A new IRS proposed regulation brings welcome news to certain Trust & Estate beneficiaries and their tax savings potential.
The Tax Cuts and Jobs Act of 2017 (TCJA) suspended the miscellaneous itemized deduction for individuals for any taxable year beginning after December 31, 2017, and before January 1, 2026. This suspension also applies to a Trust or Estate.
Code Section 67(e) specifically tells us that costs which are “paid or incurred in connection with the administration of a trust or estate and would not have been incurred if the property were not held in such estate or trust” are not considered miscellaneous itemized deductions and therefore continue to be fully deductible at the Trust or Estate level. This proposed regulation confirms that.
Prior to the TCJA, excess deductions on termination (i.e. expenses in excess of income in the final year of the trust or estate) would flow through to the beneficiaries as miscellaneous itemized deductions, subject to a 2% of adjusted gross income (AGI) limitation.
The new proposed regulation creates a tax benefit for beneficiaries of estates and non-grantor trusts. Beneficiaries will now be able to deduct expenses in excess of income as an above-the-line deduction on their personal income tax return in the final year of the trust or estate. Expenses retain their character and must be allocated among classes of income to which they relate.
Net operating losses and capital losses retain their character and flow through to the individual’s personal return as above-the-line deductions. Real estate taxes not allocated to a trade or business and excess charitable deductions will flow through as itemized deductions.
The deductions will not be subject to the 2% AGI limitation, making this tax savings vehicle an even greater value than it was pre-TCJA.
This change is retroactive, so beneficiaries who were in the final year of the trust or estate in 2018 can now file amended returns and claim a potentially significant deduction. Moving forward, the valuable deduction will be available to all beneficiaries in the final year of the estate.