The “Tax Cuts and Jobs Act” and its Impact on Income Taxation of Estates and Trusts

Paula Ellenberg, CPA, CVA, MST (Nov, 2018)

For tax years beginning in 2018-2025, estates and trusts are subject to four tax brackets:  10%, 24%, 35% and 37%.

New Rates and Thresholds - (2018 – 2025)

  • 10% - $0 - $2,550
  • 24% - $2,551 - $9,150
  • 35% - $9,151 - $12,500
  • 37% - Over $12,501

 

Capital Gains and Qualified Dividends Rates Retained

  • 15% Beginning at $2,601
  • 20% Beginning at $12,700

Qualified Business Income Deduction

Section 199A introduced by the Tax Cuts and Jobs Act, provides a deduction generally equal to 20% of net “qualified business income” to any taxpayer other than a corporation.   Thus trusts and estates are eligible for the 20% deduction.

Rules similar to the rules under old Section 199 (as in effect on December 1, 2017) apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital.

Miscellaneous Itemized Deductions in Excess of 2% Repealed

As a result of the “Tax Cuts and Jobs Act,” IRC §67(g), suspends the deduction for miscellaneous itemized deductions to the extent they exceed 2% of AGI. 

The determining factor for applying the 2% limitation within an estate or trust is whether or not such expenses would have been incurred if the property had not been held inside a trust or estate.  In other words, if the expense is commonly incurred by individuals outside the estate or trust, the 2% limitation applies. Examples of these expenses would be “investment advisory fees” and “excess deductions on termination.” 

NOTE:  The IRS has announced its intent to issue regulations providing clarification of newly enacted IRC §67(g) and its applicability to estates and trusts. 

Expenses not normally subject to the 2% limitation, such as trustee and executor fees, legal and accounting fees and tax return preparation fees are not expected to be affected and are expected to remain fully deductible.

State and Local Taxes Limited to $10,000

The law amended IRC §164(b) to limit the aggregate deduction for state and local real property taxes, state and local personal property taxes and state and local income taxes to a maximum of $10,000 per year.  This limitation applies to trusts and estates much the same way as it does to individuals.

Nonpassive Losses Limited to $250,000

Nonpassive losses are now limited to $250,000 and the excess loss is treated as a net operating loss and carried forward.

Summary

A trust is responsible for the tax on amounts retained by it and the beneficiary is responsible for the tax on amounts distributed to him or her.    It is important to understand the relationship between taxable income and fiduciary accounting income.   These two amounts are generally not the same. 

A trust’s accounting income and its distributions are controlled by its governing document and its resident state’s adoption of the Uniform Principal and Income Act (UPIA).  A trust’s taxable income is determined under the Internal Revenue Code.  The tax law concept of distributable net income (DNI) provides a ceiling on the amount of taxable income that can be distributed to a trust’s beneficiaries.

In the following example, a complex trust receives $100,000 in portfolio income, pays investment management fees of $30,000 (subject to 2%) and combined real estate and net income taxes of $15,000.  The trust agreement allows all accounting income to be distributed to the sole beneficiary at the discretion of the trustee, which the trustee has done.  Deductions allocated to income are determined under the UPIA adopted by its resident state.

 

 

Fiduciary Accounting Income

 

Taxable Income Before TCJA

 

Taxable Income After TCJA

 

 

 

 

Interest and Dividends

$    100,000 

$   100,000

$   100,000

Investment Fees

   (  10,000)

  (28,000)

-0-

State Taxes

    ( 15,000)

    (15,000)

  (10,000)

 

 

 

 

FAI/Taxable Income

       $     75,000

$     57,000

$    90,000

Beneficiary  Distributions

 $     75,000

 

 

Income Distribution Deduction

n/a

  (57,000)

  (75,000)

Exemption

n/a

           (100)

              (100)

Taxable Income

n/a

 $        (100)

$      14,900

 

Based upon the fact pattern above, this trust now owes tax and is in the highest tax bracket for trusts and estates.  Planning opportunities may exist based upon your own set of facts.  Please contact Dermody, Burke & Brown, CPAs, LLC with any questions.

 

 The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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