Last week, the IRS issued final regulations under sections 67 and 642 to clarify that certain deductions are allowed to an estate or non-grantor trust because they are not miscellaneous itemized deductions. These rules apply to estates and non-grantor trusts (including the S portion of an electing small business trust) and their beneficiaries.
The final regulations adopt the proposed regulations that came out in May of this year, with one clarification, noted below.
The final regulations allow estates and trusts the following deductions under section 67(e):
- Costs paid or incurred in connection with the administration of an estate or non-grantor trust that would not have been incurred if the property were not held in the estate or trust;
- The personal exemption of an estate or non-grantor trust;
- The distribution deduction for trusts distributing current income to beneficiaries; and
- The distribution deduction for estates and trusts accumulating income.
According to the final regulations, these deductions are not affected by the suspension of the deductibility of miscellaneous itemized deductions for individual taxpayers for tax years beginning after December 31, 2017, and before January 1, 2026, as provided in the Tax Cuts and Jobs Act. The final regulations also explain how to determine the character, amount, and allocation of deductions in excess of gross income that a beneficiary succeeds to on the termination of an estate or non-grantor trust.
Notice 2018-61, issued in July 2018, created the question of how to treat section 642(h) excess deductions, which are passed on to beneficiaries when a trust terminates. Under the final regulations, each deduction comprising the section 642(h) excess deduction retains its separate character as an amount allowed in arriving at adjusted gross income, as a non-miscellaneous itemized deduction, or as a miscellaneous itemized deduction. The preamble to the final regulations confirms that excess deductions are allocated to beneficiaries using the rules of Treas. Reg. § 1.642(h)-4. The final regulations clarify that a beneficiary of a trust or estate may claim all or a part of a section 642(h) excess deduction before, after, or together with the same character of deductions separately allowable to the beneficiary under the Internal Revenue Code.
The regulations will apply to tax years beginning after they are published as final in the Federal Register, which should be in September 2020.
