The Tax Cuts and Jobs Act (TCJA) (§67(g) of TCJA, PL 115-97) eliminated miscellaneous itemized deductions for individuals during the TCJA period (2018-2025). These consisted primarily of the Schedule A expenses subject to 2% of the taxpayer’s AGI. This law change also impacted estates and trusts.
Miscellaneous Itemized or Specific Deductions?
Miscellaneous itemized deductions for an estate or trust include items such as investment management or custodial fees and property expenses such as insurance premiums, association fees, and maintenance or repair costs on assets owned by an estate or trust not treated as business assets (Schedule C or F) or for the production of income (Schedule E). These are not deductible by an estate or trust. However, the following types of expenses ARE deductible for an estate or trust under IRC §67(e):
- Expenses paid or incurred that are connected to the administration of the estate or trust and would not have existed if the property wasn’t held in an estate or trust;
- The personal exemption of an estate or irrevocable trust (§642(b));
- Deductions for trusts which distribute current income under §651; and
- Deductions for trusts which accumulate income under §661.
The issue that arose from the deductible expense area is what happens in the final year of an estate or trust. These deductible expenses can result in excess deductions for the estate or trust. In years before TCJA, excess deductions upon the termination of an estate or trust would be picked up by the estate or trust beneficiaries via the final K-1, and typically be treated as miscellaneous itemized deductions subject to 2% of AGI on the beneficiaries Form 1040 Schedule A. The advent of TCJA left excess deductions as disallowed since miscellaneous deductions subject to 2% of AGI were eliminated during the TCJA years.
TD 9918 provides guidance and allows beneficiaries to deduct excess deductions upon the termination of an estate or trust by providing the following guidance:
Note. This section’s impact will require preparers of estate or trust final K-1s to identify the amounts and type of deductions passing through to beneficiaries on a final K-1 rather than merely providing a summary number of excess deductions as in the past.
- Net operating losses may be identified as such on the beneficiary K-1s and passed through from the estate or trust to be used by the beneficiary in the same manner as the estate or trust treated them (in other words, a leftover NOL of an estate or trust will be treated as an NOL by the estate or trust beneficiaries).
- Capital losses on the termination of an estate or trust are disclosed on the final estate or trust K-1. They are identified in the same manner as remaining net operating losses for the beneficiaries to use leftover capital loss carryovers on their personal returns, subject to the typical limitations for capital losses which have existed in the tax laws for many years (i.e., the ability to offset gains and use $3K in losses per year in excess of gains).
Specific Deductions for an Estate or Trust
That leaves how to deduct excess deductions. These would include the administrative expenses of an estate or trust (IRC §642(h)(2). The guidance explains such expenses are not miscellaneous expenses and therefore are permitted to be deducted under §67(e)) because these type of expenses would not have been incurred had the estate or trust not been established.
- Probate Fees
- Estate (or trust) tax preparation fees;
- State and local taxes;
- Legal fees for estate and trust administration;
- Fiduciary and trustee fees and commissions;
- The allowed exemption for an estate or trust
The Treasury Decision results in the characteristic of these excess expenses remaining the same when passing through to the beneficiary from the trust or estate. If an excess expense was a deduction to arrive at AGI for the estate or trust, that same expense is a deduction to arrive at AGI on the beneficiary’s tax return as an above-the-line deduction (e.g., trust administration fees). These expenses would be shown on the beneficiary’s Schedule K-1 (Form 1041) in box 11 with code A. If an excess expense was a non-miscellaneous itemized deduction at the trust or estate level, that expense flows through to the beneficiary as a non-miscellaneous itemized deduction to be deducted on their Schedule A (e.g., state and local taxes) if they itemize. These expenses would be shown on the beneficiary’s Schedule K-1 (Form 1041) in box 11 with code B. This is a significant decision, especially given the fact that the result is an “above the line” deduction for certain expenses, rather than an itemized deduction per the previous treatment, which often has been lost to the standard deduction.
The guidance of the Treasury Decision indicates it applies to tax years after December 31, 2017. If it’s practical, you may want to review recently filed Form 1041 final returns to determine if amending them makes sense if the excess deductions were not taken.
By Chris Korban, CPA
Tax Materials Specialist, U of I Tax School