(a) Unless expressly prohibited by the governing instrument, a trustee may convert a trust into a unitrust, as described in this section. A trust that limits the power of the trustee to make an adjustment between principal and income or modify the trust does not affect the application of this section unless it is clear from the governing instrument that it is intended to deny the trustee the power to convert into a unitrust.
(b) The trustee may convert a trust into a unitrust without a court order if all of the following apply:
(1) The conditions set forth in subdivision (a) of Section 16336 are satisfied.
(2) The unitrust proposed by the trustee conforms to the provisions of paragraphs (1) to (8), inclusive, of subdivision (e).
(3) The trustee gives written notice of the trustee’s intention to convert the trust into a unitrust and furnishes the information required by subdivision (c). The notice shall comply with the requirements of Chapter 5 (commencing with Section 16500), including notice to a beneficiary who is a minor and to the minor’s guardian, if any.
(4) No beneficiary objects to the proposed action in a writing delivered to the trustee within the period prescribed by subdivision (d) of Section 16502 or a longer period as is specified in the notice described in subdivision (c).
(c) The notice described in paragraph (3) of subdivision (b) shall include a copy of Sections 16336.4 to 16336.7, inclusive, and all of the following additional information:
(1) A statement that the trust shall be administered in accordance with the provisions of subdivision (e) and the effective date of the conversion.
(2) A description of the method to be used for determining the fair market value of trust assets.
(3) The amount actually distributed to the income beneficiary during the previous accounting year of the trust.
(4) The amount that would have been distributed to the income beneficiary during the previous accounting year of the trust had the trustee’s proposed changes been in effect during that entire year.
(5) The discretionary decisions the trustee proposes to make as of the conversion date pursuant to subdivision (f).
(d) In deciding whether to exercise the power conferred by this section, a trustee may consider, among other things, the factors set forth in subdivision (g) of Section 16336.
(e) Except to the extent that the court orders otherwise or the parties agree otherwise pursuant to Section 16336.5 after a trust is converted to a unitrust, all of the following shall apply:
(1) The trustee shall make regular distributions in accordance with the governing instrument construed in accordance with the provisions of this section.
(2) The term “income” in the governing instrument shall mean an annual distribution, the unitrust amount, equal to 4 percent, which is the payout percentage, of the net fair market value of the trust’s assets, whether those assets would be considered income or principal under other provisions of this chapter, averaged over the lesser of the following:
(A) The three preceding years.
(B) The period during which the trust has been in existence.
(3) During each accounting year of the trust following its conversion into a unitrust, the trustee shall, as early in the year as is practicable, furnish each income beneficiary with a statement describing the computation of the unitrust amount for that accounting year.
(4) The trustee shall determine the net fair market value of each asset held in the trust no less often than annually. However, the following property shall not be included in determining the unitrust amount:
(A) Any residential property or any tangible personal property that, as of the first business day of the current accounting year, one or more current beneficiaries of the trust have or have had the right to occupy, or have or have had the right to possess or control, other than in his or her capacity as trustee of the trust, which property shall be administered according to other provisions of this chapter as though no conversion to a unitrust had occurred.
(B) Any asset specifically devised to a beneficiary to the extent necessary, in the trustee’s reasonable judgment, to avoid a material risk of exhausting other trust assets prior to termination of the trust. All net income generated by a specifically devised asset excluded from the unitrust computation pursuant to this subdivision shall be accumulated or distributed by the trustee according to the rules otherwise applicable to that net income pursuant to other provisions of this chapter.
(C) Any asset while held in a testator’s estate or a terminating trust.
