The U.S. Treasury Department and the IRS announced on Friday, July 13, 2018, that they intend to issue regulations on the impact of new section 67(g) of the Internal Revenue Code of 1986 on certain deductions for estates and nongrantor trusts. Section 67(g) was added to the Code by the 2017 Tax Act (P.L. 115-97) and suspends temporarily miscellaneous itemized deductions.
Tax practitioners expressed concern that section 67(g) might inadvertently eliminate the deduction for costs of estate and trust administration. Practitioners have also requested guidance on whether the suspension of miscellaneous itemized deductions prohibits trust and estate beneficiaries from deducting on their individual returns the excess deductions of the trust or estate incurred during the trust’s or estate’s final taxable year.
Treasury and the IRS have stated that forthcoming regulations will clarify that the costs of trust or estate administration are not miscellaneous itemized deductions suspended by section 67(g). Treasury and the IRS have also stated that new regulations will address the impact of section 67(g) on the ability of beneficiaries to deduct an estate’s or trust’s excess deductions upon termination of the estate or trust.
Under section 67(e) of the Code, the adjusted gross income of an estate or nongrantor trust is computed in the same manner as that of an individual, with two exceptions. Section 67(e)(1) permits an estate or nongrantor trust to deduct in computing adjusted gross income the costs incurred in connection with the administration of the estate or trust that would not have been incurred if the property were not held in the estate or trust. Such expenses generally include, for example, fiduciary compensation and court accounting costs. Section 67(e)(2) provides an exception for deductions allowable under section 642(b) (relating to the personal exemption of an estate or nongrantor trust), section 651 (relating to distributions of income to beneficiaries of simple trusts), and section 661 (relating to distributions of income and principal to beneficiaries of complex trusts).
New section 67(g) of the Code suspends the deduction for miscellaneous itemized deductions for any taxable year beginning after December 31, 2017, and before January 1, 2026. Some practitioners expressed concern that section 67(g) may inadvertently eliminate the ability of an estate or nongrantor trust to deduct the administration expenses described in section 67(e)(1).
On the termination of a nongrantor trust or estate, section 642(h) of the Code allows the beneficiaries succeeding to the property of the nongrantor trust or estate to deduct the trust’s or estate’s unused net operating loss carryovers under section 172 of the Code and unused capital loss carryovers under section 1212 of the Code. If an estate or nongrantor trust has deductions (other than deductions for personal exemptions or charitable contributions) in excess of gross income in its final taxable year, then section 642(h) allows the beneficiaries succeeding to the property of the estate or trust to deduct such excess on their individual returns. Capital loss carryovers and net operating loss carryovers are taken into account in calculating adjusted gross income and are not miscellaneous itemized deductions. Section 67(g) therefore does not affect the ability of a beneficiary to make use of a capital loss carryover or net operating loss carryover received from an estate or nongrantor trust.
The excess deductions of an estate or nongrantor trust, however, are allowable only in computing taxable income and are not covered by an exception from miscellaneous itemized deductions in section 67(b). Absent guidance to the contrary, the excess deductions of an estate or nongrantor trust are now disallowed by section 67(g) for taxable years beginning after December 31, 2017, and before January 1, 2026. The inability of beneficiaries to claim excess deductions may create unwelcome and unanticipated consequences. For example, it could artificially affect timing of distributions, delay closing of estates, and create incongruity in the treatment of administration expenses — permitting them as deductions to an estate or trust but denying them when passed-out to beneficiaries.
On July 13, 2018, the IRS released Notice 2018-61. Notice 2018-61 announces that Treasury and the IRS intend to issue regulations “clarifying that estates and nongrantor trusts may continue to deduct expenses described in section 67(e)(1)” for taxable years during which section 67(g) suspends miscellaneous itemized deductions. Estates and nongrantor trusts may rely on Notice 2018-61 in continuing to deduct expenses under section 67(e)(1).
Notice 2018-61 includes a reminder that section 67(g) does not affect the determination of administration costs defined in section 67(e)(1) of the Code. Pre-existing law continues to apply to the identification of administration expenses under section 67(e)(1), including the treatment of “bundled” trustee’s fees.
Notice 2018-61 also notes that Treasury and the IRS are studying whether section 67(e) deductions and other deductions that would not be considered miscellaneous itemized deductions to an estate or nongrantor trust should continue to be regarded as miscellaneous itemized deductions when included by a beneficiary as an excess deduction under section 642(h)(2). Treasury and the IRS intend to issue regulations addressing whether a beneficiary may claim the excess deductions of a terminating estate or trust notwithstanding the suspension of miscellaneous itemized deductions under section 67(g). In connection with the drafting of new regulations, Treasury and the IRS are seeking public comments on whether amounts deductible under section 642(h)(2) of the Code should be analyzed separately from other miscellaneous itemized deductions when applying section 67 of the Code. Notice 2018-61 does not provide a timeframe for when Treasury and the IRS may issue new regulations.
For more information, contact any lawyer on the McGuireWoods LLP Private Wealth Services team.