Effects of Miscellaneous Itemized Deduction Ban on Trusts & Estates

By: Bart Saettele

President Trump signed the Tax Cuts and Jobs Act (the “Act”) into law on Friday, December 22, 2017. The provisions of the Act generally come into effect on January 1, 2018.

One new rule under the Act prohibits individuals from deducting miscellaneous itemized deductions subject to the 2% of adjusted gross income (“AGI”) floor on their federal income tax returns for tax years from 2018 through 2025. Interestingly, this change to the individual tax rules may have a significant impact on taxpayers other than individuals. Trusts and estates compute their taxable income in the same manner as individuals, except where explicit exceptions apply in the tax law. There are no explicit exceptions in the tax law relating to miscellaneous itemized deductions, either before or after the Act, and accordingly, for tax years from 2018 through 2025, trusts and estates cannot deduct miscellaneous itemized deductions.

Trusts and estates have routinely deducted expenses incurred related to the administration of assets they hold, such as investment advisor fees, and expenses incurred in preparing a decedent’s house for sale. Over the years, an increasing number of these types of expenses were deemed to fall under the category of miscellaneous itemized deductions subject to the 2% of AGI floor, and were therefore only able to be deducted to the extent they exceeded 2% of the trust’s or estate’s AGI. Under the Act, these expenses will generally no longer be able to be deducted by trusts and estates.

Trusts and estates have also routinely deducted trustee fees and personal representative fees, attorney fees, and fees regarding the preparation of fiduciary income tax returns. To the extent the particular fee was incurred because the associated asset was held in a trust or an estate, the expense was deemed not to fall under the category of miscellaneous itemized deductions, and therefore was deductible in full.

The statutory authority that has historically differentiated which deductions are to be treated as miscellaneous itemized deductions for trusts and estates is not explicit and clear. The IRS might take the position that the Act results in none of the above-discussed expenses being deductible, however. Because of Treasury Regulations and IRS Forms & Instructions that have developed through the years, that would seem to be an extreme position by the IRS.

However, the IRS may pay more attention to and become more aggressive in questioning the deduction of trustee fees and personal representative fees, attorney fees, and fees regarding the preparation of fiduciary income tax returns.  Before the Act, if the IRS could show such fees were not caused by the associated assets being held in a trust or estate (i.e., they were similar to expenses individuals would normally incur), that would just usually mean the expenses could still be deducted, but only as a miscellaneous itemized deduction to the extent they exceeded 2% of AGI. After the Act, if the IRS could make this showing, such expenses would be entirely non-deductible.

What trusts and estates can do now to be best protected is pay any expenses they have already incurred in 2017 as opposed to 2018, to make sure that it is the law that applied before the Act that governs whether and to what extent such expenses are deductible.

Remember, this new law will affect taxes for 2018 and the return filed in 2019. It will not affect taxes for 2017 and the return filed in 2018.

To review your tax situation and determine what steps you should take to comply with these changes in the tax law you should consult with an attorney or your tax preparer. The tax and estate planning lawyers at Paule, Camazine & Blumenthal will be happy to consult with you about the new law as it applies to you.

Disclaimer

Barton E. Saettele

Barton E. Saettele

Bart Saettele is not only licensed to practice law in the State of Missouri, but is also a licensed Certified Public Accountant. Prior to joining Paule, Camazine & Blumenthal, Mr. Saettele practiced in the St. Louis tax departments of two “Big Five” public accounting Firms. Mr. Saettele's legal practice includes estate planning, tax planning, probate and trust administration.