[Federal Register Volume 85, Number 202 (Monday, October 19, 2020)]
[Rules and Regulations]
[Pages 66219-66226]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-21162]
=======================================================================
-----------------------------------------------------------------------
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9918]
RIN 1545-BO87
Effect of Section 67(g) on Trusts and Estates
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
-----------------------------------------------------------------------
SUMMARY: This document contains final regulations clarifying that the
following deductions allowed to an estate or non-grantor trust are not
miscellaneous itemized deductions: Costs paid or incurred in connection
with the administration of an estate or non-grantor trust that would
not have been incurred if the property were not held in the estate or
trust, the personal exemption of an estate or non-grantor trust, the
distribution deduction for trusts distributing current income, and the
distribution deduction for estates and trusts accumulating income.
Therefore, these deductions are not affected by the suspension of the
deductibility of miscellaneous itemized deductions for taxable years
beginning after December 31, 2017, and before January 1, 2026. The
final regulations also provide guidance on determining the character,
amount, and allocation of deductions in excess of gross income
succeeded to by a beneficiary on the termination of an estate or non-
grantor trust. The final regulations affect estates, non-grantor trusts
(including the S portion of an electing small business trust), and
their beneficiaries.
DATES:
Effective date: These regulations are effective on October 19,
2020.
Applicability dates: For dates of applicability, see Sec. Sec.
1.67-4(d), 1.642(h)-2(f) and 1.642(h)-5(c).
FOR FURTHER INFORMATION CONTACT: Margaret Burow at (202) 317-5279 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to Income Tax Regulations (26 CFR
part 1) under sections 67 and 642 of the Internal Revenue Code (Code).
On May 11, 2020, the Department of Treasury (Treasury Department) and
the IRS published a notice of proposed rulemaking (REG-113295-18) in
the Federal Register (85 FR 27693) containing proposed regulations
under sections 67 and 642(h) (proposed regulations). The Summary of
Comments and Explanation of Revisions section of this preamble
summarizes the provisions of sections 67 and 642(h) and the provisions
of the proposed regulations, which are explained in greater detail in
the preamble to the proposed regulations.
On July 17, 2020, the Treasury Department and the IRS published in
the Federal Register (85 FR 43512) a notice of public hearing on the
proposed regulations scheduled for August 12, 2020. The Treasury
Department and the IRS received no requests to speak at a hearing in
response to that notice. On August 5, 2020, the Treasury Department and
the IRS published in the Federal Register (85 FR 47323) a cancellation
of the notice of public hearing.
The Treasury Department and the IRS received written and electronic
comments in response to the proposed regulations. All comments were
considered and are available at www.regulations.gov or upon request.
After full consideration of the comments received, this Treasury
decision adopts the proposed regulations with modifications described
in the Summary of Comments and Explanation of Revisions.
Summary of Comments and Explanation of Revisions
Most of the comments addressing the proposed regulations are
summarized in this Summary of Comments and Explanation of Revisions.
Comments merely summarizing or interpreting the proposed regulations or
recommending statutory revisions are not discussed in this preamble.
The Treasury Department and the IRS continue to study comments on
issues related to sections 67 and 642(h) that are beyond the scope of
these regulations, which may be discussed in future guidance if
guidance on those issues is published. The scope of the proposed
regulations and these regulations is limited to the effect of section
67(g) on the deductibility of certain expenses described in section
67(b) and (e) that are incurred by estates and non-grantor trusts and
the treatment of excess deductions on termination of an estate or trust
under section 642(h). This Summary of Comments and Explanation of
Revisions also describes each of the final rules contained in this
document.
A. Section 67
Section 67(g) was added to the Code on December 22, 2017, by
section 11045(a) of Public Law 115-97, 131 Stat. 2054, 2088 (2017),
commonly referred to as the Tax Cuts and Jobs Act (TCJA). Section 67(g)
prohibits individual taxpayers from claiming miscellaneous itemized
deductions for any taxable year beginning after December 31, 2017, and
before January 1, 2026. Prior to the TCJA, miscellaneous itemized
deductions were allowable for any taxable year only to the extent that
the sum of such deductions exceeded two percent of adjusted gross
income. See section 67(a). Section 67(b) defines miscellaneous itemized
deductions as itemized deductions other than those listed in section
67(b)(1) through (12).
[[Page 66220]]
Section 67(e) provides that, for purposes of section 67, an estate
or trust computes its adjusted gross income in the same manner as that
of an individual, except that the following additional deductions are
treated as allowable in arriving at adjusted gross income: (1) The
deductions for costs which are 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, and (2)
deductions allowable under section 642(b) (concerning the personal
exemption of an estate or non-grantor trust), section 651 (concerning
the deduction for trusts distributing current income), and section 661
(concerning the deduction for estates and trusts accumulating income).
Accordingly, section 67(e) removes the deductions described in section
67(e)(1) and (2) from the definition of itemized deductions under
section 63(d), and thus from the definition of miscellaneous itemized
deductions under section 67(b), and treats them as deductions allowable
in arriving at adjusted gross income under section 62(a). Section 67(e)
further provides regulatory authority to make appropriate adjustments
in the application of part I of subchapter J of chapter 1 of the Code
to take into account the provisions of section 67.
