The Uniform Fiduciary Income and Principal Act is a model law, approved by the Uniform Law Commission in 2018, that gives trustees and executors default rules for dividing trust money between income (the earnings assets produce) and principal (the assets themselves and what replaces them). It replaced the 1997 Revised Uniform Principal and Income Act so the rules would fit modern total-return investing, which the older act never contemplated. The split matters because it decides how much a current beneficiary receives now versus how much stays in the trust for future beneficiaries.
The Trust Document Comes First
Every rule in the act is a default. If the trust instrument says something different, the instrument wins, and the act expressly directs fiduciaries to administer the trust according to its terms.1Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 201 A trust can allocate all capital gains to income, keep certain dividends in principal, or set its own expense-sharing formula.
There is a federal tax limit on that freedom. Trust provisions that “depart fundamentally from traditional principles of income and principal” generally will not be recognized for income tax purposes.2eCFR. 26 CFR 1.643(b)-1 – Definition of Income A trust that classified all ordinary dividends and interest as principal would lose favorable tax treatment. Drafters have wide latitude, but straying too far from the act’s framework creates tax problems that cost the beneficiaries real money.
How Receipts Are Classified
Articles 4 and 5 contain the specific default rules.3Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Prefatory Note The guiding idea is simple: regular earnings on trust assets go to income, while the assets and the proceeds of selling them stay in principal.
Ordinary Receipts
Distributions from corporations and partnerships are income unless they represent a partial or complete liquidation, in which case they go to principal. Bond interest, cash dividends, and rent are standard income receipts. If the trust sells an asset and receives cash or other property in exchange, that stays in principal because it just replaces one principal asset with another.
Insurance Proceeds
Life insurance payouts and settlements for property damage, destruction, or loss of title are allocated to principal. Dividends on insurance policies follow the source of the premiums: income if premiums were paid from income, principal if paid from principal. One exception runs the other way. Insurance that compensates for lost occupancy, lost income, or lost business profits goes to income.4Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 407
Liquidating Assets
Patents, copyrights, and leaseholds produce receipts for only a limited time because the asset itself is being consumed. When the fiduciary can determine the asset’s remaining value, the share of each receipt that represents a return of value goes to principal and the rest to income. When the value cannot be determined, the default is a 10/90 split, with ten percent to income and ninety percent to principal.5Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Liquidating Assets The heavy tilt reflects that most of each payment is really a return of the asset itself, not true earnings.
Retirement Accounts and Deferred Compensation
Receipts from IRAs, retirement plans, and deferred compensation follow Section 409. A payment the payor characterizes as interest or a dividend is income. If the fiduciary determines that total payments will come to less than ten percent of the fair market value of the plan interest, those payments are also income. Everything else goes to principal, which in practice is the bulk of most retirement distributions.6Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 409 The character depends on what the payor calls the payment and on its size relative to the account, not simply on whether cash arrived.
Natural Resources and Timber
Mineral, water, and timber interests get special treatment because the asset itself is depleting.
Delay rentals and annual lease payments on mineral interests go to income, and so do receipts from renewable water interests. Receipts from non-renewable water, royalties, shut-in-well payments, take-or-pay payments, and bonuses must be divided equitably between income and principal. The act creates a useful presumption: the allocation is equitable if the amount sent to principal equals the depletion deduction allowed under the Internal Revenue Code.7Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 411 That gives fiduciaries a defensible number instead of a guess.
Timber receipts turn on the relationship between harvest and growth. If the amount cut does not exceed the growth rate, net receipts are income, because the trust is essentially harvesting only the interest on its timber investment. When cutting exceeds growth, or when standing timber is sold outright, the receipts go to principal, and the fiduciary must deduct a reasonable amount for depletion and move it to principal.8Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 412 Advance payments and bonuses that do not fit the growth-rate analysis default to principal.
How Expenses Are Allocated
Outflows follow a parallel logic. Routine costs of generating income come from income. Costs that protect long-term value come from principal.
Ordinary expenses of administering, managing, or preserving property and distributing income are paid from income when income is sufficient. That covers ordinary repairs, regularly recurring property taxes, interest on debts, and insurance premiums on policies protecting principal assets or the income they produce.9Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 501
Fiduciary compensation and fees for investment advisors or custodians are split equally, half from income and half from principal. The same even split applies to expenses for accounting, court proceedings, or other matters that involve both the income interest and future interests. That keeps overhead from falling entirely on one side.
