��104(c)]

2.         Allocation of Receipts

The Act sets out detailed rules
        a) as to how certain
                i) receipts and
                ii) expenses

           are to be allocated
                i) between
                        (a) the income and
                        (b) principal accounts
                ii) (subject to the trustee's adjustment power).

In general, the allocation rules follow traditional accounting rules.

1) Net rental income is income,
2) as is interest
        a) on a bond or a certificate of deposit. [UPAIA ��405]

The proceeds of
        a) sale of a trust asset
        b) (including
                i) any capital gains or
                ii) profit
                        (a) resulting from the sale)

1) are principal,
2) as are eminent domain awards
        a) for the governmental taking of property. [UPAIA ��404]

a.         Receipts from Entity

Money
        a) received from an entity
                i) such as
                        (a) a corporation,
                        (b) partnership, or
                        (c) real estate investment trust
        b) (e.g., cash dividends, partnership cash distributions)

1) is characterized
        a) as income
2) unless the money
        a) is characterized
                i) as a capital gain
                ii) for federal income tax purposes, or
        b) is received
                i) in partial or total liquidation of the entity.

All property
        a) other than money
                i) received from an entity
        b) (e.g., stock dividends, stock splits)

1) is characterized
        a) as principal. [UPAIA ��401]

b.         Insurance Policies and Other Contracts

Proceeds from
        a) a life insurance policy or
        b) other contract
                i) in which the trust or trustee is named beneficiary

1) are allocated
        a) to principal.

If a contract insures the trustee
        a) against a type of loss
        b) (e.g., loss of profits from a business),

1) the proceeds are allocated
        a) to income. [UPAIA ��407]

1)         Dividends from Insurance Policy

Dividends
        a) on an insurance policy

1) are allocated to the account
        a) from which the premiums are paid. [UPAIA ��407(a)]

c.         Deferred Compensation -Ten Percent Default Rule

For periodic receipts
        a) from a deferred compensation plan
        b) (e.g., pension or profit-sharing plan or individual retirement account),

1) the receipt is income
        a) to the extent that
                i) the payment is characterized
                        (a) by the payor
                        (b) as income, and
2) the balance is principal.

If no part of the payment is characterized
        a) as income or
        b) as a dividend,

1) 10% of the payment is characterized
        a) as income and

2) the balance is principal. [UPAIA ��409]

d.         Liquidating Assets Such as Patents, Copyrights -Ten Percent Rule

A "liquidating asset" is an asset
        a) whose value will diminish over time
                i) because the asset is expected
                        (a) to produce receipts
                                (i) over a limited��period.

Proceeds
        a) from such liquidating assets
        b) (e.g., patents, copyrights, book royalties)

1) are allocated
        a) 10%
                i) to income and
        b) 90%
                i) to principal. [UPAIA ��410]
2) if no part of the payment is characterized.


e.         Mineral Interests -Ten Percent Rule

For most oil, gas, mineral lease, and water right payments,

1) receipts are allocated
        a) 10% to income and
        b) 90% to principal. [UPAIA ��411]

f.         Unproductive Property

Under the former law,

if a particular trust asset produced little or no income,

1) on the asset's sale,
2) the income beneficiary was entitled to
        a) a portion
                i) of the sale proceeds
        b) under the principle of "delayed income."

The objective was
        a) to compensate the beneficiary
                i) for the income
                        (a) the asset would have earned
                        (b) had it been invested
                                (i) more productively.

Consistent with the UPIA,
        a) which looks to total return
                i) from the overall portfolio rather than
                ii) the income from particular assets,

1) the unproductive property rule was repealed
2) except for certain trusts
        a) that are intended to qualify for
                i) the estate tax marital deduction. [UPAIA ��413]

3.        Allocation of Expenses

a.         Expenses Charged to Income

The following expenses are charged
        a) against income:
                i) one-half of
                        (a) the regular compensation
                                (i) of the trustee and
                                (ii) of any person
                                        (A) providing investment
                                                (I) advisory or
                                                (II) custodial services
                                                        (L) to the trustee;

                ii) one-half of
                        (a) all expenses for
                                (i) accountings,
                                (ii) judicial proceedings, and
                                (iii) other matters
                                        (A) affecting both
                                                (I) income and
                                                (II) remainder interests;

                iii) the entire cost of
                        (a) ordinary expenses
                        (b) (including
                                (i) interest (to be payed),
                                (ii) ordinary repairs, and
                                (iii) regularly recurring taxes
                                        (A) assessed against principal); and

                iv) insurance premiums
                        (a) covering the loss of a principal asset. [UPAIA ��501]

b.        Expenses Charged to Principal

The following expenses are charged
        a) against principal:
                i) the remaining one-half of
                        (a) the compensation of
                                (i) the trustee and
                                (ii) any person
                                        (A) providing investment
                                                (I) advisory or
                                                (II) custodial services
                                                        (L) to the trustee;

                ii) the remaining one-half of
                        (a) all expenses for
                                (i) accountings,
                                (ii) judicial proceedings, and
                                (iii) other matters
                                        (A) affecting both
                                                (I) income and
                                                (II) remainder interests;

                iii) payments
                        (a) on the principal of a trust debt;

                iv) expenses of
                        (a) a proceeding
                                (i) that concerns primarily an interest in principal;

                v) estate taxes; and

                vi) disbursements
                        (a) related to environmental matters. [UPAIA ��502]
VII. WILL SUBSTITUTES