The proposed regulations under Sec. 1.67-4 clarify that expenses
described in section 67(e) remain deductible in determining the
adjusted gross income of an estate or non-grantor trust during the
taxable years in which section 67(g) applies. Accordingly, section
67(g) does not deny an estate or non-grantor trust (including the S
portion of an electing small business trust) a deduction for expenses
described in section 67(e)(1) and (2) because such deductions are
allowable in arriving at adjusted gross income and are not
miscellaneous itemized deductions under section 67(b). Commenters
agreed with the proposed amendments. These regulations adopt the
proposed regulations under Sec. 1.67-4 without modification.
Two commenters requested that the regulations address the treatment
of deductions described in section 67(e)(1) and (2) in determining an
estate or non-grantor trust's income for alternative minimum tax (AMT)
purposes. The commenters suggested that such deductions are allowable
as deductible in computing the AMT. The treatment of deductions
described in section 67(e) for purposes of determining the AMT is
outside the scope of these regulations concerning the effects of
section 67(g); therefore, these regulations do not address the AMT.
Further, no conclusions should be drawn from the absence of a
discussion of the AMT in these regulations regarding the treatment of
deductions described in section 67(e) for purposes of determining the
AMT.
One commenter suggested that the Treasury Department and the IRS
exercise their regulatory authority under section 67(e) to exempt
cemetery trusts under section 642(i) and qualified funeral trusts
(QFTs) under section 685 from the application of section 67(g). The
commenter stated that the primary type of expense incurred by these
trusts is investment advisory expenses, the tax treatment of which
differs under the Code from management expense. That is, trust
management expenses generally are allowable in computing adjusted gross
income under section 67(e)(1), while trust investment advisory expenses
are miscellaneous itemized deductions. See Sec. 1.67-4(b)(4). The
commenter asserted that it was not the intent of Congress to disallow
investment advisory expenses incurred by cemetery and funeral trusts
when Congress enacted section 67(g).
The commenter suggested that exercising the regulatory authority
under section 67(e) in this manner would be consistent with the
exercise of regulatory authority under section 1411 to exempt section
642(i) cemetery perpetual care funds and QFTs. See Sec. 1.1411-3(b)(1)
(providing that certain types of trusts, including section 642(i)
cemetery perpetual care funds, are excepted from the net investment
income tax) and Sec. 1.1411-3(b)(2) (providing a special rule for QFTs
that, for purposes of calculating any tax under section 1411, section
1411 and the regulations thereunder are applied to each QFT by treating
each beneficiary's interest in the trust as a separate trust). As
stated in the preamble to TD 9644 (78 FR 72393), the Treasury
Department and the IRS exercised their regulatory authority under
section 1411 to exclude cemetery trusts from the net investment income
tax because, by benefiting an operating company, such trusts are
considered similar to the business trusts that are excluded from the
operation of section 1411. The preamble also states that QFTs are not
excluded from the application of the net income investment tax, but
that the section 1411 tax is calculated consistent with the taxation of
QFTs under chapter 1. The commenter noted that they advocated the
treatment of each beneficiary's interest in the QFT as a separate trust
because such treatment reduces the likelihood of the QFT beneficiaries
being subject to the net investment income tax. The Treasury Department
and the IRS continue to consider these comments but providing an
exemption for cemetery and funeral trusts under section 67(g) is
outside the scope of these regulations.
B. Section 642(h)
1. In General
Section 642(h) provides that if, on the termination of an estate or
trust, the estate or trust has: (1) A net operating loss carryover
under section 172 or a capital loss carryover under section 1212, or
(2) for the last taxable year of the estate or trust, deductions (other
than the deductions allowed under section 642(b) (relating to the
personal exemption) or section 642(c) (relating to charitable
contributions)) in excess of gross income for such year, then such
carryover or excess will be allowed as a deduction, in accordance with
the regulations prescribed by the Secretary of the Treasury or his
delegate (Secretary), to the beneficiaries succeeding to the property
of the estate or trust.
Section 1.642(h)-2(a), as articulated in the proposed regulations
and these final regulations, provides that if, on termination of an
estate or trust, the estate or trust has for its last taxable year
deductions (other than the deductions allowed under section 642(b) or
section 642(c)) in excess of gross income, the excess deductions are
allowed under section 642(h)(2) as items of deduction to the
beneficiaries succeeding to the property of the terminated estate or
trust.
2. Character and Amount of Excess Deductions
Section 1.642(h)-2(b)(1) of the proposed regulations provides that
each deduction comprising the excess deductions under section 642(h)(2)
retains, in the hands of the beneficiary, its character (specifically,
as allowable in arriving at adjusted gross income, as a non-
miscellaneous itemized deduction, or as a miscellaneous itemized
deduction) while in the estate or trust. The character of these
deductions does not change when succeeded to by a beneficiary on
termination of the estate or trust. Furthermore, an item of deduction
succeeded to by a beneficiary remains subject to any limitation
applicable under the Code in the computation of the beneficiary's tax
liability.
