The Uniform Principal and Income Act is a model law that tells trustees how to divide every dollar flowing through a trust into two accounts: principal, which preserves the underlying assets for future beneficiaries, and income, which represents current earnings paid out to present beneficiaries. First completed by the Uniform Law Commission in 1931 and revised in 1962, 1997, and most recently in 2018 as the Uniform Fiduciary Income and Principal Act (UFIPA), it has been adopted in some form in most states. The classification matters because income beneficiaries and remainder beneficiaries have competing financial interests, and every misallocated dollar helps one group at the other’s expense.
Why Classification Matters: The Duty of Impartiality
Section 103 of the act requires a fiduciary to administer a trust “impartially, based on what is fair and reasonable to all of the beneficiaries.”1Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 103 A trustee cannot favor a current beneficiary who wants cash now over a remainder beneficiary who inherits later, or the other way around.
The exception is when the trust document itself tells the trustee to favor someone. If the settlor wrote clear language directing the trustee to prioritize a spouse’s comfort over the growth of principal, the trustee follows that instruction. Without such language, the default is even-handedness, and the mechanical rules that follow all exist to serve that default.
Sorting Receipts Into Income or Principal
The general rule is straightforward: cash distributions from entities such as corporations, partnerships, and LLCs go to income.2Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 401 Ordinary dividends, bond interest, partnership distributions, rent from real property, and interest on savings accounts all fall here because they represent ongoing earnings from trust assets.
Receipts that represent a change in the form of an investment go to principal. If a trustee sells land for $500,000, the entire sale price is principal even if the land cost far less to buy. Stock splits, capital gain distributions from mutual funds and REITs, and money received in partial liquidation of a company are all principal as well. These transactions convert one asset into another rather than generating new earnings.
Where receipts blur the line, the act uses a 20-percent threshold. If a special distribution from a closely held business exceeds 20 percent of the trust’s share of the entity’s gross assets, the excess is treated as a capital distribution and goes to principal.
Retirement Accounts and Deferred Compensation
Trusts holding interests in IRAs, 401(k) plans, pensions, or annuities follow separate rules because these accounts blend investment gains, employer contributions, and tax-deferred growth into a single payment stream. Under Section 409 of the 1997 act, the trustee first looks at how the payment is characterized: any portion labeled as interest or a dividend goes to income, and the remainder goes to principal.3CyberCPA. Uniform Principal and Income Act Section 409
When no part of a payment is characterized as interest or a dividend and the payment is a required distribution (such as a required minimum distribution from an IRA), the trustee allocates 10 percent to income and 90 percent to principal. If no distribution is required and the trustee simply withdraws funds voluntarily, the entire amount goes to principal.
Trustees managing a marital trust that qualifies for the estate tax marital deduction face an additional constraint. The surviving spouse must receive all the trust’s income, so if the standard 10-percent allocation does not produce enough, the trustee must allocate more of the retirement plan distribution to income to preserve the deduction. The IRS has confirmed that a flat 10-percent allocation, standing alone, may not be enough for a qualifying marital deduction trust.4Internal Revenue Service. Revenue Ruling 2006-26
Natural Resources and Timber
Mineral rights, oil and gas interests, and timberland need special treatment because extracting the resource depletes the underlying asset. Under Section 411 of the 1997 act, receipts from mineral and natural resource interests follow a 90/10 split: 90 percent of royalties, shut-in-well payments, bonuses, and working-interest proceeds go to principal, and 10 percent goes to income.5CyberCPA. Uniform Principal and Income Act Section 411 Nominal delay rentals and annual lease payments go entirely to income. The 2018 UFIPA replaced the fixed 90/10 default with a flexible standard requiring an “equitable” allocation, with a safe-harbor presumption that the allocation is equitable if the amount sent to principal equals the federal income tax depletion deduction.6Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 411
Timber follows its own logic. Net receipts are income to the extent that harvesting does not exceed the natural growth rate during the accounting period. Once the cut exceeds the growth rate, the excess goes to principal. Proceeds from selling standing timber outright go entirely to principal.
Splitting Expenses Between the Two Accounts
Sections 501 and 502 split trust expenses based on what each expense protects or maintains.
Charged entirely to income:
- Routine repairs, property management, insurance premiums covering loss of income or use of an asset, and recurring property taxes.
- Half of regular trustee compensation, half of investment advisory fees, and half of the cost of accountings or court proceedings that involve both the income and remainder interests.
Charged entirely to principal:
- The other half of trustee compensation, advisory fees, and accounting expenses.
- Payments on trust debt principal, expenses to prepare property for sale, and the costs of legal proceedings that primarily concern principal (such as defending title).
- Estate, inheritance, and similar transfer taxes apportioned to the trust.
- Environmental cleanup, remediation, monitoring, and penalties.
The 50/50 split for shared administrative costs is where this gets practical. If a trust pays $10,000 for a formal accounting, $5,000 comes from income and $5,000 from principal, because both current and future beneficiaries benefit from proper administration. Environmental cleanup, by contrast, hits principal entirely because it protects the long-term value of the asset.7Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 502
The Power to Adjust
Sometimes the mechanical rules produce a result that shortchanges one group. The power to adjust lets a trustee move money between the two accounts when the standard allocation is unfair. A trustee invested for total return might see the portfolio grow 10 percent in a year while producing only 1 percent in dividends. Without an adjustment, the income beneficiary gets almost nothing while the remainder beneficiary enjoys all the growth.
