Proposed Regulations Address Deductibility of Trust and Estate Administrative Expenses and Excess Deductions on Termination of Trusts and Estates
By Anthony Rappa, Melissa Gonzalez and Richard Bloom
May 14, 2020
The IRS recently issued proposed regulations (REG-113295-18) under Internal Revenue Code (IRC) Sections 67(g) and 642(h)(2). These clarified that certain deductions are allowed to an estate or non-grantor trust because they are not miscellaneous itemized deductions and also explain how to determine the character, amount, and allocation of deductions in excess of gross income that a beneficiary succeeds to on the termination of an estate or non-grantor trust.
IRC Sec. 67(g) was enacted into law on December 22, 2017 as part of the Tax Cuts and Jobs Act. IRC Sec. 67(g) prohibits individual taxpayers from claiming miscellaneous itemized deductions for any tax year beginning after December 31, 2017 and before January 1, 2026.
Subsequently, the IRS issued Notice 2018-61 on July 13, 2018 announcing that proposed regulations would be issued concerning the effect of Section 67(g) on the deductibility of certain expenses incurred by estates and non-grantor trusts. The notice stated that regulations would clarify that 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 estate or trust remain deductible in determining the adjusted gross income of an estate or non-grantor trust.
Excess deductions incurred in the year a trust terminates are allocated to the beneficiaries of the trust. These deductions were treated as miscellaneous itemized deductions which, as stated above, are not deductible for tax years beginning after December 31, 2017 and before January 1, 2026, as a result of the enactment of IRC Section 67(g). Notice 2018-61 requested comments regarding the effect of Section 67(g) on the ability of the beneficiary to deduct excess deductions on the termination of an estate or non-grantor trust and expressed the intent to address this issue in regulations.
Proposed Regulation 1.67-4
The proposed regulations formally adopt Notice 2018-61’s treatment and clarify that the following deductions under Section 67(e) allowed to an estate or non-grantor trust are not miscellaneous itemized deductions and are not affected by the suspension of the deductibility of miscellaneous itemized deductions:
- Costs paid or incurred in connection with the administration of an estate or non-grantor trust that would not have been incurred if the property were not held in the estate or trust;
- The personal exemption of an estate or non-grantor trust;
- The distribution deduction for trusts distributing current income; and
- The distribution deduction for estates or trusts accumulating income.
Proposed Regulation 1.642(h)-2
The proposed regulations also provide guidance on determining the character, amount, and allocation of deductions in excess of gross income succeeded to by a beneficiary on the termination of an estate or non-grantor trust. They clarify that the character of the deductions does not change when succeeded to by a beneficiary on the termination of the estate or trust and require the fiduciary to separately identify deductions that may be limited when claimed by the beneficiary.
Under the proposed regulations, each excess deduction on termination shall retain its separate character:
- As an amount allowed in arriving at adjusted gross income (AGI);
- As a non-miscellaneous itemized deduction; or
- As a miscellaneous itemized deduction.
These proposed regulations will apply to taxable years beginning after the date they are published as final. However, estates, non-grantor trusts, and their beneficiaries may rely on these proposed regulations for taxable years beginning after December 31, 2017 and on, or before, the date these regulations are published as final.
Trust and estate returns that were filed for 2018 and 2019, prior to the release of the proposed regulations, should be reviewed to determine if modifications are necessary. Beneficiaries who received a final year Schedule K-1 from any non-grantor trust or estate for 2018 or 2019 should reach out to the fiduciary or administrator for additional information regarding excess deductions.
Please contact your Mazars USA LLP professional for additional information.