One commenter noted that section 642(h) states that excess
deductions on termination of an estate or trust are to
[[Page 66221]]
be ``allowed as a deduction, in accordance with regulations prescribed
by the Secretary'' and that there is no express authority to treat
excess deductions as miscellaneous or non-miscellaneous itemized
deductions (or tax preference items for AMT purposes). The Treasury
Department and the IRS disagree with this comment. The characterization
of these excess deductions as a single miscellaneous itemized deduction
in the current regulations was made before the enactment of section
67(g) and served as an administrative convenience. Making a change to
that characterization is now appropriate to reflect the temporary
disallowance of miscellaneous itemized deductions under section 67(g)
since the regulations were written and is a proper exercise of the
Secretary's specific grant of regulatory authority in section 642(h).
Another commenter requested that non-miscellaneous itemized
deductions included in excess deductions be fully deductible by the
beneficiary and not subject to a second level of limitation applicable
on the beneficiary's return, because the amounts already would have
been subject to limitation on the return of the estate or trust. The
commenter provided an example of a terminated trust that paid $25,000
of state income tax, for which the trust is limited to a $10,000
deduction under section 164(b)(6)(B) for taxable years beginning after
December 31, 2017, and before January 1, 2026. In the commenter's
example, the entire amount of the allowable $10,000 deduction was
passed through to the beneficiary as an excess deduction on termination
of the trust. The excess of state income tax over the $10,000
limitation ($15,000) would not pass through as an excess deduction to
the beneficiaries in this circumstance because the excess amount was
not deductible to the trust. Excess state income tax on termination of
the estate or trust may, however, pass through to a beneficiary if the
estate or trust had insufficient income to absorb the entire $10,000 of
state income tax deduction. In that circumstance, the commenter opined
that the limitation under section 164(b)(6)(B), having already been
applied at the trust level, should not again be applied at the
beneficiary level. The Treasury Department and the IRS carefully
considered the comment but determined that beneficiaries remain subject
to the limitation in section 164(b)(6)(B). The Treasury Department and
the IRS found no authority to exempt such items from the application of
any limitations applicable to the beneficiary under the Code. The
excess deductions retain their character in the hands of the
beneficiary on termination of the trust, and all applicable limitations
apply to all of the beneficiary's items of that character, regardless
of their origin.
One commenter noted that, under Sec. 1.641(c)-1(j), if an electing
small business trust (ESBT) election terminates or is revoked and the S
portion has a net operating loss or capital loss carryover or
deductions in excess of gross income, then any such loss, carryover or
excess deductions are allowed as a deduction, in accordance with the
regulations under section 642(h), to the trust or to the beneficiaries
succeeding to the property of the trust if the entire trust terminates.
However, the commenter also noted that under the TCJA, section
641(c)(2)(E) was amended to provide that ESBT charitable contributions
are deductible under section 170, rather than under section 642(c), so
that, unlike other trust charitable deductions, an ESBT's charitable
deduction could constitute part of the excess deductions on termination
of the trust. The commenter stated that neither the legislative history
nor the explanation of the staff of the Joint Committee on Taxation
addressed whether this result was intended. The Treasury Department and
the IRS note that charitable contribution deductions under both
sections 170 and 642(c) are non-miscellaneous itemized deductions under
sections 63(d) and 67(b)(4) to the estate or trust and maintain that
such character is retained in the hands of the beneficiary in these
regulations. Although the Treasury Department and the IRS continue to
consider the application of section 170 to ESBT charitable
contributions under section 641(c)(2)(E), this issue is outside the
scope of these regulations.
Another commenter requested clarification of whether an excess
deduction on termination of a trust or estate that is allowed in
determining the net investment income under section 1411 of the estate
or trust remains deductible in the hands of the beneficiary in
determining the net investment income of the beneficiary under section
1411. These final regulations provide that each excess deduction
retains its separate character as a section 67(e) deduction, non-
miscellaneous itemized deduction, or miscellaneous itemized deduction
in the hands of the beneficiary. Whether a deduction retains its
character as allowable in computing the net investment income of the
beneficiary, however, is outside the scope of these regulations.
3. Reporting of Excess Deductions
Section 1.642(h)-2(b)(1) of the proposed regulations provides that
an item of deduction succeeded to by a beneficiary remains subject to
any additional applicable limitation under the Code and must be
separately stated if it could be so limited, as provided in the
instructions to Form 1041, U.S. Income Tax Return for Estates and
Trusts, and the Schedule K-1 (Form 1041), Beneficiary's Share of
Income, Deductions, Credit, etc. Commenters requested that the Treasury
Department and the IRS provide guidance on how the excess deductions
are to be reported by both the terminated estate or trust and by its
beneficiaries. The Treasury Department and the IRS released
instructions for beneficiaries that chose to claim excess deductions on
Form 1040 in the 2019 or 2018 taxable year based on the proposed
regulations. In addition, the Treasury Department and the IRS plan to
update the instructions for Form 1041, Schedule K-1 (Form 1041), and
Form 1040, U.S. Individual Income Tax Return, for the 2020 and
subsequent tax years to provide for the reporting of excess deductions
that are section 67(e) expenses or non-miscellaneous itemized
deductions.
