The Default Rule and Its Exceptions
The baseline is simple. Money a trust receives from an entity goes to income. This means income beneficiaries benefit from dividends or partnership draws.
Except as otherwise provided in this section, a trustee shall allocate to income money received from an entity.
A.R.S. § 14-7410(A)The statute carves out exceptions for receipts that return capital rather than earnings. These exceptions protect the trust's capital base over time.
For example, property other than money goes to principal. So do proceeds from selling a trust's interest in an entity, liquidation payments, and capital gain dividends from investment companies or real estate trusts.
Understanding Partial Liquidation
The statute gives two tests for partial liquidation. First, if the entity labels a distribution as a partial liquidation, the trustee can rely on that label.
Second, a distribution that tops twenty percent of the entity's gross assets counts as a partial liquidation by default. The trustee checks the entity's most recent year-end statements.
Money is received in partial liquidation to the extent that the entity, at or near the time of a distribution, indicates that it is a distribution in partial liquidation.
A.R.S. § 14-7410(C)(1)Trustees can also rely on board statements about the source of a distribution. This safe harbor lets them classify receipts without a separate review.
Getting this right matters. A wrong call can shift value between income and remainder beneficiaries in ways the trust creator never planned.