Deductibility of Certain Trust and Estate Expenses Under TCJA
(IRS Issues Final Regulations: TD 9918)
On September 21, 2020, the IRS issued final regulations (TD 9918) detailing the deductibility of certain expenses incurred by estates and nongrantor trusts as well as the treatment of certain excess deductions upon termination of an estate or nongrantor trust.
Pursuant to IRC § 67(g) enacted as part of the Tax Cuts and Jobs Act (TCJA), miscellaneous itemized deductions are disallowed for tax years beginning after December 31, 2017 and before January 1, 2026. Miscellaneous itemized deductions – or the so called “2% deductions” – are defined at IRC § 67(b) as itemized deductions other than twelve categories of expenses that are allowable under other specific code sections such as interest, charitable, and medical expenses. These rules are generally applicable to individuals, trusts, and estates.
IRC § 67(e) provides a carve out for estates and trusts allowing “costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate” to be deducted in arriving at Adjusted Gross Income (AGI) for the estate or trust. Such expenses include probate court costs, fiduciary fees, legal fees, and tax preparation fees associated with administering the estate or nongrantor trust. The final regulations affirm at Treasury Regulation § 1.67-4 that Section 67(e) deductions are not itemized deductions under Section 63(d), not miscellaneous deductions under Section 67(b), and are not disallowed under Section 67(g).
The final regulations go on to clarify the deductibility of certain excess deductions upon the termination of an estate or trust. In the final year of an estate or trust, deductions may exceed gross income. Those excess deductions are allowed to the beneficiaries succeeding to the estate or trust property under IRC § 642(h)(2).
Treasury Regulation § 1.642(h)-2 as revised by the final regulations places excess deductions into three categories: (1) amounts allowed in arriving at AGI; (2) itemized deductions other than miscellaneous itemized deductions (such as state and local taxes); and (3) miscellaneous itemized deductions. The regulations clarify that the character of the excess deductions will remain the same in the hands of the beneficiary as the character while held by the estate or trust. Thus, an individual beneficiary receiving a final Schedule K-1 from an estate or trust may have (1) above-the-line deductions allowable in computing the individual’s AGI; (2) itemized deductions that must be taken into account with the individual’s other deductions of the same character to determine deductibility by the individual; and (3) miscellaneous deductions that the individual is not allowed to deduct.
Importantly, the regulations state that these final regulations may be used only for tax years beginning after December 31, 2017. Amending tax returns prior to that date to treat excess deductions upon termination as an above-the-line adjustment is not allowed. Opportunities to amend 2018 and 2019 tax returns may exist, however, and should be considered.
The IRS has provided instructions for reporting excess deductions of the above-the-line character as adjustments to Schedule 1 for an individual’s 2018 or 2019 Form 1040.
For more information or a discussion on how this may impact you, please contact Jean McDevitt Bullens or your BNN advisor at 800.244.7444.
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