On Friday, July 13, 2018, the U.S. Department of the Treasury (the “Treasury”) and the IRS published Notice 2018-61 (the “Notice”), stating that they plan to issue regulations providing clarification of the effect of § 67(g) of the Internal Revenue Code (the “Code”) on the deductibility of certain expenses incurred by estates and non-grantor trusts. Congress added § 67(g) to the Code in the legislation previously known as the “Tax Cuts and Jobs Act” (the “Act”) (see alert here) which President Trump signed into law on December 22, 2017.
The Act limits the amount of state and local taxes an individual taxpayer may deduct in one calendar year to $10,000. One strategy to work around the limits imposed by the Act is for individuals to place real property located in highly-taxed states into limited liability companies, then transfer the limited liability company interests to non-grantor trusts in lower-taxed states where trusts may claim deductions for the payment of property taxes.
In May, the Treasury and the IRS issued Notice 2018-54 (see alert here), discouraging the use of nonprofit entities and charitable funds controlled by state and local governments as a method for circumventing the limits on state and local tax deductions. In the Notice, the Treasury and the IRS did not go so far as to discourage the use of non-grantor trusts, stating that the regulations will clarify which expenses an estate or non-grantor trust may deduct under § 67(g) of the Code.
Section 67(g) of the Code suspends § 67(a) of the Code, which provides that miscellaneous itemized deductions are allowed to the extent that the aggregate of such deductions exceeds 2% of adjusted gross income for any taxable year. Under § 67(g) of the Code, no miscellaneous itemized deductions are allowed for any taxable year beginning after December 31, 2017 and before January 1, 2026. Over the last couple of months, commentators have read § 67(g) of the Code to eliminate the ability of estates and non-grantor trusts to deduct any expenses described in § 67(e)(1) of the Code and § 1.67-4 of the Treasury Regulations for the taxable years during which § 67(g) of the Code suspends the application of § 67(a) of the Code. Under § 67(e) of the Code, the adjusted gross income of an estate or trust is computed in the same manner as that of an individual, except that the following deductions are allowable in calculating adjusted gross income:
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the deductions for costs paid or incurred in connection with the administration of the estate or trust that would not have been incurred if the property were not held in such estate or trust; and
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the deductions allowed under § 642(b) of the Code (personal exception deductions for estates and trusts, including qualified disability trust deductions), § 651 of the Code (deductions for trusts required to distribute current income only), and § 661 of the Code (deductions for estates and trusts accumulating income or distributing corpus).
In the Notice, the Treasury and the IRS make clear that commentators have incorrectly read § 67(g) of the Code. They also note that nothing in § 67(g) of the Code affects the ability of an estate or trust to take deductions under § 67(b) of the Code, which includes itemized deductions other than the 12 deductions specifically excluded by that section. Examples of allowable itemized deductions under § 67(b) of the Code include interest, taxes paid, charitable contributions, medical and dental expenses, and estate tax paid on income in respect of a decedent.
The Treasury and the IRS intend to issue regulations clarifying that estates and non-grantor trusts may continue to deduct expenses under § 67(e)(1) of the Code and amounts allowable as deductions under §§ 642(b), 651, and 661 of the Code in determining the estate or non-grantor trust’s adjusted gross income during taxable years beginning after December 31, 2017 and before January 1, 2026. The regulations will also clarify that deductions outlined in § 67(b) and 67(e) of the Code remain outside of the definition of “miscellaneous itemized deductions” and are unaffected by the newly enacted § 67(g) of the Code.
Some tax professionals are concerned that the enactment of § 67(g) of the Code also affects a beneficiary’s ability to deduct § 67(e) expenses upon the termination of a trust or estate as provided in § 642(h) of the Code, which outlines unused loss carryovers and excess deductions available to beneficiaries in such circumstances. The Treasury and the IRS plan to issue regulations to address concerns regarding beneficiary deductions and currently are receiving written comments from the public.