Under the 1997 act, the trustee had to meet three conditions before adjusting: investing under the prudent investor standard, administering a trust that defined distributions by reference to income, and determining that the standard allocation made impartial administration impossible. The 2018 UFIPA simplified this to a single requirement: the trustee determines that the adjustment will help administer the trust impartially.
Before adjusting, the trustee weighs the nature and expected duration of the trust, the settlor’s intent, each beneficiary’s circumstances, whether the trust holds financial assets or real estate and business interests, the expected effect of economic conditions and inflation, and the tax consequences. The trustee should also check whether the trust document already grants a power to invade principal or accumulate income, since those existing powers may fix the imbalance without a formal adjustment.
When a Trustee Cannot Adjust
The act draws hard lines around situations where adjustment is off-limits, mostly to prevent unintended tax consequences. A trustee cannot adjust if the move would:
- Reduce income in a trust designed to qualify for an estate or gift tax marital deduction.
- Reduce the value of an income interest in a trust intended to qualify for the annual gift tax exclusion.
- Alter amounts payable as a fixed annuity or fixed percentage of trust value.
- Shift funds permanently set aside for charity, or cause the trust to lose a charitable deduction.
- Cause the trust to be treated as owned by an individual for income tax purposes (grantor trust status) when it otherwise would not be.
- Cause trust assets to be included in someone’s taxable estate when they otherwise would not be.
- Benefit the trustee personally.
A trustee who is also a beneficiary cannot exercise the power at all. These restrictions carry over from the 1997 UPIA to the 2018 UFIPA, though the newer version restructured the numbering.8CyberCPA. Uniform Principal and Income Act Section 104 If an adjustment is needed in one of these situations, the trust typically needs a co-trustee or independent party to make it.
Converting to a Unitrust
The 2018 UFIPA added a cleaner alternative to the power to adjust: converting a traditional income trust into a unitrust. Instead of classifying each receipt and then possibly adjusting, a unitrust pays beneficiaries a fixed percentage of the trust’s total market value each year. The distribution is tied to portfolio value rather than the type of return the investments produce, which eliminates most classification disputes.
The IRS recognizes a unitrust payout between 3 and 5 percent of fair market value as a reasonable allocation of total return for tax purposes.9eCFR. 26 CFR 1.643(b)-1 – Definition of Income Most states that have adopted the unitrust option use this range as the safe harbor. The trust can value assets annually or average values over multiple years to smooth out market volatility.
To convert, the trustee must send written notice to all qualified beneficiaries, any co-trustees, and anyone with the power to appoint or remove a trustee. The notice must explain the proposed action, include a copy of the unitrust policy, identify how objections can be filed, and set a deadline for objections at least 30 days out.10Colorado Bar Association. Uniform Fiduciary Income and Principal Act – Section 304 If no one objects by the deadline, the trustee may proceed without court approval. The trustee can also reverse the conversion later using the same notice process.
For trusts with special tax benefits such as a marital or charitable deduction or S corporation eligibility, the unitrust percentage must stay within the 3-to-5-percent range and be calculated annually. Outside those tax-sensitive trusts, the act gives wider flexibility to set the rate, choose the valuation method, and handle hard-to-value assets.
Which Version Applies: 1997 UPIA or 2018 UFIPA
Many states still operate under the 1997 Uniform Principal and Income Act, but the trend is toward the 2018 replacement. Because the two versions differ on several meaningful points, confirming which one a trust’s governing state has adopted is a necessary first step for any trustee.
The biggest structural change is that the UFIPA codified unitrust conversions as part of the act itself rather than leaving them to separate state legislation. The power to adjust was simplified from a three-condition test to a single impartiality determination. Natural resource receipts shifted from the fixed 90/10 split to the equitable-allocation standard tied to the federal depletion deduction.
Remedies also softened. Under the older act, a court could order a trustee to pay from personal funds to make a beneficiary whole. The newer version encourages courts to first try remedies that restore the beneficiary to their original position, such as ordering a distribution, withholding from future distributions, or reversing a unitrust conversion. Personal financial liability remains possible but is no longer the first tool.
What Happens When a Trustee Gets It Wrong
Courts have broad authority to remedy a breach of fiduciary duty, and remedies scale with severity. A beneficiary who catches a misallocation early can seek a court order blocking the transaction before it takes effect. After the fact, a court can compel the trustee to restore property or pay money to correct the imbalance, reduce or eliminate the trustee’s compensation, or appoint a special fiduciary. In serious cases, the court can remove the trustee entirely and void the improper transactions.
The risk is highest when a trust holds both income-producing and growth assets. Consistently steering rental income toward principal starves the current beneficiary while padding the remainder. Doing the opposite depletes the trust for future beneficiaries. Either pattern invites litigation, and the trustee bears the burden of showing that each allocation followed the act’s rules or fell within a legitimate exercise of the power to adjust.
Trustees protect themselves by documenting the reasoning behind every allocation, especially when adjusting. A written record showing that the required factors were considered and that advisors were consulted holds up far better in court than an after-the-fact explanation.