The Treasury Department and the IRS are aware that the income tax
laws of some U.S. states do not conform to the Code with respect to
section 67(g), such that beneficiaries may need information on
miscellaneous itemized deductions of a terminated estate or trust.
However, because miscellaneous itemized deductions are currently not
allowed for Federal income tax purposes, that information is not needed
for Federal income tax purposes. Therefore, it would not be appropriate
to modify Federal income tax forms to require or accommodate the
collection of such information while this deduction is suspended.
Estates, trusts, and beneficiaries are advised to consult the relevant
state taxing authority for information about deducting miscellaneous
itemized expenses on their state tax returns.
4. Determinations of Deductions in Year of Termination of the Trust
Section 1.642(h)-2(b)(2) of the proposed regulations provides that
the provisions of Sec. 1.652(b)-3 are used to allocate each item of
deduction among the classes of income in the year of termination for
purposes of determining the character and amount of the excess
deductions under section 642(h)(2). Accordingly, the amount of each
separate deduction remaining after application of Sec. 1.652(b)-3
comprises
[[Page 66222]]
the excess deductions available to the beneficiaries succeeding to the
property of the estate or trust as provided under section 642(h)(2). In
addition, as previously explained, an item of deduction succeeded to by
a beneficiary remains subject to any additional applicable limitation
under the Code. Furthermore, Sec. 1.642(h)-2(c) of the proposed
regulations provides that excess deductions are allowable only in the
taxable year of the beneficiary in which or with which the estate or
trust terminates. That is, excess deductions of a terminated estate or
trust may not carry over to a subsequent year of the beneficiary.
One commenter requested that these regulations provide an ordering
rule clarifying whether excess deductions on termination of a trust
allowed as a deduction to the beneficiary are claimed before, after, or
ratably with the beneficiary's other deductions, particularly when the
amount of the excess deductions and other deductions exceed the
beneficiary's gross income. These final regulations clarify that
beneficiaries may claim all or part of the excess deductions under
section 642(h)(2) before, after, or together with the same character of
deductions separately allowable to the beneficiary under the Code.
That commenter also requested that the final regulations include an
exception for investment interest expense under section 163(d) from the
general rule that excess deductions on termination of a trust or estate
may be claimed only in the beneficiary's taxable year during which the
trust or estate terminated. That section permits the carryforward of
investment interest under section 163(d)(2) to the taxpayer's
subsequent taxable years if the taxpayer is unable to deduct the
investment interest in the current taxable year. The commenter stated
that the disallowance of the carryover of section 642(h)(2) excess
deductions should not apply to those excess deductions that are no
longer treated as miscellaneous itemized deductions under the proposed
regulations, and that carryover should be permitted to the extent
otherwise permitted under the Code. The preamble to the proposed
regulations states that addressing suspended deductions under section
163(d) is beyond the scope of the regulations and the same is true of
these final regulations.
A commenter requested that the amount of a beneficiary's net
operating loss carryover to a later taxable year under section 172
should include all of the beneficiary's section 642(h)(2) excess
deductions that are section 67(e) deductions, as deductions that are
attributable to the beneficiary's trade or business and thus deductions
attributable to a trade or business under section 172(d)(4). Section
642(h) makes it clear that a net operating loss carryover under
paragraph (1) of that section is separate and distinct from the excess
deductions on termination described in paragraph (2) of that section.
Furthermore, Sec. 1.642(h)-2(d) provides that a deduction based upon a
net operating loss carryover generally will not be allowed to
beneficiaries under both paragraphs (1) and (2) of section 642(h).
Therefore, an excess deduction allowable to the beneficiary under
section 642(h)(2) is not a net operating loss carryover succeeded to by
the beneficiary under section 642(h)(1) and (with one exception) a net
operating loss carryover is not an excess deduction on termination.
Moreover, these regulations provide that it is the character of the
excess deductions as section 67(e) deductions, non-miscellaneous
itemized deductions, and miscellaneous itemized deductions, and not the
character of a deduction as attributable to a trade or business, that
is retained in the hands of the beneficiary. Thus, whether section
642(h)(2) excess deductions that are section 67(e) deductions may be
included in a beneficiary's net operating loss carryovers under section
172, separate from those it succeeds to from a terminated estate or
trust, is beyond the scope of these regulations. Because Sec.
1.642(h)-2(a) is clear that excess deductions on termination of an
estate or trust are not carried over to future years and that such
deductions are separate from a net operating loss carryover from the
estate or trust, the Treasury Department and the IRS do not adopt this
comment.
6. Example 1
Section 1.642(h)-5(a), Example 1, of the proposed regulations
(Example 1) updates an existing example illustrating computations under
section 642(h) when there is a net operating loss. Section 1.642-
5(a)(2)(ii) of Example 1 explains that the beneficiaries of the trust
cannot carry back any of the net operating loss of the terminating
estate that was made available to them under section 642(h)(1).
Two commenters requested that Example 1 be revised to take into
account the amendments to section 172(b)(1)(D) under sec. 2302(b) of
the Coronavirus Aid, Relief, and Economic Security Act, Public Law 116-
136, 134 Stat. 281 (2020) (CARES Act), by allowing a beneficiary to
carry back the net operating loss carryover the beneficiary succeeds to
under section 642(h)(1) for net operating losses arising in taxable
years beginning after December 31, 2017, and before January 1, 2021.
