Trust Allocation of Timber Sale Proceeds under the Uniform Principal and Income Act

The Uniform Principal and Income Act (the “UPAIA”) was completed by the Commissioners on Uniform State Laws in 1997.  The UPAIA was adopted shortly afterward by the State of Idaho.  It has been adopted as of the writing of this article with minor variations by 44 states and the District of Columbia.

Much attention has been paid to a few of the innovative provisions of the UPAIA such as the Trustee’s “Power to Adjust” and the treatment of receipts by Trustees from entities.  However, one innovative provision has had little real attention paid to it in professional literature (at least that I can find) and that is §412 (§68-10-412 of the Idaho Code) of the UPAIA dealing with the allocation of receipts by a Trustee from the sale of timber.

§412 was innovative in that it formally recognizes timber as a renewable resource, rather than a depleting resource such as minerals, water and other natural resources.  Prior law in many states only instructed Trustees to allocate the proceeds of the sale of timber between income and principal in a manner that is “reasonable and equitable.” Thus, timber was treated in many cases as a depleting resource for trust accounting purposes. The result was an inconsistent use of statutory depletion rates, the federal income tax depletion rate, or some other method concocted by a trustee and the trust’s accountant.

Idaho adopted the UPAIA with no changes to §412.  Here is the current Idaho statute:

68-10-412. TIMBER. (a) To the extent that a trustee accounts for receipts from the sale of timber and related products pursuant to this section, the trustee shall allocate the net receipts:

1)  To income to the extent that the amount of timber removed from the land does not exceed the rate of growth of the timber during the accounting periods in which a beneficiary has a mandatory income interest;

(2)  To principal to the extent that the amount of timber removed from the land exceeds the rate of growth of the timber or the net receipts are from the sale of standing timber;

(3)  To or between income and principal if the net receipts are from the lease of timberland or from a contract to cut timber from land owned by a trust, by determining the amount of timber removed from the land under the lease or contract and applying the rules in paragraphs (1) and (2) of this subsection; or

(4)  To principal to the extent that advance payments, bonuses, and other payments are not allocated pursuant to paragraph (1), (2) or (3) of this subsection.

(b)  In determining net receipts to be allocated pursuant to subsection (a) of this section, a trustee shall deduct and transfer to principal a reasonable amount for depletion.

(c)  This chapter applies whether or not a decedent or transferor was harvesting timber from the property before it became subject to the trust.

(d)  If a trust owns an interest in timberland on the effective date of this chapter, the trustee may allocate net receipts from the sale of timber and related products as provided in this chapter or in the manner used by the trustee before the effective date of this chapter. If the trust acquires an interest in timberland after the effective date of this chapter, the trustee shall allocate net receipts from the sale of timber and related products as provided in this chapter.”

A Trustee does have the option of using §403 of the UPAIA to allocate receipts and disbursements.  §403 is particularly helpful if a timber operation is an ongoing operation that is operated as a sole proprietorship (as opposed to a corporate entity) by the Trustee.  However, it has been my experience that the sale of timber by many Trustees is an incidental transaction that occurs occasionally over time.  The proper allocation of the proceeds of a timber sale are critical to calculating the interests of the trust’s income and principal beneficiaries.

To calculate the proper allocation between principal and income, the Trustee will need to know  (1) the Net Timber Value of the timber owned by the trust and (2) the growth rate of the timber for the year in which the timber is sold.  The Net Timber Value is the gross Merchantable or Saleable Timber Value minus the estimated harvesting and sale costs. The growth rate is the estimated growth is the estimated annual growth rate of the harvestable timber.  To get both of these numbers, the Trustee will need to engage a timber expert or consultant to evaluate the timber and report on the timber’s value and estimated growth rate.  The growth rate can vary depending upon the type of timber, local environmental factors, and recent climate.

There are two basic calculations described in §412(a).  §412(a)(1) addresses the calculation required if the actual sale of timber is less than the growth rate for the year in which the timber was sold.  §412(a)(2) addresses the calculation required if the actual sale of timber is more than the growth rate for the year in which the timber was sold.

