Trust Income Beneficiary Entitled to Net Income, Not Gross

On July 22, 2020, the Iowa Court of Appeals issued an opinion reversing a district court decision interpreting a family trust. The district court had ruled that the income beneficiary was entitled to a distribution of the gross income of the trust, but her children argued that she was only entitled to the net income. The court agreed, ruling that a settlement agreement and the Iowa Uniform Principal and Income Act required a net income distribution.

Background

In 2014, a couple established a living trust. The remainder beneficiaries were presumably their children. The father passed away in 2016. The next year, the couple’s children submitted a petition to the court to determine if the trust became irrevocable at the father’s death. In addition, they petitioned to prevent their mother from modifying the trust. Eventually, the parties entered into an agreement which stated:

1. [The trust] . . . shall continue in force.

2. Pursuant to Article II A[1] of the Trust Declaration, [the mother] shall be entitled to enjoy all income from the Trust for the remainder of her natural life as she may request or direct.

3. Pursuant to Article II B[2] of the Trust Declaration, the Trustee shall retain the discretion to invade principal of the Trust, to the extent it deems necessary or advisable, to provide for the proper care, support, maintenance, and education of [the mother]. The Trust Declaration shall not be construed to permit the invasion of the principal of the Trust other than for these purposes during the life of [the mother]

Later, the mother requested a distribution of the gross income of the trust as opposed to net income. The trustee petitioned the court for guidance because complying with the request would cause the trustee to invade the principal for normal expenses such as real estate taxes, insurance, land repairs, and trustee’s and attorneys’ fees. The district court found the “all income” clause in the second element of the settlement agreement did not limit how the beneficiary could receive income and the beneficiary could demand the trustee distribute gross income.

Iowa Uniform Principal and Income Act & the Iowa Trust Code

The Iowa Uniform Principal and Income Act allows an income beneficiary of a trust to receive all or part of the trust’s net income depending on the terms of the trust. An income beneficiary is defined as “a person to whom a trust’s net income is or may be payable.” Iowa Code § 637.102(5), (6). Here, the mother was an income beneficiary with an income interest. Because neither the trust nor the settlement agreement directed differently, the trust should have distributed the net income of the trust.

A trust normally pays its expenses before disbursing income to beneficiaries. The settlement agreement granted the beneficiary “all income from the Trust,” but only allowed the trustee to invade the principal if necessary for the care and support of the beneficiary. Allowing the trust to disburse gross income would violate the settlement agreement. Therefore, the court reversed the district court’s decision and ruled that “all income” meant "net income."