Final regulations determine deductions for trusts and estates after the TCJA

Editor: Sally P. Schreiber, J.D.

The IRS on Sept. 21 issued final regulations (T.D. 9918) clarifying that certain expenses incurred by, and certain excess deductions upon the termination of, an estate or nongrantor trust are not affected by the suspension of miscellaneous itemized deductions for tax years 2018 through 2025. The regulations also provide guidance on determining the character, amount, and allocation of excess deductions that are succeeded to by beneficiaries.

The final regulations adopt with few changes proposed regulations issued in May 2020 (REG-113295-18; see also Schreiber, “Trusts and Estates Are Permitted Certain Deductions,” The Tax Adviser (May 8, 2020)).

Sec. 67(g), enacted by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, disallows miscellaneous itemized deductions for any tax year beginning after Dec. 31, 2017, and before Jan. 1, 2026. Before the TCJA, miscellaneous itemized deductions were allowed to the extent that their aggregate amount exceeded 2% of adjusted gross income (AGI). Miscellaneous itemized deductions are defined as itemized deductions other than those listed under Secs. 67(b)(1) through (12).

Sec. 67(e) directs that the AGI of an estate or trust is computed in the same manner as for an individual, except that deductions are allowed for (1) costs paid or incurred in connection with the administration of the estate or trust that would not have been incurred if the property were not held in an estate or trust, and (2) deductions allowable under Sec. 642(b) (personal exemption amounts for estates and trusts) and Secs. 651 and 661 (distributions by trusts distributing current income and trusts accumulating income, respectively).

In Notice 2018-61 issued in July 2018, the IRS announced it would issue regulations to clarify that Sec. 67(e) deductions are not suspended or eliminated by Sec. 67(g).

The proposed regulations adopted this position, along with addressing the treatment of excess deductions upon an estate’s or a trust’s termination under Sec. 642(h)(2). That provision allows beneficiaries succeeding to the property of a terminating trust or estate to take a deduction of any excess of certain deductions over gross income of the trust or estate in its last tax year. Prior regulations provided that excess deductions were allowed by beneficiaries in computing taxable income and not AGI; thus, they were treated as a single miscellaneous itemized deduction.

In the proposed regulations, the IRS and Treasury recognized that excess deductions may consist of (1) deductions allowable in arriving at AGI; (2) non—miscellaneous itemized deductions; and (3) miscellaneous itemized deductions. Only the third type is suspended under Sec. 67(g). Consequently, the final regulations, as did the proposed regulations, provide rules for trustees to determine for a terminating estate or trust the character and amount of each deduction type and, therefore, their respective allocations to, and applicable limitations upon, the succeeding beneficiaries.

The final regulations apply to tax years beginning after Oct. 19, 2020; taxpayers may choose to apply amendments to Regs. Secs. 1.67-4, 1.642(h)-2, and 1.642(h)-5 to tax years beginning after Dec. 31, 2017, and on or before Oct. 19, 2020.