A.         IN GENERAL

If
        a) a settlor desires to transfer,
                i) at the moment of her death,
                ii) property interests
                        (a) to a trustee and beneficiaries (i.e., testamentary trust)
                        (b) (or merely to a beneficiary), (i.e., will)

1) she must do so
        a) by a duly executed will.

However,

it is possible for a settlor
        a) to make an inter vivos transfer
                i) by which economic benefits pass
                        (a) at her death
                        (b) without the formalities of a will.

The principal vehicles
        a) by which this is done

1) are
        a) revocable inter vivos trusts, (in CL, all irrevocable, in UTC and CA, all revocable)
        b) life insurance designations, and
        c) bank arrangements.

B.         REVOCABLE INTER VIVOS TRUSTS

A revocable inter vivos trust
        a) avoids the costs and delays
                i) of probate (of a will) and
        b) has a number of advantages
                i) over a will.

The reason
        a) why the revocable trust
                i) is not a will, and
                ii) does not have to comply with the Statute of Wills,

1) is that an interest passes
        a) to the beneficiary
        b) during the settlor's life;
2) it merely becomes possessory
        b) on the settlor's death.

1) The interest can be
        a) revoked or
        b) divested
                i) during the settlor's life,

2) but it passes
        a) subject to revocation.

1.         Determining Whether an Interest Passes

Whether "an interest passes"
        a) during the settlor's life

1) is really a conclusion
        a) derived from applying
                i) the ritual and
                ii) evidentiary
                        (a) policies of the Statute of Wills.

Where a written instrument is delivered
        a) to an independent third-party trustee,

1) there is little doubt that
        a) these policies are satisfied.

Still, certain problems remain
        a) with the revocable trust

1) when the court is not satisfied
        a) that the policies are met.

a.         Where Trustee Given Usual Powers

If
        a) a settlor transfers property
                i) to another (i.e., trustee)
                ii) in a revocable inter vivos trust, and

        b) the trustee has normal trustee powers,

1) the trust is valid
        a) everywhere. (i.e., in any jurisdiction)



Example:   S transfers toT a sum in trust to pay the income to S for life, then on S's death to pay the principal as S directs by will, and if S fails to direct, to pay the principal to C.

        S retains the right to revoke the trust.

         This is a valid trust.






b.         Where Administrative Powers Retained

If
        a) a settlor transfers property
                i) in writing
                ii) to another
                        (a) in a revocable inter vivos trust,

        b) but the settlor retains
                i) administrative and
                ii) investment
                        (a) control over the trustee,

1) it can be argued that
        a) the arrangement is no more than an agency
                i) that ceases
                        (a) at the settlor-principal's death.
        b), thus, not a trust which gives trustee the normal trustee powers.

However,

almost all modern cases sustain a revocable trust of this kind.

Rationale:

        a) The ritual and
        b) evidentiary
                i) policies of the Statute of Wills

1) are satisfied
        a) by
                i) the writing and
                ii) delivery,
2) even though the trustee is not independent.

c.         Declaration of Trust

If a settlor declares herself
        a) the trustee of
                i) a revocable inter vivos trust,

1) the trust might fail
        a) on the theory that
                i) the settlor is still the owner and
                ii) no interest has passed to a beneficiary.

Inasmuch as any act by the settlor-trustee could be deemed
        a) a revocation of the trust,

1) it is hard to see
        a) how any beneficiary would ever have any enforceable right
                i) against the settlor-trustee.

Nonetheless,

such a trust has been upheld in modern cases

1) where the settlor
        a) notified(i.e., declare) third parties or
        b) took some action
                i) that made clear her intention to create a trust.

Example:    S declares herself trustee of shares of stock in Bay View Corporation.

        The income is payable to S; the trust is revocable at any time, but if it remains unrevoked at S's death, the stock is payable to B.

        S notifies the corporation(i.e., some action) that she is holding the stock under a declaration of trust.

         The trust is valid.




Comment:    If S merely wrote out a declaration of trust, which she kept in her desk drawer, and did not change the name on the corporation's books or notify anyone,

         probably no trust would be created.

        The courts want to be sure that S intended to make a binding transfer, even though revocable. The witnessing of a declaration of trust may give that assurance.

2.         Advantages of Revocable Trust

A revocable inter vivos trust
        a) is widely used
                i) in estate planning and
        b) has the following advantages:

a.         Management of Assets

Example :   Harold has retired, and he and his wife, Wanda, do a lot of traveling in their motor home.