Major one-time costs come from principal. These include estate and inheritance taxes, costs of preparing property for sale, and payments on trust debts.10Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 502 When a trust asset secures a loan, the interest comes from income and the principal repayments on the debt come from the principal account. Environmental costs, from assessment and remediation to penalties and defense, are charged to principal, including the insurance premiums covering those risks.11Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 502
The Power to Adjust
The default rules work well for traditional income-producing assets like bonds and rental properties. They produce lopsided results when a trustee pursues a total-return strategy weighted toward growth stocks that generate little traditional income. The power to adjust is the primary fix.
A fiduciary may reallocate amounts between income and principal, without court approval, when doing so will help administer the trust impartially.12Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 203 In practice this often means reclassifying some capital gains as income so the current beneficiary receives a reasonable payout while the portfolio stays invested for growth. It can also run in reverse when assets produce outsized current income at the expense of long-term value.
The fiduciary should weigh the nature of the assets, the anticipated duration of the trust, the effects of inflation, and the settlor’s intent, and must record the decision in writing. This is not a blank check. The fiduciary must genuinely be unable to achieve a fair result through the default rules alone.
A fiduciary who is not an “independent person” under the act cannot exercise the power. The restriction covers fiduciaries who are also beneficiaries and other situations where self-interest could cloud judgment. An independent co-fiduciary may exercise the power instead, and if none exists, the restricted fiduciary can appoint one, even a special fiduciary with limited powers, specifically to make the adjustment decision.13Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 203 The act also lets a fiduciary release or delegate the power to a co-fiduciary when holding it would create adverse tax consequences.
Converting to a Unitrust
Rather than making case-by-case adjustments, a fiduciary can convert the trust to a unitrust. The income beneficiary then receives a fixed percentage of total asset value each year, which removes the need to classify every receipt for distribution purposes.
To stay within the federal tax safe harbor, the unitrust rate must fall between three and five percent of the fair market value of the trust’s assets.2eCFR. 26 CFR 1.643(b)-1 – Definition of Income The rate can apply to the current year’s value or to a rolling average over a stated number of preceding periods, and the commentary offers twelve quarters as one example of a smoothing period.14Uniform Law Commission. Uniform Fiduciary Income and Principal Act – Section 307 Averaging keeps distributions from swinging wildly after a single bad quarter or a market spike.
Before converting, the fiduciary must send written notice to all qualified beneficiaries, trust directors, and any person with the power to appoint or remove a trustee. The notice describes the proposed conversion, including the intended rate and relevant dates. Beneficiaries then have an objection window of at least 30 days from the date notice is sent.15Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 304 If no one objects, the conversion proceeds without court involvement. If someone does object, the fiduciary may need court approval or must abandon the conversion. The same notice-and-objection process governs changing the rate or converting back.
How This Interacts With Federal Income Tax
The IRS respects a state’s allocation framework only if it provides “a reasonable apportionment between the income and remainder beneficiaries of the total return of the trust.”2eCFR. 26 CFR 1.643(b)-1 – Definition of Income Both the power to adjust and unitrust conversion fall within this safe harbor, as the Treasury Regulation specifically blesses state statutes that permit trustee adjustments for impartiality and unitrust rates between three and five percent.
After a unitrust conversion, the tax character of distributions follows ordering rules. The unitrust amount is generally treated as flowing first from ordinary income, then from capital gains, and finally from principal. That ordering determines how much of each distribution is taxable to the income beneficiary and at what rate. A fiduciary making large adjustments between income and principal should also keep an eye on distributable net income, the figure that drives how much of a distribution is taxable. The act includes savings clauses meant to prevent the power to adjust from creating unintended tax consequences, but those protections work only if the fiduciary stays within a reasonable exercise of discretion.
Challenging a Fiduciary’s Decision
A beneficiary who believes an allocation, adjustment, or unitrust conversion was unfair can take the decision to court. The standard is abuse of discretion. A court will not substitute its own judgment for the fiduciary’s unless the decision crossed into unreasonableness, and the beneficiary carries the burden of proving that.16Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 202
When a court does find an abuse, it has broad options to put the beneficiaries back in the positions they would have occupied, including ordering or reversing an adjustment, converting to or from a unitrust, directing a specific distribution, requiring return of a prior distribution, or withholding future amounts.16Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 202 A cautious fiduciary can also petition the court for instructions before acting, which flips the burden onto any beneficiary who wants to oppose the planned decision.