Here are two examples, one for each calculation. The examples are based upon an actual timber evaluation on behalf of an income beneficiary of a trust where the Trustee not only failed to properly manage the trust’s timber, but also inadvertently caused the income beneficiaries not to realize the income to which they were otherwise entitled.  The results were justifiable claims in litigation by the income beneficiary. In both calculations the assumed value of the timber owned by the trust is $2,000,000.  The growth rate reported by the timber expert was 1.5% for the year in question.

Example 1 – §412(a)(1):

Gross Merchantable Timber Value                             $  2,000,000

Estimated Harvesting and Sale Costs                            (     972,331)

Net Timber Value                                                       $       1,027,669

Estimated Growth Rate                                                          1.5%

Value of Current Year Growth                                   $         30,000

Actual Net Proceeds of Sale                                       $          25,000

Amount allocated to Income                                      $          25,000

Amount allocated to Principal                                    $             – 0 –

Note:  Since the amount realized from the actual sale of timber is less than the value of current year growth, the entire amount of the sale is allocated to Income.  Note that, to determine the value of current year growth, the estimated growth rate is applied to the gross timber value, not the net timber value.

Example 2 – §412(a)(2):

Gross Merchantable Timber Value                             $  2,000,000

Estimated Harvesting and Sale Costs                            (     972,331)

Net Timber Value                                                       $       1,027,669

Estimated Growth Rate                                                             1.5%

Value of Current Year Growth                                  $           30,000

Actual Net Proceeds of Sale                                       $          342,556

Amount allocated to Income                                     $            30,000

Amount allocated to Principal                                   $          312,556

§412(a)(3) goes on to say that, if a Trustee receives proceeds of a lease or other contract that represents the sale of timber owned by the trust, such proceeds should be allocated by §412(a)(1) and (2) as well.  Further §412(a)(4) instructs the Trustee to allocate advance payments, bonuses, or other amounts that are not allocated by subsections (1) and (2) entirely to principal.

It is critical that a Trustee properly and accurately calculate the allocations between income and principal of a trust.  While the UPAIA gives Trustees discretion to allocate transactions between income and principal, this discretion should not be exercised in hindsight. Proper allocation of timber sales should be done concurrently with the actual sale so that the Trustee fulfills his or her duties to both income and principal/remainder beneficiaries.

Copyright Steve Masterson 2012. All rights reserved.

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“TRUSTEE SCORECARD®” TRADEMARK REGISTRATION AWARDED

 Masterson Receives Registration by US Patent and Trademark Office

Serving as a Trustee of a Trust can be a daunting process for even the most well-prepared person.   The personal liability for a Trustee can be overwhelming, if the Trustee is even aware of it.  Steve Masterson, of Coeur d’Alene, Idaho, has developed and implemented a review process that can be used by a Trustee, or a Beneficiary of a Trust, to evaluate what kind of job the Trustee is doing managing the Trust.  Masterson calls the review process Trustee Scorecard®.

On Tuesday, October 30, 2012, the US Patent and Trademark Office awarded trademark registration of the term Trustee Scorecard® to S&K Ventures, LLC, an Idaho limited liability company controlled by Masterson.

A Trustee’s duties are described in trust documents and in applicable State laws. These duties carry significant personal obligations and liability. Fiduciary litigation is very costly and fiduciary duties can be unexpectedly broad.  Trustee Scorecard® assists a Trustee in assessing the extent to which he or she is meeting the requirements of the relevant trust documents and applicable State and federal laws. After a thorough review of relevant documents and other materials, a Trustee Scorecard® report is delivered detailing strengths and weaknesses, and where applicable, recommendations for improvement.

Trustee Scorecard® is appropriate for Trustees of irrevocable trusts and revocable trusts  where the Trustee is a different person or entity than the current or future beneficiaries. Beneficiaries, you can take advantage of Trustee Scorecard® to assess the job your Trustee is doing for you.  Trustee Scorecard®  can be used to evaluate individual, professional, or corporate Trustees.

