Proposed Rules Clarify IRC Section 67(g) Effect on Trusts and Estates

| 5/14/2020
Proposed Rules Clarify IRC Section 67(g) Effect on Trusts and Estates

On May 7, the IRS released proposed regulations clarifying which expenses can be deducted by an estate or a nongrantor trust (including the S portion of an electing small-business trust (ESBT)) rather than being treated as miscellaneous itemized deductions not deductible under the Tax Cuts and Jobs Act of 2017 (TCJA). More important, the proposed regulations explain how the TCJA changes affect excess deductions upon termination, which pass to the beneficiary in the final year of an estate or trust.


Under IRC Section 67, miscellaneous itemized deductions are deductible by an individual only to the extent the aggregate of those deductions exceeds 2% of the individual’s adjusted gross income (AGI). IRC Section 67(b) provides that deductions subject to the 2% floor are deductions other than deductions for interest, state and local taxes, casualty losses, and charitable contributions.

IRC Section 67(e) generally states that the AGI of an estate or nongrantor trust is computed in the same manner as for an individual. However, certain expenses, such as costs incurred for the administration of the estate or trust that would not have been incurred if the property were not held in the trust or estate, are deductible in computing AGI.

The TCJA added IRC Section 67(g) to disallow all miscellaneous itemized deductions for taxable years beginning after 2017 and before 2026.

Notice 2018-61 addresses the interplay between IRC Section 67(e) and Section 67(g). It clarifies that future regulations will provide that costs described in IRC Section 67(e) for an estate or trust will continue to be deductible in computing AGI. Notice 2018-61 also requests comments regarding the interplay of IRC Section 67(g) with IRC Section 642(h)(2). IRC Section 642(h)(2) allows the beneficiary of an estate or trust to deduct the net of all costs incurred by the estate or trust in excess of its gross income during its last tax year. This deduction is a miscellaneous itemized deduction under IRC Section 67(b) and, therefore, without a regulatory fix would not be deductible for the beneficiary before 2026 under IRC Section 67(g). However, denying this deduction to the beneficiary results in an inconsistency with IRC Section 67(e), which allows the estate or trust a deduction for such costs.

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Proposed regulations

The proposed regulations adopt some of the comments into Notice 2018-61. For instance, the proposed regulations provide that instead of the beneficiary reporting a single, aggregate miscellaneous itemized deduction for the final year of the estate or trust, the different costs comprising the Section 642(h)(2) excess deduction on termination retain their character for the beneficiary as one of the following:

  1. An amount allowed in arriving at AGI under Sections 62 and 67(e), such as a capital loss, or the costs of administration of the estate or trust
  2. A nonmiscellaneous itemized deduction under Section 63(d) that is allowable in computing taxable income, such as a deductible state or local tax expense
  3. A miscellaneous itemized deduction currently disallowed under Section 67(g)

The proposed regulations require the fiduciary to separately identify on the Form K-1 these three components of the excess deductions that may be limited when claimed by the beneficiary as specified in the instructions to Form 1041. This requirement will result in more complexities for preparers of fiduciary income tax returns.

The proposed regulations contain two examples of how to compute and determine the character of excess deductions upon termination (including allocation among the beneficiaries); however, neither is an example of the third category of expenses described as miscellaneous itemized deductions. The most common expense of this type that would be incurred by an estate or nongrantor trust likely would be investment advisory fees since such fees are expenses that could be incurred by a hypothetical individual and therefore are not unique to the estate or trust.

The proposed regulations apply to taxable years beginning after the date they are published as final regulations. However, estates, nongrantor trusts, and their beneficiaries may apply the rules in the proposed regulations for taxable years beginning after Dec. 31, 2017.

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Sally E. Day
Sally Day
Managing Director