California CPA March/April 2024 | Page 25

accounting income , so expenses need to be allocated to offset gross income . Expenses incurred in income producing activities are allocated to those activities , but many expenses are not related to a specific source of income . In addition , trusts that receive tax-exempt income must allocate administrative expenses between taxable income and tax-exempt income . There is no mandatory rule with allocation of the administrative expenses , but the normal practice is to make the allocation based on the percentage of the tax-exempt income to the total income included in DNI .

However , another method would be to make the allocation using percentage of tax-exempt income to the values of the assets in the trust . Once the allocation has been made the remaining administrative expenses need to be allocated as well . Again , this needs to be reasonable but two options there are provided by most if not all of the tax software programs .

First , they can be allocated amongst the various types of income on a pro rata basis . Second , they can be allocated based on the type of income with interest and dividends receiving an allocation first and other income or capital gains thereafter . The second method could yield a greater benefit from the administrative expense . This election is made on an annual basis .

When looking at making this allocation , one should consider the difference between Fiduciary Accounting Income and Trust Taxable Income . In particular , administrative expenses that are allowed under federal tax law versus state fiduciary law .

Unitrusts There is a trust strategy developed around the total return concept whereby the income distribution is based on a percentage of the total invested assets of the trust . Under this concept the income distribution is based on a percentage return on assets in the trust . This is not an annual election made by the trustee but a change in the trust operation itself ( assuming that the trust is in existence and is computing its income distribution under the fiduciary accounting rules ).

The UPIA specified a maximum limit on the percentage that can be used . For California the percentage was 4 percent . California adopted the Uniform Fiduciary Income and Principal Act (“ UFIPA ”), which is effective in 2024 . With UFIPA between 4 percent and 6 percent can be chosen . To convert a normal trust to a unitrust the trustee will have to permission for the court of jurisdiction . A good reason to convert to a unitrust would be a situation where because of the character of the assets the trust is not distributing an amount that is sufficient to meet the normal living expenses of the beneficiary . Capital gains are distributed after ordinary income with a unitrust .

The various elections and strategies discussed above are not a complete treatise on the topic . They are intended to be a summary of the various options that relate to distributions from trusts and estates . The reader is advised to review other information related to these topics .

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