Under section 2303 of the CARES Act, net operating losses arising in
taxable years beginning after December 31, 2017, and before January 1,
2021, generally may be carried back five years before being carried
forward. One of these commenters further requested confirmation that a
beneficiary is allowed a carryback of the net operating loss under
section 642(h)(1) for net operating losses of an estate or trust
arising in taxable years ending before January 1, 2018, to the extent
the beneficiary succeeds to a net operating loss carryover attributable
to those net operating losses on a termination of the estate or trust
between January 1, 2018, and December 31, 2020.
Unless otherwise provided under the Code, a net operating loss
incurred by a taxpayer may only be used as a deduction by that taxpayer
and cannot be transferred to another taxpayer for use by that other
taxpayer. Calvin v. U.S. 354 F.2d 202 (10th Cir. 1965), Mellott v.
U.S., 257 F.2d 798 (3d Cir. 1958). As an exception to this general
principle, section 642(h) provides that if, on termination of an estate
or trust, the estate or trust has a net operating loss carryover under
section 172, then such carryover is allowed as a deduction, in
accordance with the regulations prescribed by the Secretary, to the
beneficiaries succeeding to the property of the estate or trust.
Section 1.642(h)-1(a) provides that if, on the termination of an estate
or trust, a net operating loss carryover under section 172 would be
allowable to the estate or trust in a taxable year subsequent to the
taxable year of termination but for the termination, a carryover is
allowed under section 642(h)(1) to the beneficiaries succeeding to the
property of the estate or trust. In addition, Sec. 1.642(h)-1(b)
provides that the first taxable year of the beneficiary to which the
net operating loss will be carried over is the taxable year of the
beneficiary in which or with which the estate or trust terminates.
Section 642(h)(1) provides a specific rule that allows the
beneficiary to succeed to a net operating loss carryover of the estate
or trust and deduct the amount of the net operating loss over the
remaining carryover period that would have been allowable to the estate
or trust but for the termination of the estate or trust. The phrase in
section 642(h)(1) ``the estate or trust has a net operating loss
carryover' '' means that the estate or trust incurred a net
[[Page 66223]]
operating loss and either already carried it back to the earliest
allowable year under section 172 or elected to waive the carryback
period under section 172(b)(3), and now is limited to carrying over the
remaining net operating loss. Accordingly, because the net operating
loss is a carryover for the estate or trust, the beneficiary succeeding
to that net operating loss may, under section 642(h)(1), only carry it
forward.
The CARES Act amendments to section 172(b) mentioned by the
commenters allow taxpayers a five-year carryback of certain net
operating losses incurred by that taxpayer. The CARES Act amendments do
not change the result that a beneficiary succeeding to the net
operating loss carryover of a terminated estate or trust may only
carryover that net operating loss in the same manner as the terminated
estate or trust, but for the termination. Consequently, the Treasury
Department and the IRS do not adopt these comments and add a citation
to Sec. 1.642(h)-1 to reference the rule that a beneficiary that
succeeds to a net operating loss carryover of a terminated estate or
trust may only carry forward the net operating loss.
7. Example 2
Section Sec. 1.642(h)-5(b), Example 2, of the proposed regulations
(Example 2) demonstrates computations under section 642(h)(2). The
expenses in Example 2 include rental real estate taxes in an attempt to
illustrate a deduction subject to limitation under section 164(b)(6) to
the beneficiary that must be separately stated as provided in Sec.
1.642(h)-2(b)(1).
Multiple commenters noted that Example 2 raises several issues that
could be potentially relevant to that example, such as whether the
decedent was in a trade or business and the application of section 469
to estates and trusts. To avoid these issues, which are extraneous to
the point being illustrated, one commenter suggested that the example
be revised so that the entire amount of real estate expenses on rental
property equals the amount of rental income. The Treasury Department
and the IRS did not intend to raise such issues in the example and
consider both issues to be outside the scope of these regulations.
Accordingly, the Treasury Department and the IRS adopt the suggestion
by the commenter and modify Example 2 to avoid these issues by having
rental real estate expenses entirely offset rental income with no
unused deduction.
Commenters also noted that Example 2 does not properly allocate
rental real estate expenses because the example characterizes the
rental real estate taxes as itemized deductions. These commenters
asserted that real estate taxes on property held for the production of
rental income are not itemized deductions but instead are allowed in
computing gross income and cited to section 62(a)(4) as providing that
ordinary and necessary expenses paid or incurred during the taxable
year for the management, conservation, or maintenance of property held
for the production of income under section 212(2) that are attributable
to property held for the production of rents are deductible as above-
the-line deductions in arriving at adjusted gross income. One commenter
suggested that, if the goal of Example 2 is to illustrate state and
local taxes passing through to the beneficiary, then the example should
include state income taxes rather than real estate taxes on rental real
estate. The Treasury Department and the IRS have revised this example
in the final regulations to include personal property tax paid by the
trust rather than taxes attributable to rental real estate.