        This makes management and supervision of Harold's investments rather inconvenient, so Harold transfers his investment assets to Central National Bank as trustee of a revocable trust, to pay the income to Harold for life, then to Wanda for her life, then to distribute the principal to their descendants per stirpes.

This arrangement
        a) provides for effective management of Harold's assets
                i) by a bank
                        (a) with investment expertise and
        b) provides the other benefits
                i) described below.

b.         Planning for Incapacity -Avoidance of Guardianship

Suppose that
        a) Harold,
                i) in the above example,
                ii) has a stroke and is incapacitated.

If
        a) Harold had not established the revocable trust
        b) (and if Harold had not given
                i) Wanda or
                ii) some other family member
                        (a) a "durable" power of attorney),

1) it would be necessary
        a) to have
                i) Harold adjudicated
                        (a) an incompetent and
                ii) a guardian appointed
                        
        b) to manage his assets.

But because Harold transferred
        a) legal title in his investment assets
                i) to the bank as trustee,

1) the trust continues to operate
        a) for Harold's benefit
        b) without the necessity of a guardianship administration.

c.         Avoidance of Probate

Suppose
        a) Harold dies,
                i) survived by
                        (a) Wanda and
                        (b) their children.

Because legal title to Harold's investment assets is held
        a) by the bank as trustee,

1) the assets are not subject to
        a) probate administration.

The assets continue to be held
        a) for the benefit of Wanda (and the children)
        b) without the expenses and delays of a probate administration.

d.         Secrecy

1) A will is a public record, but
2) an inter vivos trust is not recorded anywhere.

Secrecy
        a) as to
                i) assets and
                ii) beneficiaries

1) is thus available.



e.        Choice of Law

The settlor can
        a) select
                i) as trustee
                ii) a person
                        (a) living in another state and
        b) provide that
                i) the law of
                        (a) that other state

                   shall govern the trust.

Local restrictions
        a) on testation

1) can thereby be avoided
        a) -e.g., by choosing a state
                i) that
                        (a) permits spendthrift trusts, or
                        (b) permits a spouse's statutory forced share
                                (i) to be avoided
                                        (A) by a revocable trust.

f.         Defeat Spouse's Forced Share?

In almost all common law states,

the surviving spouse is given
        a) a forced share
        b) (usually one-third or one-half)
                i) in the decedent's estate
                ii) at death.

By
        a) putting her assets
                i) in a revocable trust and
        b) removing them
                i) from her estate,

1) a person can
        a) in some states
        b) prevent the spouse
                i) from sharing in her property.

In most states, however,

1) a revocable trust
        a) is deemed
                i) an illusory transfer and        
        b) can be set aside
                i) to the extent of the spouse's forced share.

3.         "Pour-Over" Gift from Will to Revocable Trust

Suppose that
        a) S has created a revocable trust
                i) that will continue
                        (a) after her death
                ii) for the benefit of
                        (a) her nephews and nieces.

By her will,

1) S wants to bequeath her residuary estate
        a) in trust
        b) for the same nephews and nieces.

One approach might be
        a) for S's will
                i) to create a testamentary trust.

However, this would result in
        a) two trusts
                i) for the same beneficiaries,
        b) two sets of trustee's fees, and
        c) added complications.

Instead,

S's will might provide:

        a) "I bequeath my residuary estate
                i) to the First National Bank,
                        (a) trustee
                                (i) under an instrument of trust
                                        (A) executed by me on May 11, 2010,
                ii) to be
                        (a) added to and
                        (b) administered
                                (i) in accordance with the trust terms,
                                        (A) including any amendments thereto."

Such a gift
        a) to an inter vivos trust
        b) (called a pour-over gift in practice)

1) is valid
        a) under the Uniform Testamentary Additions to Trusts Act ("UTATA"),
                i) which has been adopted by most states.

The statute thus permits the integrated disposition
        a) of testamentary assets
        b) with a trust
                i) created during the settlor's lifetime. [UTATA ��1]

a.         Trust Must Be in Existence Before or Executed Concurrently with Will

A pour-over gift
        a) from a will
        b) to an inter vivos trust

1) is not valid
2) unless the trust was executed
        a) prior to or
        b) contemporaneously with
                i) the will. (i.e., not after the will execution)

If
        a) the testator's will (making a pour-over gift) is executed on a Monday
        b) but the trust is established two weeks later,

1) the pour-over gift
        a) is invalid and
        b) lapses.(because, it is by incorporation by reference, thus the trust must exist already)



b.         Trust May Be Amendable and Revocable

A pour-over gift
        a) by will

1) is valid
2) even though the inter vivos trust is
        a) amendable and
        b) revocable.

The gift is
        a) to the trust
                i) as it exists at the testator's death,
                ii) including amendments to the trust
                        (a) made after the will was executed.

c.      

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