(5) The unitrust amount, as otherwise computed pursuant to this subdivision, shall be reduced proportionately for any material distribution made to accomplish a partial termination of the trust required by the governing instrument or made as a result of the exercise of a power of appointment or withdrawal, other than distributions of the unitrust amount, and shall be increased proportionately for the receipt of any material addition to the trust, other than a receipt that represents a return on investment, during the period considered in paragraph (2) in computing the unitrust amount. For the purpose of this paragraph, a distribution or an addition shall be “material” if the net value of the distribution or addition, when combined with all prior distributions made or additions received during the same accounting year, exceeds 10 percent of the value of the assets used to compute the unitrust amount as of the most recent prior valuation date. The trustee may, in the reasonable exercise of his or her discretion, adjust the unitrust amount pursuant to this subdivision even if the distributions or additions are not sufficient to meet the definition of materiality set forth in the preceding sentence.
(6) In the case of a short year in which a beneficiary’s right to payments commences or ceases, the trustee shall prorate the unitrust amount on a daily basis.
(7) Unless otherwise provided by the governing instrument or determined by the trustee, the unitrust amount shall be considered paid in the following order from the following sources:
(A) From the net taxable income, other than capital gains, determined as if the trust were other than a unitrust.
(B) From net realized short-term capital gains.
(C) From net realized long-term capital gains.
(D) From tax-exempt and other income.
(E) From principal of the trust.
(8) Expenses that would be deducted from income if the trust were not a unitrust may not be deducted from the unitrust amount.
(f) The trustee shall determine, in the trustee’s discretion, all of the following matters relating to administration of a unitrust created pursuant to this section:
(1) The effective date of a conversion to a unitrust.
(2) The frequency of payments in satisfaction of the unitrust amount.
(3) Whether to value the trust’s assets annually or more frequently.
(4) What valuation dates to use.
(5) How to value nonliquid assets.
(6) The characterization of the unitrust payout for income tax reporting purposes. However, the trustee’s characterization shall be consistent.
(7) Any other matters that the trustee deems appropriate for the proper functioning of the unitrust.
(g) A conversion into a unitrust does not affect a provision in the governing instrument directing or authorizing the trustee to distribute principal or authorizing the exercise of a power of appointment over or withdrawal of all or a portion of the principal.
(h) A trustee may not convert a trust into a unitrust in any of the following circumstances:
(1) If payment of the unitrust amount would change the amount payable to a beneficiary as a fixed annuity or a fixed fraction of the value of the trust assets.
(2) If the unitrust distribution would be made from any amount that is permanently set aside for charitable purposes under the governing instrument and for which a federal estate or gift tax deduction has been taken, unless both income and principal are set aside.
(3) If possessing or exercising the power to convert would cause an individual to be treated as the owner of all or part of the trust for federal income tax purposes, and the individual would not be treated as the owner if the trustee did not possess the power to convert.
(4) If possessing or exercising the power to convert would cause all or part of the trust assets to be subject to federal estate or gift tax with respect to an individual, and the assets would not be subject to federal estate or gift tax with respect to the individual if the trustee did not possess the power to convert.
(5) If the conversion would result in the disallowance of a federal estate tax or gift tax marital deduction that would be allowed if the trustee did not have the power to convert.
(i) If paragraph (3) or (4) of subdivision (h) applies to a trustee and there is more than one trustee, a cotrustee to whom the provision does not apply may convert the trust unless the exercise of the power by the remaining trustee or trustees is prohibited by the governing instrument. If paragraph (3) or (4) of subdivision (h) applies to all of the trustees, the court may order the conversion as provided in subdivision (b) of Section 16336.5.
(j) (1) A trustee may release the power conferred by this section to convert to a unitrust if either of the following circumstances exist:
(A) The trustee is uncertain about whether possessing or experiencing the power will cause a result described in paragraph (3), (4), or (5) of subdivision (h).
(B) The trustee determines that possessing or exercising the power will or may deprive the trust of a tax benefit or impose a tax burden not described in subdivision (h).
(2) A release pursuant to paragraph (1) may be permanent or for a specified period, including a period measured by the life of an individual.
(Amended by Stats. 2010, Ch. 621, Sec. 10. (SB 202) Effective January 1, 2011.)