Excess Deductions Are Back!

January 29, 2021
Nichole M. Baer

This summer, the IRS issued interim regulations clarifying that excess deductions from a Trust or an Estate can pass out to beneficiaries.  In the early fall, the IRS issued final regulations to the same effect.  What does this mean for you?

History of Excess Deductions

The Trump administration passed the Tax Cuts and Jobs Acts (the “TCJA”) at the end of 2017.  The TCJA prohibited individuals, estates, and non-grantor trusts from claiming miscellaneous deductions for any years beginning after December 31, 2017, and before January 1, 2026.

Before the passage of TCJA, Trusts and Estates could pass out excess deductions to their beneficiaries in the year the estate or trust terminated.  The beneficiaries could then take such deductions on their personal tax returns as miscellaneous itemized deductions.  After the passage of TCJA, it appeared that the new IRS section 67(g) prohibited such excess deductions as TCJA specifically disallowed 2 % miscellaneous itemized deductions incurred in tax years 2018-2025.

Current Status

The final regulations reversed the long-standing IRS and Treasury interpretation that excess deductions passed out of a terminating non-grantor trust or estate were miscellaneous itemized deductions when received by a beneficiary, regardless of the character of the deductions.

The new regulations, though, provide guidance to taxpayers and preparers on determining the character of the excess deductions. The regulations also provide the manner of allocating excess deductions that beneficiaries are receiving out of a terminated estate or non-grantor trust.

Now, each excess deduction, upon the termination of an estate or non-grantor trust, retains its character as

  • an amount allowed in calculating adjusted gross income (“AGI)
  • a non-miscellaneous itemized deduction, or
  • a miscellaneous itemized deduction.

The final regulations also clarify that the following deductions are allowable in calculating the AGI:

  • Deductions for costs incurred in connection with the administration of an estate or trust which would not have been incurred if a non-grantor trust or an estate did not hold the property. These typically include trustee, legal, and accounting fees.
  • Deductions concerning the personal exemption of an estate or non-grantor trust.
  • Distribution deductions for non-grantor trusts distributing current income.
  • Distribution deductions for non-grantor trusts accumulating income.

IRS form K-1 was also amended to reflect the regulation change by

  • adding to Box 11, Code A for excess deductions, 67(e) expenses, and
  • adding to Box 11, Code B, excess deductions – non-miscellaneous itemized deductions.

Planning Pointer

If you are a beneficiary who previously received distributions from a terminating non-grantor trust or estate, you should consult with your tax preparer and attorney to determine if you should amend your prior-year tax returns from 2018 and 2019.