July 19, 2018 IRS plans to issue regulations clarifying effect on trusts and estates of Section 67(g), disallowing miscellaneous deductions The IRS has announced (Notice 2018-61) its intention to issue regulations clarifying the effect of new Section 67(g) on the deductibility of certain expenses described in Section 67(b) and (e) that are incurred by estates and non-grantor trusts. Background Added to the code by the Tax Cuts and Jobs Act (TCJA), Section 67(g) suspends the deduction of certain miscellaneous itemized deductions for tax years 2018 through 2025. Before enactment of the TCJA, individuals could deduct certain expenses as miscellaneous itemized deductions under Section 67(a) to the extent that the aggregate of the deductions exceeded 2% of adjusted gross income (AGI), defined in Section 62(a). For purposes of Section 67, miscellaneous itemized deductions are defined as itemized deductions other than those listed in Section 67(b)(1) through (12), personal exemptions, Section 199A deductions, and above-the-line deductions. The AGI of an estate or trust generally is computed for Section 67 purposes in the same manner as AGI for an individual, although certain additional deductions are allowed. Specifically, these items may be factored into determining AGI: (1) costs paid or incurred in connection with the administration of the trust or estate if those costs would not have been incurred if the property were held by an individual, and (2) deductions available under Section 642(b) (the personal exemption), Section 651 (income distribution deduction for trusts distributing current income only), and Section 661 (income distribution deduction for estates and trusts accumulating income or distributing corpus). Reg. Section 1.67-4(a) explains an exception to the 2% floor for miscellaneous itemized deductions for costs paid or incurred in the administration of an estate or non-grantor trust if the costs would not have been incurred had the property been held by an entity other than an estate or non-grantor trust (e.g., by an individual). Pending regulations The IRS points out that some commentators "have suggested that the new [S]ection 67(g) might be read to eliminate the ability of estates and non-grantor trusts to deduct any expenses described in [S]ection 67(a)"; the IRS and Treasury, however, "do not believe that this is a correct reading of Section 67(g)." The notice explains that Section 67(g) denies a deduction for miscellaneous itemized deductions, which are defined as itemized deductions other than those listed in Section 67(b). Itemized deductions, as defined in Section 63(d), exclude personal exemptions, Section 199A deductions, and deductions used to arrive at AGI. This means, the IRS explains, that "neither the above-the-line deductions used to arrive at adjusted gross income nor the expenses listed in [S]ection 67(b)(1) — (12) are miscellaneous itemized deductions." Because AGI for an estate or trust, as determined under Section 67(e), treats expenses described in Section 67(e)(1) (those paid or incurred in connection with administration of an estate or trust that would not have been incurred if the property was held by the trust or estate) as above-the-line deductions allowable in determining AGI, the "suspension of the deductibility of miscellaneous itemized deductions under Section 67(a) does not affect the deductibility of payments described in [S]ection 67(e)(1)," the notice explains. Reasoning that "[n]othing in [S]ection 67(g) impacts the determination of what expenses are described in [S]ection 67(e)(1)" or inhibits the estate or trust from taking an itemized deduction under Section 67(b), the notice states that the IRS and Treasury "intend to issue regulations clarifying that estates and non-grantor trusts may continue to deduct expenses described in [S]ection 67(e)(1) and amounts allowable as deductions under [S]ection 642(b), 651 or 661, including the appropriate portion of a bundled fee, in determining the estate or non-grantor trust's" AGI from tax years 2018 through 2025. Further, the regulations will clarify that deductions listed in Section 67(b) and (e) "continue to remain outside the definition of 'miscellaneous itemized deductions' and thus are unaffected by [S]ection 67(g)." Citing some concerns that Section 67(g) could affect a beneficiary's ability to deduct Section 67(e) expenses when a trust or estate terminates, as provided in Section 642(h), the notice states that Treasury and the IRS are studying whether Section 67(e) deductions, and any other deductions that would not be subject to the limitations imposed under Section 67(a) and (g) in the hands of an estate or trust, "should continue to be treated as miscellaneous itemized deductions when they are included as a [S]ection 642(h)(2) excess deduction." Comments are requested on the effect that Section 67(g) has on a beneficiary's ability to deduct Section 642(h)(2) excess deductions when a trust or estate terminates. The notice is effective as of July 13, 2018 and may be relied upon for tax years beginning after December 31, 2017. Implications This notice should provide comfort to fiduciaries concerned that Section 67(g) might prohibit trusts and estates from deducting Section 67(e) expenses such as trustee fees or executor commissions. (See Tax Alert 2018-0157.) Given that fiduciaries can rely on the notice for tax years 2018 through 2025, actually issuing the proposed regulations might not be a high priority for the government when compared to other TJCA projects. The more surprising aspect of the notice is the comment request concerning the beneficiary's ability to deduct Section 67(e) expenses when a trust or estate terminates. These have been miscellaneous itemized deductions for decades and many beneficiaries found these deductions useless due to the alternative minimum tax (AMT). Now that all taxpayers lose the deduction, not just those under the AMT, the government is trying to find a way around a literal reading of Section 67(b) that excludes Section 642(h)(2) from non-itemized deduction treatment. Maybe it could be done by amending Reg. Section 1.67-2T, but until then, deductions described in Section 642(h)(2) remain nondeductible for all non-corporate beneficiaries for estate and trust terminations occurring between 2018 and 2025. ———————————————
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