Kara Sears
The Tax Cuts and Jobs Act (TCJA) of 2017 has brought about several changes that impact the ability to deduct trustee fees. The Act introduces a number of uncertainties, especially for trusts and estates, and eliminates or minimizes many deductions for individuals. Trusts and estates are generally subject to the same income reporting and deduction rules as individuals, with some exceptions. This includes the elimination of all miscellaneous itemized deductions under Code §67, which imposes a 2% limit on such deductions. The Act also caps the deduction for state and local taxes at $10,000 total. However, there are exceptions and planning opportunities that can be considered to optimize deductions. The impact of the Act on trustee fee deductions is still being assessed, and the Treasury Department is expected to provide further guidance and regulations in the coming years.
| Characteristics | Values |
|---|---|
| Trustee fees deductibility | Trustee fees can be deducted from fiduciary accounting income (TAI) but not from distributable net income (DNI) |
| Tax rates for trusts vs. beneficiaries | The disparity between a trust's and beneficiary's tax rates is likely greater under the Act |
| Uncertainty regarding Treasury's application | Unpaid administrative costs and fees should be paid before the tax year-end to avoid uncertainty |
| Impact of the Act on trusts and estates | The Act eliminates or minimizes deductions for individuals, and trusts and estates are subject to similar rules with a few exceptions |
| Section 67(e) interpretation | If fiduciary-specific expenses are excluded from miscellaneous itemized deductions, trusts and estates can benefit from deductions not available to individuals |
| Section 67(g) clarification | The IRS intends to issue regulations clarifying that certain expenses of trusts and estates are not miscellaneous itemized deductions and thus remain deductible |
| Deductible expenses under Section 67(e) | Tax preparation fees, appraisal fees, certain fiduciary expenses, and administrative expenses specific to trusts and estates |
| Non-deductible expenses | Ownership costs such as homeowners association fees, insurance, and maintenance |
| Charitable contributions | Trusts and estates can make tax-deductible charitable contributions if explicitly allowed in the trust document |
| Deductions for administrative expenses | Expenses incurred in preserving and distributing the estate, including storage and maintenance costs, may be deductible under §20.2053-3(d)(1) |
| Form 1041 instructions | The executor or trustee files Form 1041 under the estate's or trust's name and TIN, checking the "Decedent's estate" box and providing information for each electing trust |
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What You'll Learn
- Tax reporting and deductions for individuals vs. trusts and estates
- Distributable net income (DNI) vs. trust or fiduciary accounting income (TAI)
- Uncertainty regarding Treasury's application of the new law
- The elimination of miscellaneous itemized deductions
- The cap on the deduction for state and local taxes
Tax reporting and deductions for individuals vs. trusts and estates
The Tax Cut and Jobs Tax Act of 2017 (the “Act”) has brought about changes in the way that individuals, estates, and trusts report their income and deductions. Trusts and estates are subject to the same income reporting and deduction rules as individuals, with a few exceptions.
One key difference is that individuals can deduct the full value of certain non-cash assets without recognizing the related gain. In contrast, a trust's or estate's charitable deduction is limited to the asset's cost basis. Additionally, the Act eliminates or minimizes many deductions for individuals, such as the elimination of all miscellaneous itemized deductions under Code §67. Trusts and estates may still be able to benefit from some deductions that individuals cannot, depending on the interpretation of Section 67(e)'s exclusion of fiduciary-specific expenses.
When it comes to reporting income, individuals typically report their income on a tax return, such as Form 1040 in the US. They can claim deductions for things like charitable contributions, which were increased under the CARES Act in response to the COVID-19 pandemic. Estates and trusts, on the other hand, may use different forms, such as Schedule K-1 to report a beneficiary's share of income, credits, and deductions, or Form 1041-ES for estimated income tax. In Pennsylvania, for example, estates and trusts report income on the PA-41 Fiduciary Income Tax Return. They are required to report and pay tax on the income they receive during their taxable year, and they can deduct distributions of income that they are required to distribute to beneficiaries.
Another difference is how trustee fees are treated. For individuals, trustee fees may be deducted from taxable income. However, for trusts, a portion of the trustee's fees is typically deducted from fiduciary accounting income (TAI), but not from distributable net income (DNI). As a result, the beneficiary may see a higher amount of reportable taxable income, even if distributions do not change.
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Distributable net income (DNI) vs. trust or fiduciary accounting income (TAI)
Distributable net income (DNI) is the maximum taxable amount that can be distributed to the beneficiaries of a trust. It is calculated using the trust's taxable income, subtracting the capital gain or adding the capital loss, then adding the exemption. DNI is intended to provide trust beneficiaries with a reliable income source while minimising the amount of income tax paid by the trust.
Trust accounting income (TAI), on the other hand, is the amount of income that a trust recognises for accounting purposes. TAI is typically lower than DNI because a portion of the trustee's fees is deducted from TAI, whereas they would not be deducted from DNI.
When preparing the trust or fiduciary accounting, the trustee follows the terms of the document as established by the settlor upon the trust's creation. The settlor may have outlined how the trustee allocates receipts and disbursements between income and principal, or they may have granted the trustee discretionary powers to decide these allocations. If the trust document is silent on these allocations, the trustee must follow the governing law of the jurisdiction in which the trust is administered.
For a simple trust, it may make sense from an income tax perspective to prepare trust accounting income in a manner that parallels the DNI calculation. By doing so, the trustee can generate the largest income distribution deduction taken at the trust level.
