Side Effect of TCJA 2017 Temporary Suspension of Miscellaneous Itemized Deductions under IRC Section 67(g):

 so much for making use of estate or trust excess deductions

          Prior to the enactment of HR 1 signed into law on December 22, 2017, (which I will refer to as the “Tax Cuts and Jobs Act of 2017” or as “TCJA 2017”), under IRC Section 642(g), the excess of deductions over income of an estate or trust in its final tax year, (commonly referred to as an “excess deduction”), could flow out to the residuary beneficiaries of an estate, or to the remaindermen of a trust in question, as the case may be, basically in the same % as to which they were beneficiaries.  Further, pursuant to IRC Section 67, for those individual taxpayers who itemize deductions, they could take their excess deduction (which would be reported to them on a Form K-1 from the estate or trust for its final tax year) as a miscellaneous itemized deduction on Schedule A, line 23[1] of their federal income tax return for their tax year in which the year of the estate or trust ended. For example, if the estate had excess deductions for its final fiscal tax year 2016, which tax year lets say ran from July 1, 2016 through June 30, 2017, then the excess deduction passed out to the residuary beneficiaries in connection with the wrap up of the estate administration, could be picked up by the residuary beneficiaries on Schedule A, line 23 of their personal federal income tax return (US Form 1040) for calendar year 2017 (as that is the beneficiary’s tax year in which the tax year of the estate ended even though the tax year of the estate was 2016).  An excess deduction was, however, one of the miscellaneous itemized deductions subject to the 2% of AGI floor.  That is, it was only the amount of the miscellaneous itemized deductions above 2% of the Taxpayer’s (i.e., beneficiary’s) AGI that wound up being deductible. Nonetheless, the excess deduction did afford beneficiaries a potential income tax savings in connection with, for example, the wrap up expenses of the estate to the extent they exceeded income, (in addition to their share of a capital loss carryover or a NOL carryover that also might separately pass through to them). 

          Under Section 11045 of the TCJA 2017, however, it is provided that,

          “(a)  IN GENERAL.—Section 67 is amended by adding at the end the following new subsection:

          “(g) SUSPENSION FOR TAXABALE YEARS 2018 THROUGH 2025.—Notwithstanding subsection (a), no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.”

          The effective date of the above suspension is stated to apply to taxable years beginning after December 31, 2017.

          Thus, for any taxable year of an estate or trust that ends in 2018 through 2025, the excess deduction which the individual beneficiary would have previously been entitled to use if they itemized deductions, will be disallowed.  Therefore, if, for example, an estate with a fiscal tax year starting date of February 1, 2017 terminates on January 31, 2018, then the excess deduction would flow out to the residuary beneficiary for his or her tax year 2018 (as that is his/her tax year in which the estate’s tax year ends), but because of the change in the tax law, the residuary beneficiary would be unable to use the excess deduction as a miscellaneous itemized deduction on his or her Schedule A for tax year 2018. If the tax year of the estate had ended say on December 31, 2017, then the excess deduction would have flowed out to the individual taxpayer for his or her tax year 2017 and thus been allowed.

          Typically in the final tax year of an estate or trust there is not going to be any income taxes owing by the estate or trust as all of the income, and assets, will have been distributed out to the beneficiaries.  With that said, unless the income of the estate or trust is above the filing requirement, the Executor or Trustee may face the question of whether the fiduciary needs to file a final tax year federal fiduciary income tax return for that year particularly if no excess deductions are going to be allowed to be taken by the beneficiary (and assuming no capital loss carryover or NOL carryover to be passed out to the beneficiaries). Before the JCTA 2017 changes, the Executor or Trustee would surely have filed in order to pass out the excess deduction in that final tax year. Note though that the filing or not of the final federal fiduciary income tax return where the excess deduction will not be allowed to used by the beneficiary under IRC 67(g), must also consider what the state impact would be for that beneficiary.  To be noted, the New Jersey fiduciary gross income tax does not allow a flow through of excess deductions or capital losses in the final tax year of the estate. 

          Further to be noted is Section 11046 of the TCJA 2017, which is referred to as the repeal of the Pease limitation.  This Section of the Act provides, as to the SUSPENSION OF OVERALL LIMITATION ON ITEMIZED DEDUCTIONS, that,

          “(a) IN GENERAL—Section 68 is amended by adding at the end the following new subsection:

          “(f)  SECTION NOT TO APPLY.—This section shall not apply to any taxable year beginning after December 31, 2017, and before January 1, 2026.”

          The effective date of this new provision is stated as applying to taxable years beginning after December 31, 2017.  As to excess deductions for the years in question, 2018 – 2025, it won’t matter in the sense that the excess deductions are not being allowed at all under amended Section 67, so the Pease limitation under Section 68 would not apply to limit them during the suspension years 2018 – 2015, even if Section 68 had not been amended.

Barry M. Benson, Esq.

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[1] For tax years 2016 and 2017, an individual taxpayer’s miscellaneous itemized deductions were to be reported on Form 1040, Schedule A, line, 23.  The line in future years (at least in future years when allowed), would of course depend upon the layout of the Schedule A form itself for that year.