IRS Issues Proposed Regulations for Miscellaneous Deductions for Trusts and Estates

Attorneys who handle trusts and estates, but don't file tax returns for trusts and estates, should consider how the estate or trust income tax return (Form 1041) will affect the beneficiaries.  While tax consequences aren't the only consideration in administering a trust or estate, they certainly are on the list. A geat tool for trustees, personal representatives, and their attorneys is IRS Publication 559, which provides an overview for the taxation of trusts and estates.  While the current estate tax exemption of $11.58 million means few estates will owe estate tax, many estates and trusts still have income that must be reported on Form 1041.

Administration expenses are deductible against the estate or trust's income. The timing of the payment of those expenses is one item that affects the bottom line for the trust or an estate. It also has an impact on beneficiaries who itemize deductions on their personal return.  Under current law, an individual has a standard deduction of $12,000, while married couples have a deduction of $24,000.  This simplifies the tax return for many taxpayers, because they don't have enough itemized deductions to exceed the generous standard deduction. For those who do itemize, the use of the estate's unused deductions in its final year could help those taxpayers who itemize. It all depends upon the number of beneficiaries and the total itemized deductions that each beneficiary could claim if they received a share of the estate or trust's unused itemized deductions.

On December 22, 2017, Congress passed “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97 (Act).  The new law added Section 67(g) to the Internal Revenue Code.  This new subsection eliminated miscellaneous itemized deductions.  There was confusion about whether this eliminated the ability of trusts and estates to pass unused deductions on to the beneficiaries for use on their personal returns.
In IRS Notice 2018-61, the Internal Revenue Service addressed this confusion.  Link to IRS Notice 2018-61.   The IRS Notice explained:

The Treasury Department and the IRS intend to issue regulations clarifying that estates and non-grantor trusts may continue to deduct expenses described in section 67(e)(1) and amounts allowable as deductions under section 642(b), 651 or 661, including the appropriate portion of a bundled fee, in determining the estate or nongrantor trust’s adjusted gross income during taxable years, for which the application of section 67(a) is suspended pursuant to section 67(g). Additionally, the regulations will clarify that deductions enumerated in section 67(b) and (e) continue to remain outside the definition of “miscellaneous itemized deductions” and thus are unaffected by section 67(g).

Section 67(e)(1) of the Internal Revenue Code says:

(e)Determination of adjusted gross income in case of estates and trusts. For purposes of this section, the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual, except that—

(1)

the deductions for 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, and

(2)

the deductions allowable under sections 642(b), 651, and 661, 

shall be treated as allowable in arriving at adjusted gross income. Under regulations, appropriate adjustments shall be made in the application of part I of subchapter J of this chapter to take into account the provisions of this section.

In IRS Newswire 2020-90, The Internal Revenue Service announced that it has now issued proposed regulations.  The release offered the following summary, including a link to the proposed regulations.

WASHINGTON — The Internal Revenue Service today issued proposed regulations that provide guidance for estates and trusts clarifying that certain deductions of estates and non-grantor trusts are not miscellaneous itemized deductions. 

The Tax Cuts and Jobs Act (TCJA) prohibits individual taxpayers from claiming miscellaneous itemized deductions for any taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2026.
Specifically, the proposed regulations clarify the following deductions are allowable in figuring adjusted gross income and are not miscellaneous itemized deductions:

• Costs paid or incurred in connection with the administration of the estate or      trust which would not have been incurred otherwise.
• Deductions concerning the personal exemption of an estate or non-grantor trust.
• Deductions for trusts distributing current income.
• Deductions for trusts accumulating income

Finally, the guidance clarifies how to determine the character, amount and manner for allocating excess deductions that beneficiaries succeeding to the property of a terminated estate or non-grantor trust may claim on their individual income tax returns.
For more information about this and other TCJA provisions, visit IRS.gov/taxreform.

After the initial confusion in 2018, the proposed regulations are a welcome indication of the Internal Revenue Service's position on these issues.