If you're representing a personal representative or trustee in a complicated estate or trust administration case, the "who gets what" question won't be easy to answer. No surprise there. What may be surprising, especially to lawyers, is how large a role Florida's Principal and Income Act (Ch. 738) or "FPIA" often plays in these cases.
Here's why: trusts and estates have two basic classes of owners: income beneficiaries and principal beneficiaries. Sometimes the same people are both income and principal beneficiaries, sometimes they're not. When they're not, there's an inherent conflict: if a receipt is accounted for as income, the income beneficiary benefits to the detriment of the principal beneficiary, and vice versa. It's up to PR's and trustees to resolve this conflict, and the way they do that is governed by the FPIA.
Who gets what?
In a traditional trust where the income beneficiary receives distributions of income at least annually and the principal beneficiary gets the trust principal at the death of the income beneficiary, the FPIA rules governing income/principal determine the benefits to be shared between the beneficiaries. Same goes for wills: the FPIA governs what the income is and who gets it. However, these are all default rules, and according to F.S. 738.103(1), these rules can all change depending on what the will or trust agreement says. For example, if a trust agreement says that receipts from the sale of a particular asset must be allocated 25% to income and 75% to principal, you do exactly that, and there's no need to decipher the FPIA rules otherwise governing the transaction. Bottom line, to the extent the written instrument provides guidance on accounting for income and principal, this guidance is treated by Florida law as the final authority.
For an excellent explanation of how the FPIA works in real life, you'll want to read Things That May Surprise You About Florida’s Principal and Income Act and Related Accounting Law, Parts I and II, a two-part series published in the Florida Bar Journal by William C. Carroll and John W. Randolph, Jr., which I previously wrote about here and here.
So what changed in 2013?
Since its adoption in 2002, there have been three separate "glitch bills" to fix various problems with the FPIA. During the 2012 legislative session, Florida adopted its fourth FPIA glitch bill [click here]. For an in-depth explanation of the statutory changes, you'll want to read the Legislative Staff Analysis. For a plain-English explanation of the FPIA changes most relevant to those of us in the trenches, you'll want to read Principal & Income Act Updated, published in the Winter 2013 edition of ActionLine by attorney Edward F. Koren and CPA F. Gordon Spoor. Here's an excerpt from the ActionLine article:
Fiduciary Duties; General Principals
While most of Florida’s Principal and Income Act is intended to apply to all fiduciaries, including trustees and personal representatives [F.S. 738.102(4)], certain sections of the Act that were intended to apply to all fiduciaries contained the word “trustee.” Additionally, the word “fiduciary(ies)” was used in certain sections that were only intended to apply to “trustee(s).” The 2012 Revisions clarify some of these inconsistencies by using the word “trustee” rather than “fiduciary” in all sections intended to apply only to trusts. Additionally, the 2012 Revisions added a specific provision that states that, “All provisions of this chapter also apply to any estate that is administered in Florida, unless the provision is limited to a trustee rather than a fiduciary.” [F.S. 738.103(3)].
. . .
Addition of “Carrying Value”
The 2012 Revisions re-introduce the concept of “inventory value” by . . . adopting the phrase “carrying value.” In addition to harmonizing . . . F.S. § 736.08135(2)(b) with Florida Probate Rule 5.346, Appendix B(IV), several statutes within the [FPIA] were revised to reference “carrying value” within the context of income and principal allocations. [F.S. 738.202, 738.401(6), and 738.603].
“Carrying value” is defined in F.S. § 738.102(3) as “the fair market value at the time the assets are received by the fiduciary.” This is different from “cost basis,” which is defined in the Internal Revenue Code. For the estates of decedents, and trusts described in F.S. § 733.707(3) after the grantor’s death (i.e., revocable trusts), the carrying value of assets received upon the grantor’s death is the value as determined for federal estate tax purposes (or date of death if no estate tax return is re- quired). For assets acquired during the administration of the estate or trust, the carrying value is equal to the acquisition cost of the asset.
. . .
Changes to Unitrust Provisions
The ease of administration aspect of a unitrust has caused it to gain wide acceptance. Typically, the annual unitrust amount is based on the valuation of the trust as of a specific date. [F.S. 738.1041(2)(b)2.d.] Recent market fluctuations, however, have impacted the value of trust as- sets, resulting in significant variations in the annual calculation of the unitrust amounts. In an effort to minimize these fluctuations, the 2012 Revisions incorporate a “smoothing rule” to be used when computing the fair market value of the unitrust. The smoothing rule incorporates an “Average Fair Market Value” concept [F.S. 738.1041(1)(a)], which requires that fair market value for purposes of the unitrust computation be computed using the average of the fair market value of the trust’s assets at the beginning of the current year and each of the prior two years.
. . .
Distributions To Residuary And Remainder Beneficiaries
As was the case under the 1974 Act, the 2012 Revisions now require that accounting income be allocated to beneficiaries based upon carrying values, except in cases where dispro- portionate distributions are made. This greatly simplifies trust administration by not requiring valuation of trust assets each time a distribution is made--unless disproportionate distributions are made [F.S. 738.202].
. . .
Distributions From Entities
The 2002 Act provided that cash distributions from entities not in liquidation were allocated to income. In determining if a distribution was in liquidation, absent a representation from the entity, a default rule existed that provided that any distributions made by the entity in excess of 20% of the entity’s gross assets (as shown on the entity’s year end financial statements immediately pre- ceding the initial receipt) was deemed to be made in liquidation.
. . .
The 2012 Revisions attempt to . . . clarify the application of the 20% rule used in determining liquidating distributions. For non-publicly traded entities, cash distributions are treated as income unless they are determined to have been received in liquidation. If the total distributions by the entity exceed 20% of the entity’s gross assets as shown on the entity’s year-end financial state- ments immediately preceding the initial receipt, the distribution will be allocated to income to the extent that total distributions received from the entity – for the number of years or portions thereof while it was subject to the trust – have not equaled a cumulative annual return of 3% of the entity’s carrying value, computed at the beginning of each period included in the measuring period. Distributions in excess of this amount are treated as principal [F.S. 738.401(5)(b)].
For publicly traded entities, cash distributions are treated as income unless they are determined to have been made in liquidation. The 20% default rule is replaced by 10% of the entity’s fair market value as of the beginning of the measuring period. If total distribu- tions exceed this 10% threshold, such distributions will be income to the extent that amounts allocated to income for the number of years (or portion of years) that the trust held an interest in the entity have not equaled a cumulative return of 3% of the entity’s fair market value at the beginning of each measuring period [F.S. 738.401(e)].