Update: On May 11, 2020, IRS issued proposed regulations to address the question of excess deductions. These reliance regulations provide that the excess deductions retain the character they had at the trust or estate level when they are passed through to the beneficiary. This was generally good news for taxpayers.
On July 13, 2018, in Notice 2018-61, IRS and Treasury clarified that estates and non-grantor trusts may continue to deduct administrative fees and expenses, even while miscellaneous itemized deduction are suspended (through 2025) for individual taxpayers.
Pursuant to new IRC § 67(g), the Tax Cuts and Jobs Act of 2017 (TCJA) suspended all miscellaneous itemized deductions previously allowed to individual taxpayers by IRC § 67(a) for tax years 2018 through 2025. This raised concern that non-grantor trusts and estates, which are allowed deductions for the cost of administration under IRC § 67(e) and other expenses under IRC § 67(b), might also be prevented from taking these deductions for the next eight years.
Deductions for Non-Grantor Trusts and Estates Continue
Notice 2018-61 eliminates this concern by stating that the agencies do not believe this is a correct reading of IRC § 67(g). Section 67(g) denies a deduction for “miscellaneous itemized deductions,” which are defined in § 67(b) as “itemized deductions,” except those listed in § 67(b)(1)-(12). Section 63(d) also excludes from the definition of “itemized deductions” “deductions used to arrive at adjusted gross income.” As such, neither above-the-line deductions used to arrive at adjusted gross income nor expenses listed in § 67(b)(1)-(12) are miscellaneous itemized deductions subject to suspension. Specifically, § 67(e) provides that the adjusted gross income of a trust or estate is determined in the same way as for an individual, except that expenses described in § 67(e)(1) and deductions pursuant to § § 642(b), 651, and 661 are allowable as deductions in arriving at adjusted gross income. Consequently, expenses allowable under § 67(e) are not itemized deductions subject to suspension, but instead are above-the-line deductions allowable in determining adjusted gross income under IRC § 62(a).
The Notice points out that an expense commonly or customarily incurred by an individual (including the appropriate portion of a bundled fee) is impacted by the suspension of miscellaneous itemized deductions and is not deductible to the estate or non-grantor trust during the suspension of IRC § 67(a).
The Notice states that nothing in section 67(g) impacts the determination of what expenses are described in § 67(e)(1) or the ability of the estate or trust to take a deduction listed under § 67(b). These deductions are not “miscellaneous itemized deductions.” This includes, for example, the deduction allowed by IRC § 67(b)(7) for estate tax in case of income in respect of the decedent (under IRC § 691(c)).
The agencies say that they intend to issue regulations clarifying that estates and non-grantor trusts may continue to deduct expenses described in IRC § 67(e)(1) and amounts allowable as deductions under §642(b), 651 or 661, including the appropriate portion of a bundled fee, in determining the estate or non-grantor trust’s adjusted gross income. Additionally, the regulations will clarify that deductions enumerated in IRC § 67(b) and (e) continue to remain outside the definition of “miscellaneous itemized deductions” and thus are unaffected by the suspension of miscellaneous itemized deductions.
This notice is effective July 13, 2018. Estates and non-grantor trusts may rely on this notice for taxable years beginning after December 31, 2017.
Questions Remain and Comments Requested
Although the deductibility of expenses for estates and non-grantor trusts was left secure by the Notice, it does raise questions regarding excess deductions that have typically been deductible by beneficiaries under IRC § 642(h)(2) upon the termination of the trust or estate. Although these excess deductions may comprise § 67(e) deductions and other deductions that would not have been “miscellaneous itemized deductions” if taken by the estate, most are allowed to the beneficiary only through § 642(h)(2), which treats the excess deduction as a “miscellaneous itemized deduction.”
The Notice states that it appears these excess deductions are suspended by IRC § 67(g) through 2025; however, the agencies are “studying whether section 67(e) deductions, as well as other deductions that would not be subject to limitation in the hands of the trust or estate should continue to be treated as miscellaneous itemized deductions when they are included as a § 642(h)(2) excess deduction.” To that end, the agencies are requesting comments concerning whether the separate amounts comprising the § 642(h)(2) excess deduction, such as any amounts that are § 67(e) deductions, should be separately analyzed when applying IRC § 67.