The Deductibility of an Estate’s Excess Deductions to Beneficiaries

March 25, 2019

As we planned for and now prepare estate and trusts returns for 2018, beneficiaries and executors want to know: After the Tax Cuts and Jobs Act (TCJA), can a beneficiary still deduct excess estate tax deductions on his/her individual return?

Prior to the 2017 Tax Cuts and Jobs Act, individual taxpayers could deduct a variety of miscellaneous itemized deductions subject to the 2% of adjusted gross income (AGI) limitation under §67(b). Estates and trusts, which are subject to similar income tax provisions, could also deduct miscellaneous itemized deductions under various code sections.

Under §212, most expenses of administering an estate or trust were deductible, allowing deductions for amounts paid for “the production or collection of income” and “management, conservation, or maintenance of property held for production of income.” §212 deductions were generally defined at miscellaneous itemized deductions under §67(b). Additionally, §67(e) allowed 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 trust or estate.”

642(h) provided that in the year of termination of a trust or estate, any excess deductions (claimed under either §67(b) or §67(e)) should be passed to the beneficiaries and were considered §67(b) miscellaneous itemized deductions subject to the 2% AGI limitation. The beneficiary would then claim the excess estate or trust deductions on his/her personal return in aggregate with his/her other miscellaneous itemized deductions subject to the 2% AGI limitation.

2018-2025 under the Tax Cuts and Jobs Act
Beginning in 2018, the TCJA enacted §67(g), which suspends the deductibility of miscellaneous itemized deductions subject to the 2% floor under §67(b) for years 2018-2025 for individuals, estates, and trusts.  Individuals, estates, and trusts filing their 2018 income tax returns are realizing firsthand the impact of losing these itemized deductions.

However, in Notice 2018-61 (effective July 23, 2018), the IRS confirmed that §67(e) deductions, claimed by estates and trusts, are not suspended by TCJA’s §67(g) and remain deductible. Thus, estates and trusts can still deduct costs that, but for being held in a trust or estate, would not have been incurred, such as income tax preparation fees.

Since §67(e) deductions remain deductible for estates and trusts, this begs the question: If these deductions are allowed under §67(e) for estates and trusts, are excess deductions in the final year of the estate or trust also valid miscellaneous itemized deductions for individuals, despite the TCJA-imposed suspension of §67(b) deductions under §67(g)?

We hoped for guidance on this issue when the IRS released Notice 2018-61. While the IRS clarified the §67(e) deductibility question for estates and trusts in the notice, it did not offer any guidance to individual taxpayers with excess estate or trust deductions as they prepare their 2018 income tax returns. Instead, the IRS requested comments from the public and tax practitioners on this matter, stating that the Treasury Department and the IRS “intend to issue regulations in this area…” No further guidance or regulation has been issued on this matter to date.

Without further guidance, taxpayers with excess estate or trust deductions are left in a difficult position. If you or an estate or trust that you administer are faced with this issue at any time during 2018-2025, be sure to carefully consult with competent tax professionals who regularly practice in estate and trust income taxation, in order to understand the potential options and risks.

For more information regarding estate and trust income tax issues, please contact John Ure or one of our estate and trust tax advisors at 301.231.6200.