The interplay of these concepts can be seen in Form 1041, U.S. Income Tax Return for Estates and Trusts, and its instructions. Calculating DNI on Schedule B, Income Distribution Deduction, of Form 1041, involves starting with the adjusted total income calculated on page 1, line 17.
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Uncertainty regarding Treasury's application of the new law
The Tax Cuts and Jobs Tax Act of 2017, which came into effect in 2018, has created uncertainty regarding the Treasury's application of the new law. The Act eliminates or minimizes several deductions for individuals, and trusts and estates are subject to the same income reporting and deduction rules. However, there are two significant deduction eliminations in the Act with unclear implications for trusts and estates.
The first elimination is the removal of all miscellaneous itemized deductions under Code §67, which imposes a 2% limit on such deductions. Trusts and estates may still benefit from deductions that individuals cannot claim if Section 67(e)'s exclusion of fiduciary-specific expenses means they are not miscellaneous itemized deductions. However, if the exclusion is only related to the 2% floor, then the same deductions eliminated for individuals will also be eliminated for trusts and estates.
The second unclear deduction elimination is the cap on the deduction for state and local taxes, which the Act limits to $10,000 total. While there are some exceptions to this cap, the lack of clarity has created uncertainty for trusts and estates. The Treasury Department is expected to be busy in the coming years providing guidance, rulings, and temporary regulations to address these uncertainties.
In addition, the language of Sec. 67(g) has created confusion regarding the elimination of expenses deductible under Sec. 67. While expenses deductible under Sec. 67(e), such as tax preparation fees and certain fiduciary expenses, are expected to remain deductible, the Treasury and the IRS intend to issue regulations to clarify the impact of Sec. 67(g). These regulations are anticipated to confirm that the deductibility of administrative expenses of trusts and estates has not been suspended by Sec. 67(g).
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The elimination of miscellaneous itemized deductions
The Tax Cuts and Jobs Act (TCJA), enacted on December 22, 2017, brought about significant changes to the tax landscape, including the elimination of certain deductions. One notable change was the suspension of miscellaneous itemized deductions under Section 67(g) of the Act. This provision explicitly disallowed miscellaneous itemized deductions for individuals, estates, and trusts for the tax years 2018 through 2025.
Prior to the TCJA, individuals could claim a variety of miscellaneous itemized deductions on their tax returns. These deductions included expenses such as investment management fees, tax preparation fees, and certain fiduciary expenses. However, the TCJA introduced a new limitation by stating that "no miscellaneous itemized deduction shall be allowed" during the specified tax years.
To address this uncertainty, the Internal Revenue Service (IRS) issued Notice 2018-61, which provided clarification on the interpretation of Section 67(g). The notice stated that expenses that are administrative in nature and would not have been incurred if the trust or estate did not exist are not considered miscellaneous itemized deductions. These expenses, such as tax preparation fees and fiduciary fees, remain deductible for trusts and estates.
In conclusion, while the TCJA did eliminate miscellaneous itemized deductions for individuals, estates, and trusts, it is important to distinguish between those deductions and administrative expenses that are inherent to the existence of a trust or estate. By providing clarification on this distinction, the IRS has offered guidance to taxpayers and ensured that certain essential deductions can still be claimed.
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The cap on the deduction for state and local taxes
The state and local tax (SALT) deduction allows taxpayers who itemize when filing federal taxes to deduct certain taxes paid to state and local governments. The Tax Cuts and Jobs Act (TCJA) capped the SALT deduction at $10,000 per year, consisting of property taxes plus state income or sales taxes, but not both. This cap applies to tax years 2018 to 2025 and is set to expire in 2026.
Prior to the TCJA, there was no cap on the SALT deduction, so taxpayers could deduct 100% of their state and local taxes paid. The SALT cap has stirred much debate, especially within high-tax states, as opponents argued that it was unconstitutional. In 2018, the governments of New York, New Jersey, Connecticut, and Maryland filed a lawsuit against the Treasury Department and IRS, arguing that the cap unfairly restricts their ability to pursue their own preferred tax policies. However, the courts, including the Supreme Court, have ruled that the SALT cap is constitutional.
A key driver for implementing the SALT deduction cap was to help increase federal revenues by limiting deductions. The SALT deduction is a large tax expenditure, and capping it tends to increase the balance of payments deficit. The Joint Committee on Taxation (JCT) estimated that the deduction for state and local taxes paid would cost the federal government $24.4 billion for 2020.
There are several efforts underway to restore the SALT deduction, including the relaunch of the bipartisan SALT Caucus in the 118th Congress. Additionally, in April 2021, a bipartisan group of House lawmakers threatened to block the Build Back Better Act if a raise on the SALT deduction was not included.
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Frequently asked questions
The new law, or the Tax Cuts and Jobs Tax Act of 2017 (TCJA), suspends miscellaneous itemized deductions for tax years 2018-2025. This includes deductions for trustee fees, which are no longer allowed as miscellaneous itemized deductions.
Yes, there are a few exceptions. The new law does not impact deductions for costs that are necessary for administering an estate or trust, such as tax preparation fees, appraisal fees, and certain fiduciary expenses. These are not considered miscellaneous itemized deductions and are still deductible.
The new law clarifies that beneficiaries can still deduct excess deductions from an estate or trust upon its termination. The deductions in the hands of the beneficiary are treated the same as they were by the trust or estate.
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