In May of 2020 the IRS issued long-awaited proposed regulations to give us guidance on how to determine the character, amount and allocation of deductions passed on to a beneficiary of an estate or trust at the time of its termination. These regulations detailed that any excess deduction on termination of an estate or trust that is allowed in arriving at the estate or trust’s Adjusted Gross Income is allowed as a deduction for an individual. Don’t miss: Dealing with a deceased relative’s debt These expenses that are used to compute a trust or estate’s Adjusted Gross Income (AGI) are expenses under Code Section 67(e). Under this code section, the allowable costs include those paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such estate or trust. For example, legal and accounting fees, which would not have ever been incurred unless there was a trust in existence. Section 67(e) also includes deductions allowable under Sections 642(b), 651 and 661, which are detailed below.
- 642(b) – Deduction for personal exemption ($600 for estates, $100 for complex trusts, $300 for simple trusts). This deduction is specific to the estate or trust and cannot contribute to the excess deductions passed to the beneficiary.
- 651 – Trusts distributing current income (simple trusts) are allowed a deduction in the amount of income for the taxable year which is required to be distributed currently. Also known as the income distribution deduction. Because this deduction is limited to current income, it cannot contribute to the excess deductions passed to the beneficiary.
- 661 – Trusts accumulating income or distributing corpus (complex trusts) are allowed deductions for any income that is required to be distributed, as well as any other amount properly paid, credited, or required to be distributed. This deduction cannot exceed the distributable net income (DNI) of the estate or trust. In simpler terms, you are allowed a deduction for distributions to beneficiaries, as long as they do not exceed the trust’s DNI. Because this deduction is limited to current income, it cannot contribute to the excess deductions passed to the beneficiary.
- Deductions permitted in arriving at the trust or estate’s AGI. These include estate administration costs, trustee fees, legal fees, accounting fees, etc.
- Non-miscellaneous itemized deductions, such as state and local income taxes or mortgage interest paid.
- Miscellaneous itemized deductions, which are not unique to a trust/estate and would be incurred by an individual owning the same assets. Examples of these include investment management and custodial fees, which are no longer deductible for individuals on their 1040.