IRS Offers Important Guidance on Deductions for Trusts + Estates
May 21, 2020
- A new proposed IRS regulation will have meaningful impacts on deductions for trusts and estates related to the Tax Cuts + Jobs Act of 2017
- Costs incurred under Section 67(e) are NOT miscellaneous itemized deductions subject to the TCJA suspension, but are rather “above the line”
- Excess deductions under Section 642(h)(2) retain their character for the beneficiary upon termination of an estate or trust.
The Tax Cuts and Jobs Act of 2017 (TCJA) suspended the deductibility of miscellaneous itemized deductions beginning after December 31, 2017, and before January 1, 2016 by adding Subsection G to Section 67 of the Internal Revenue Code.
On May 7, 2020, the IRS issued Regulation 113295-18 (“Proposed Regulation”), which proposes:
- confirmation that costs incurred under Section 67(e) by estates and non-grantor trusts are not miscellaneous itemized deductions subject to the TCJA’s suspension, but rather are “above-the-line” deductions still allowed in determining adjusted gross income; and
- clarification that excess deductions typically taken by beneficiaries upon the termination of an estate or trust pursuant to Section 642(h)(2) retain their character for the beneficiary.
Permissible Deductions for Estates + Nongrantor Trusts under Section 67(e)
The Proposed Regulation confirms that estates and nongrantor trusts are allowed the following deductions under Section 67(e):
- Deductions for costs that are paid or incurred in connection with the administration of the estate or trust and that would not have been incurred if the property were not held in such trust or estate;
- Deductions concerning the personal exemption of an estate or nongrantor trust [Section 642(b)];
- Deductions for trusts distributing current income (Section 651); and
- Deductions for trusts accumulating income (Section 661).
These deductions are not considered miscellaneous itemized deductions subject to the TCJA’s suspension. Rather, such deductions would be expressly excluded from the definition of miscellaneous itemized deductions and consequentially still allowable. Careful note should be taken that costs incurred by an estate or trust that would commonly or customarily be incurred by a hypothetical individual holding the same property are still miscellaneous itemized deductions and therefore likely not allowable.
Excess Deductions Retain Character for the Beneficiary under Section 642(h)(2)
The Proposed Regulation confirms that excess deductions typically taken by beneficiaries upon the termination of an estate or trust pursuant to Section 642(h)(2) retain their character for the beneficiary meaning the character of the deductions remains the same when transferred to a beneficiary as a result of a termination of an estate or trust. Instead of the total excess deductions being treated as one miscellaneous itemized deduction for a beneficiary, the Proposed Regulation would require an executor of an estate or trustee of a trust to separately identify deductions and characterize such deduction as:
- An amount allowed in arriving at adjusted gross income, such as those allowed in Section 67(e) as costs of administering an estate or trust;
- A nonmiscellaneous itemized deduction that is allowable in computing taxable income; or
- A miscellaneous itemized deduction currently disallowed.
The following list highlights just a few examples of the different types of above-referenced deductions, but is not meant to be exhaustive. Executors and trustees must consult with counsel for specific guidance as to their unique tax filings:
A Section 67(e) Allowable Deduction (Allowed):
- Probate Fees
- Estate tax preparation fees;
- Legal Fees concerning estate and trust administration
- Fiduciary commissions
Nonmiscellaneous Itemized Deductions (Allowed):
- State tax expense
- Local tax expense
Miscellaneous Itemized Deductions (Disallowed):
- Insurance premiums on underlying assets
- Homeowner’s association fees or mortgage expenses
- Maintenance or repair costs
- Investment management and custodial fees
- Estates and trusts may continue to deduct costs associated with administering the estate, so long as those costs would not have been incurred if the property were not held in the estate or trust and would not have been incurred by a hypothetical individual holding the same property.
- Executors and trustees need to characterize deductions on Form K-1’s issued to beneficiaries.
- A beneficiary would essentially step into the shoes of an estate or trust during its final year and be able to benefit by claiming deductions for costs of administering an estate or trust, regardless of whether such deduction exceeded 2% of the beneficiary’s adjusted gross income because such deductions are already excluded from the 2% threshold that is otherwise applicable to miscellaneous itemized exemptions.
- Executors and trustees may rely on the Proposed Regulation for tax years beginning after December 31, 2017, until the final regulations are published in the Federal Register.
The IRS is currently accepting comments on the Proposed Regulation. Executors and trustees are encouraged to reach out to counsel concerning deductions claimed after December 31, 2017, to see if an amended return is warranted and to consult counsel prior to making any future deductions.
Kegler Brown will continue to monitor the developments surrounding the publication of the final regulations and its impact on itemized deductions for trusts and estates.