Lastly, commenters noted that Example 2 does not demonstrate the
broad range of trustee discretion in Sec. 1.652(b)-3(b) and (d) for
deductions that are not directly attributable to a class of income, or
deductions that are, but which exceed such class of income,
respectively. In response to these comments, the Treasury Department
and the IRS have modified Example 2 to illustrate the application of
trustee discretion as found in Sec. 1.652(b)-3(b) and (d).
C. Applicability Dates
The proposed regulations provide that the changes to Sec. Sec.
1.67-4, 1.642(h)-2, and 1.642(h)-5 apply to taxable years beginning
after the date the regulations are published as final. The preamble to
the proposed regulations explains that estates, non-grantor trusts, and
their beneficiaries may rely on the proposed regulations under section
67 for taxable years beginning after December 31, 2017, and on or
before the date these regulations are published as final. Taxpayers may
also rely on the proposed regulations under section 642(h) for taxable
years of beneficiaries beginning after December 31, 2017, and on or
before the date the regulations are published as final, in which an
estate or trust terminates.
One commenter requested that Sec. 1.642(h)-2 of the proposed
regulations be applied retroactively not only to taxable years
beginning after December 31, 2017, but to all open years. The commenter
asserted that the existing regulation treating excess deductions on
termination of an estate as a miscellaneous itemized deduction was in
error. As an example, the commenter argues that the current regulations
mistakenly describe section 67(e) expenses as an exception to the rules
applicable to miscellaneous itemized deductions, and therefore
requested that the final regulations be applicable to all open years.
The Treasury Department and the IRS have the authority to treat an
excess deduction on termination of an estate or trust as a single
miscellaneous itemized deduction. See section 642(h). The suspension
under section 67(g) of miscellaneous itemized deductions caused the
Treasury Department and the IRS to reconsider the treatment of excess
deductions under section 642(h)(2) because the Treasury Department and
the IRS do not interpret section 67(g) as suspending such deductions
allowable under section 642(h)(2). The Treasury Department and the IRS
interpret section 67(g) as not disallowing excess deductions succeeded
to beneficiaries from terminated estates and trusts under section
642(h)(2). Therefore, taxpayers may rely on these regulations as of the
effective date of section 67(g), but not for earlier periods.
The final regulations apply to taxable years beginning after
October 19, 2020. Pursuant to section 7805(b)(7), taxpayers may choose
to apply the amendments to Sec. 1.67-4 and Sec. Sec. 1.642(h)-2 and
1.642(h)-5 set forth in this Treasury decision to taxable years
beginning after December 31, 2017, and on or before October 19, 2020.
Special Analysis
These regulations are not subject to review under section 6(b) of
Executive Order 12866 pursuant to the Memorandum of Agreement (April
11, 2018) between the Treasury Department and the Office of Management
and Budget regarding review of tax regulations. Therefore, a regulatory
impact assessment is not required.
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it
is hereby certified that these regulations will not have a significant
economic impact on a substantial number of small entities. This
certification is based on the fact that the amount of time necessary to
report the required information will be minimal in that it requires
fiduciaries of estates and trusts to provide on the Schedule K-1 (Form
1041) issued to beneficiaries information that is already maintained
and reported to the IRS on Form 1041. Moreover, it should take an
estate or trust no more than 2 hours to satisfy the information
requirement in these regulations. Accordingly, the
[[Page 66224]]
Secretary certifies that the rule will not have a significant economic
impact on a substantial number of small entities.
Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking that preceded these regulations was submitted to the Chief
Counsel for the Office of Advocacy of the Small Business Administration
for comment on its impact on small businesses, and no comments were
received.
Paperwork Reduction Act (PRA)
The collection of information related to these regulations under
section 642(h) is reported on Schedule K-1 (Form 1041), Beneficiary's
Share of Income, Deductions, Credits, etc., and has been reviewed in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) and
approved by the Office of Management and Budget under control number
1545-0092.
The collection of information in these regulations is in Sec.
1.642(h)-2(b)(1). The IRS requires this information to ensure that
excess deductions on an estate's or trust's termination that are
subject to additional applicable limitations retain their character
when taken into account by beneficiaries on their returns. The
respondents will be estates, trusts, and their fiduciaries.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a valid
control number assigned by the Office of Management and Budget. Books
or records relating to a collection of information must be retained as
long as their contents may become material in the administration of any
internal revenue law. Generally, tax returns and tax return information
are confidential, as required by section 6103.
Drafting Information
The principal author of these regulations is Margaret Burow of the
Office of Associate Chief Counsel (Passthroughs and Special
Industries). Other personnel from the Treasury Department and the IRS,
however, participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding
entries for Sec. Sec. 1.67-4, 1.642(h)-2, and 1.642(h)-5 in numerical
order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.67-4 also issued under 26 U.S.C. 67(e).
* * * * *
Section 1.642(h)-2 also issued under 26 U.S.C. 642(h).
Section 1.642(h)-5 also issued under 26 U.S.C. 642(h).