Steve Masterson has 29 years experience managing a wide variety of trust and estate assets, designing estate plans for high net worth clients, and creating custom financial solutions for unique family circumstances. He developed his expertise while working for Gardere & Wynne, LLP, Dallas, Texas, Wells Fargo Bank, N.A, and two independent trust companies.  He holds a B.A. from Dallas Baptist University and completed the Texas Bankers Association School of Trust Banking at Southern Methodist University.

Further information can be found at http://www.idahotrustee.com, by email to samasterson61@gmail.com, at www.facebook.com/TrusteeScorecard.

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Omissions Are [Still] Not Ambiguous

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The Power of Words

The words we use can fall flat or they can be powerful.  You must watch this video and then use the idea to re-evaluate how you say what you say, about yourself and about your business.

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Entrepreneurialism and Jobs

A departure here from my usual posts regarding trusts and estates, but I’m an entrepreneur offering several services and products within three separate entities. The article by Walter Russell Mead to which I’ve linked below hits the nail on the head with regard to the current issues we face in our economy. It’s a long article, so I’ll include the most pertinent quote first, then the link to the article.

“Currently, the American legal and regulatory system is set up to bind as many people to employers as possible. The government wants you to be a wage slave and sets up a regulatory framework that keeps as many of us as possible yoked to bosses and management. The IRS doesn’t like the self-employed, fearing they many conceal income. Banks and credit card companies view such people with suspicion, and it is notoriously difficult for start ups and part time enterprises to have access to formal finance. Many services are hard for the self-employed to get on terms like those made available to employees of large corporations: from health insurance to retirement planning, many things are harder and more expensive for the self-employed. The payroll tax system is brutal: the self-employed pay both the employer and employee halves of Social Security and Medicare taxes, almost 20 percent of income and likely to go higher. Many cities will tack on unincorporated business taxes, mass transit taxes, and other interesting feudal exactions and dues.

“There are other, subtler ways in which the current system favors old style large employers over small firms.  The cost of hiring people can be prohibitively high for small businesses: the paperwork involved in hiring so much as a cleaning person or babysitter can be cumbersome.  Hiring full time workers involves negotiating the requirements for worker compensation, unemployment insurance and much else. The cost of these barriers cannot be calculated: jobs foregone, businesses stifled in their cradles, ideas untested, innovations untried.

“In order to create the kind of job and service explosion that can provide better incomes for more Americans going forward, the government needs to shift policy. It must favor the small firm and entrepreneur: the owner-proprietor group needs to become the apple of the government’s eye. Their taxes should be cut; their paperwork burdens drastically reduced; regulations should be rewritten and simplified to meet their needs.”

Beyond Blue 5: Jobs, Jobs, Jobs

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Death Tax on the Middle Class

Sen. Max Baucus (D-Montana) attempted to sneak this provision into the transportation bill currently working it’s way through the Senate. It was removed, but Baucus has made it clear that this is a high priority for him. By taking away distribution options from an inherited IRA or an inherited 401K, Baucus’ provision forces an acceleration of the income tax.  Check it out:

Five-year Rule Proposal

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Estate Tax Attorney and Accountant Full Employment Act of 2012

Of course, that is not the title of any piece of legislation, pending or passed. In Obama’s budget proposal, presented the other day, tax rates are raised for the mostly hard-earned (and previously taxed) assets of dead people. In addition, several planning techniques are attacked that will make planning a bit more difficult.

But the truth is, just like during earlier times of even higher estate tax rates, those wealthy families who are willing to pay attorneys and accountants to plan appropriately will substantially mitigate or even avoid the estate tax.  Those estates that will actually get socked with the higher rates are those where the dead person was not willing to pay to plan.

Another bone to pick here is that FOB (friend of Barack) Warren Buffett (whose estate will pay zero estate tax) owns several life insurance companies. One of the most common ways to fund large estate tax bills is to buy loads of life insurance. FOB Warren is getting rewarded for his support.

Here is an article from Forbes that goes through the details of the proposal. I don’t agree with including “Wealth Advisors” in the title since those advisors will make more money by designing and implementing new estate plans to mitigate the increased tax burden.

Obama Declares War on Rich Folks and Wealth Advisors

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