The Tax Cuts and Jobs Act is widely regarded as one of the most significant tax bills passed in the last 30 years,  affecting nearly every type of taxpayer when it was passed in late 2017.  While the majority of the changes under the new law were aimed at individuals and businesses, the new law made a number of changes to fiduciary income tax returns for years ending after December 31, 2017.

Deductibility of Certain Expenses

The new law limited or repealed certain deductions that were previously available to fiduciaries. Similar to individual returns, the law eliminated the deduction for expenses considered 2% miscellaneous itemized deductions. These expenses primarily include property ownership costs, investment management fees (including unbundled corporate fiduciary fees allocated to investment management) and certain professional fees. Costs related to a rental activity or trade or business continue to be fully deductible

In addition, the new law also limited the deductibility of state and local taxes (including state income taxes and property taxes) to $10,000, similar to individual returns.  It is important to note that property taxes related to a rental activity or trade or business activity continue to be fully deductible.

Amounts paid or incurred in connection with the administration of a trust or an estate that would not have been incurred if the property were not held in a trust or estate continue to be fully deductible.  Examples of these expenses include fiduciary fees (not including unbundled corporate fiduciary fees allocated to investment management), probate or court costs, fiduciary bond premiums, legal publication costs or notices to heirs and creditors, death certificate fees and costs related to the preparation of fiduciary probate filings.  In addition, certain accounting and appraisal fees continue to be deductible by the estate or trust.

At this point, based on draft forms provided by the IRS, it appears that excess deductions reported to beneficiaries on a Schedule K-1 from a final trust or estate income tax return will continue to be deductible by beneficiaries as a miscellaneous itemized deduction (not subject to 2%) when beneficiaries prepare their individual income tax return in 2018 and later.

Simple Trusts and DNI

Based on changes in new law, some correspondents have indicated a potential issue affecting simple trusts which are required to distribute all of their net income to a beneficiary.  Due to changes in the deductibility of certain expenses for tax purposes and the computation of the income distribution deduction, it appears that these types of trusts could potentially be faced with undistributed taxable income at the trust level, which would cause the trust to owe tax on income rather than distributing it fully to the named beneficiaries.  Unfortunately, at this point, the treatment remains unclear until further guidance is issued from the IRS.

20% 199A Deduction

One of the main components of the new tax law was a new 20% deduction on qualified business income for eligible taxpayers.  While the specifics of the deduction are not yet final, trusts and estates are eligible to claim the deduction on qualified business income subject to certain limitations.  Qualified business income includes income from rental activities or trade or business activities, as well qualified business income reported to the trust or estate on a Schedule K-1.  In order to compute the deduction amount, certain limitations and thresholds are taken into consideration.   Income from certain types of businesses (primarily service and professional oriented businesses) may be further limited in claiming the deduction. In addition, the 199A deduction also allows a 20% deduction on qualified REIT and qualified publically traded partnership income.

Income Tax Rates

While the overall tax rates on ordinary income were reduced for trusts and estates (with the top rate being reduced from 39.6% to 37%), the income threshold at which those rates apply were unchanged (trusts and estates still reach the top income tax bracket at $12,500 of taxable income). No changes were made to capital gain rates or the net investment income tax rate. Given the more favorable individual income tax rates, the prior strategy of distributing income to beneficiaries when applicable rather than taxing it in the trust still likely remains the more favorable strategy in most cases.

Estate and Gift Tax

The new law also doubled the lifetime exemption amount for individual taxpayers from $5.49 in 2017 to $11.18 million for 2018 (and $11,400,000 in 2019). Due to this increase in the exemption amount, individuals should consider revisiting their estate planning documents and reviewing them with legal counsel to ensure their documents still accomplish the intended purposes originally set forth in the documents.  This is particularly important for documents which contain a formula clause or other provisions based on the lifetime exemption amount.

Other Considerations

Given changes to the deductibility of certain expenses, it is anticipated that trust and estates may end up distributing additional income to beneficiaries in the coming years or paying tax on higher amount of income retained in the trust.  Given this, it may be worthwhile for fiduciaries to discuss these changes with beneficiaries and inform them that their Schedule K-1’s from the trust may report additional taxable income to them in the future.

What’s next?

Many aspects of the new tax law are still pending further guidance from the IRS. We are happy to discuss any questions or how YHB can assist you in further detail.

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