* * * * *
0
Par. 2. Section 1.67-4 is amended by revising paragraph (a) and the
heading of paragraph (d) and adding two sentences to the end of
paragraph (d) to read as follows:
Sec. 1.67-4 Costs paid or incurred by estates or non-grantor trusts.
(a) Deductions--(1) Section 67(e) deductions--(i) In general. An
estate or trust (including the S portion of an electing small business
trust) not described in Sec. 1.67-2T(g)(1)(i) (a non-grantor trust)
must compute its adjusted gross income in the same manner as an
individual, except that the following deductions (section 67(e)
deductions) are allowed in arriving at adjusted gross income:
(A) Costs that are paid or incurred in connection with the
administration of the estate or trust that would not have been incurred
if the property were not held in such estate or trust; and
(B) Deductions allowable under section 642(b) (relating to the
personal exemption) and sections 651 and 661 (relating to
distributions).
(ii) Not disallowed under section 67(g). Section 67(e) deductions
are not itemized deductions under section 63(d) and are not
miscellaneous itemized deductions under section 67(b). Therefore,
section 67(e) deductions are not disallowed under section 67(g).
(2) Deductions subject to 2-percent floor. A cost is not a section
67(e) deduction and thus is subject to both the 2-percent floor in
section 67(a) and section 67(g) to the extent that it is included in
the definition of miscellaneous itemized deductions under section
67(b), is incurred by an estate or non-grantor trust (including the S
portion of an electing small business trust), and commonly or
customarily would be incurred by a hypothetical individual holding the
same property.
* * * * *
(d) Applicability date. * * * Paragraph (a) of this section applies
to taxable years beginning after October 19, 2020. Taxpayers may choose
to apply paragraph (a) of this section to taxable years beginning after
December 31, 2017, and on or before October 19, 2020.
0
Par. 3. Section 1.642(h)-2 is amended by:
0
1. Revising paragraph (a).
0
2. Redesignating paragraph (b) as paragraph (d) and adding a heading
for newly redesignated paragraph (d).
0
3. Redesignating paragraph (c) as paragraph (e) and adding a heading
for newly redesignated paragraph (e).
0
4. Adding new paragraphs (b) and (c) and paragraph (f).
The revisions and additions read as follows:
Sec. 1.642(h)-2 Excess deductions on termination of an estate or
trust.
(a) Excess deductions--(1) In general. If, on the termination of an
estate or trust, the estate or trust has for its last taxable year
deductions (other than the deductions allowed under section 642(b)
(relating to the personal exemption) or section 642(c) (relating to
charitable contributions)) in excess of gross income, the excess
deductions as determined under paragraph (b) of this section are
allowed under section 642(h)(2) as items of deduction to the
beneficiaries succeeding to the property of the estate or trust.
(2) Treatment by beneficiary. A beneficiary may claim all or part
of the amount of the deductions provided for in paragraph (a) of this
section, as determined after application of paragraph (b) of this
section, before, after, or together with the same character of
deductions separately allowable to the beneficiary under the Internal
Revenue Code for the beneficiary's taxable year during which the estate
or trust terminated as provided in paragraph (c) of this section.
(b) Character and amount of excess deductions--(1) Character. The
character and amount of the excess deductions on termination of an
estate or trust will be determined as provided in this paragraph (b).
Each deduction comprising the excess deductions under section 642(h)(2)
retains, in the hands of the beneficiary, its character (specifically,
as allowable in arriving at adjusted gross income, as a non-
miscellaneous itemized deduction, or as a miscellaneous itemized
deduction) while in the estate or trust. An item of deduction succeeded
to by a beneficiary remains subject to any additional applicable
limitation under the Internal Revenue Code and must be separately
stated if it could be so limited, as provided in the instructions to
Form 1041, U.S. Income Tax Return for Estates and Trusts, and the
Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions,
Credit, etc., or successor forms.
[[Page 66225]]
(2) Amount. The amount of the excess deductions in the final year
is determined as follows:
(i) Each deduction directly attributable to a class of income is
allocated in accordance with the provisions in Sec. 1.652(b)-3(a);
(ii) To the extent of any remaining income after application of
paragraph (b)(2)(i) of this section, deductions are allocated in
accordance with the provisions in Sec. 1.652(b)-3(b) and (d); and
(iii) Deductions remaining after the application of paragraph
(b)(2)(i) and (ii) of this section comprise the excess deductions on
termination of the estate or trust. These deductions are allocated to
the beneficiaries succeeding to the property of the estate of or trust
in accordance with Sec. 1.642(h)-4.
(c) Year of termination--(1) In general. The deductions provided
for in paragraph (a) of this section are allowable only in the taxable
year of the beneficiary in which or with which the estate or trust
terminates, whether the year of termination of the estate or trust is
of normal duration or is a short taxable year.
(2) Example. Assume that a trust distributes all its assets to B
and terminates on December 31, Year X. As of that date, it has excess
deductions of $18,000, all characterized as allowable in arriving at
adjusted gross income under section 67(e). B, who reports on the
calendar year basis, could claim the $18,000 as a deduction allowable
in arriving at B's adjusted gross income for Year X. However, if the
deduction (when added to other allowable deductions that B claims for
the year) exceeds B's gross income, the excess may not be carried over
to any year subsequent to Year X.
