SEG C.S.H.B. 2936 75(R)BILL ANALYSIS


PENSIONS & INVESTMENTS
C.S.H.B. 2936
By: Williams
4-18-97
Committee Report (Substituted)



BACKGROUND 

The Internal Revenue Code (IRC) permits the creation of split-interest
trusts called charitable remainder trusts (CRTs).  Such trusts permit
individuals to gift property into a trust, but retain the right to receive
income generated from such property for their lifetimes.  At the death of
the beneficiaries of a trust, the corpus of the trust will pass to a
qualifying charity with no federal estate tax assessed on the value of the
corpus.  The trustee must protect the interest of the charity which will
ultimately receive the corpus, but can also administer the trust for the
benefit of the income beneficiary provided such actions do not constitute
self-dealing with the income beneficiary or in any way harm the remainder
interest passing to charity. 

The IRC requires all "income" to be distributed out of the trust annually
to the income beneficiary of the trust.  However, the IRC permits these
trusts to include make-up provisions in the event the income of the trust
is insufficient to pay out the prescribed amount of income set forth in
the trust language.  For example, assume an individual gifted $1 million
worth of appreciated stock to a charitable remainder trust.  The trust
states the trustee will pay the individual the lesser of the "net income"
of the trust or 9% of the corpus of the trust.  If the trust has no
income, the amount not distributed in a current year can be "made-up" in
future years. 

Let's assume the trustee determines the beneficiary of the charitable
remainder trust does not need income currently, but wishes to create and
manage a diversified portfolio of assets which will benefit both the
ultimate beneficiary, the charity, and the current income beneficiary.
The trustee determines that a deferred annuity, especially a variable
annuity, is the ideal investment vehicle.  The income beneficiary will
receive income when the trustee determines it is most beneficial.  If the
beneficiaries die while there is make-up money in the trust, that amount
all passes to the charity.  Thus, the charity could receive an amount
greater than the original gift to the CRT.   

The trustee reviews the Texas Principal and Income Act and is unclear
whether the build-up in the annuity contract is principal or income since
the Texas statute does not address the issue. The Principal and Income Act
was enacted well before deferred annuities and zero coupon bonds became
popular investment vehicles.  Today trustees seek greater flexibility to
manage assets for growth and income in accordance with a standard that is
prudent and reasonable. 

Four other states (Maryland, South Dakota, Indiana, and Delaware) have
addressed the issue, and codified the language that specifically states
the inside build-up of an annuity is not "distributable income," and
therefore the trustee is not required to pay out the annual earnings of
the annuity. The annuity makes sense, but the IRC says income and
principal is determined under state law. State law is not specific, and
the trustee needs guidance.  HB 2936 would give the trustee the guidance
he or she needs. 

PURPOSE

HB 2936 seeks to clarify the Texas Trust Code relating to charitable
remainder trusts by specifying proceeds from obligations distributable as
income and those determined to be principal, and when such proceeds are
distributable. 

RULEMAKING AUTHORITY
 
It is the committee's opinion that this bill does not expressly grant any
additional rulemaking authority to a state officer, department, agency or
institution. 

SECTION BY SECTION ANALYSIS

SECTION 1.  Amends Subchapter D, Chapter 113, Property Code by adding
Section 113.1021 (a)-(c). 

Sec. 113.1021.  ALLOCATION OF PRINCIPAL AND INCOME IN CERTAIN TRUSTS.

  (a) Defines an increase in the value over the original purchase value of
a deferred              annuity before annuitization and a life insurance
contract before the insured's   death as income.  

  (b) Allows the value increase of an obligation to be available for
distribution upon   receipt of the cash on account by the trustee;
clarifies that surrendered or partially   liquidated obligations must
attribute cash received to the increase first; defines   whom shall
receive the increase in the value of the obligation. 

  (c) Provides for the application of Section 113.109. 

SECTION 2. (a) Effective date is September 1, 1997.

  (b) Clarifies that the change in law is only applicable to principal and
income          subject to allocation on or after September 1, 1997.  Any
principal and income   allocated before September 1, 1997 is governed by
law previously in effect    before that date, continued for that purpose. 

SECTION 3.  Emergency Clause.

COMPARISON OF ORIGINAL TO SUBSTITUTE

SECTION 1.  The original bill amends Section 113.102. Texas Trust Code,
(VTCS and Codes Annotated Property Code, Title 9), and the substitute bill
amends Subchapter D, Chapter 113, Property Code by adding Section 113.1021
which provides for the allocation of principal and income in certain
trusts as stipulated. 

SECTION 2 of the substitute provides conditions for the effective date.