(d) Net operating loss carryovers. * * *
(e) Items included in net operating loss or capital loss
carryovers. * * *
(f) Applicability date. Paragraphs (a) through (c) of this section
apply to taxable years beginning after October 19, 2020. The rules
applicable to taxable years beginning on or before October 19, 2020 are
contained in Sec. 1.642(h)-2 as in effect prior to October 19, 2020
(see 26 CFR part 1 revised as of April 1, 2020). Taxpayers may choose
to apply paragraphs (a) through (c) of this section to taxable years
beginning after December 31, 2017, and on or before October 19, 2020.
0
Par. 4. Section 1.642(h)-5 is revised to read as follows:
Sec. 1.642(h)-5 Examples.
Paragraphs (a) and (b) of this section (Examples 1 and 2)
illustrate the application of section 642(h).
(a) Example 1: Computations under section 642(h) when an estate has
a net operating loss--(1) Facts. On January 31, 2020, A dies leaving a
will that provides for the distribution of all of A's estate equally to
B and an existing trust for C. The period of administration of the
estate terminates on December 31, 2020, at which time all the property
of the estate is distributed to B and the trust. For tax purposes, B
and the trust report income on a calendar year basis. During the period
of administration, the estate has the following items of income and
deductions:
Table 1 to Paragraph (a)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Income:
Taxable interest.................................. $2,500
Business income................................... 3,000
-----------------
Total income.................................. 5,500
------------------------------------------------------------------------
Table 2 to Paragraph (a)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Deductions:
Business expenses (including administrative 5,000
expense allocable to business income)............
Administrative expenses not allocable to business 9,800
income that would not have been incurred if
property had not been held in a trust or estate
(section 67(e) deductions).......................
-----------------
Total deductions.............................. 14,800
------------------------------------------------------------------------
(2) Computation of net operating loss. (i) The amount of the net
operating loss carryover is computed as follows:
Table 3 to Paragraph (a)(2)(i)
------------------------------------------------------------------------
------------------------------------------------------------------------
Gross income.......................................... $5,500
Total deductions...................................... 14,800
Less adjustment under section 172(d)(4) (allowable 7,300
non-business expenses ($9,800) limited to non-
business income ($2,500))........................
-----------------
Deductions as adjusted................................ 7,500
=================
Net operating loss................................ 2,000
------------------------------------------------------------------------
(ii) Under section 642(h)(1), B and the trust are each allocated
$1,000 of the $2,000 unused net operating loss carryover of the
terminated estate in 2020, with the allowance of any net operating loss
carryover to B and the trust determined under section 172. Neither B
nor the trust can carry back any of the net operating loss of A's
estate made available to them under section 642(h)(1). See Sec.
1.642(h)-1(b).
(3) Section 642(h)(2) excess deductions. The $7,300 of non-business
deductions not taken into account in
[[Page 66226]]
determining the net operating loss of the estate are excess deductions
on termination of the estate under section 642(h)(2). Under Sec.
1.642(h)-2(b)(1), such deductions retain their character as section
67(e) deductions. Under Sec. 1.642(h)-4, B and the trust each are
allocated $3,650 of excess deductions based on B's and the trust's
respective shares of the burden of each cost.
(4) Consequences for C. The net operating loss carryover and excess
deductions are not allowable directly to C, the trust beneficiary. To
the extent the distributable net income of the trust is reduced by the
net operating loss carryover and excess deductions, however, C may
receive an indirect benefit from the carryover and excess deductions.
(b) Example 2: Computations under section 642(h)(2)--(1) Facts. D
dies in 2019 leaving an estate of which the residuary legatees are E
(75%) and F (25%). The estate's income and deductions in its final year
are as follows:
Table 4 to Paragraph (b)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Income:
Dividends......................................... $3,000
Taxable Interest.................................. 500
Rent.............................................. 2,000
Capital Gain...................................... 1,000
-----------------
Total Income.................................. 6,500
------------------------------------------------------------------------
Table 5 to Paragraph (b)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Deductions:
Section 62(a)(4) deductions:
Rental real estate expenses................... 2,000
Section 67(e) deductions:
Probate fees.................................. 1,500
Estate tax preparation fees................... 8,000
Legal fees.................................... 2,500
-----------------
Total Section 67(e) deductions............ 12,000
Non-miscellaneous itemized deductions:
Personal property taxes....................... 3,500
-----------------
Total deductions.......................... 17,500
------------------------------------------------------------------------
(2) Determination of character. Pursuant to Sec. 1.642(h)-2(b)(2),
the character and amount of the excess deductions is determined by
allocating the deductions among the estate's items of income as
provided under Sec. 1.652(b)-3. Under Sec. 1.652(b)-3(a), the $2,000
of rental real estate expenses is allocated to the $2,000 of rental
income. In the exercise of the executor's discretion pursuant to Sec.
1.652(b)-3(b), D's executor allocates $3,500 of personal property taxes
and $1,000 of section 67(e) deductions to the remaining income. As a
result, the excess deductions on termination of the estate are $11,000,
all consisting of section 67(e) deductions.
(3) Allocations among beneficiaries. Pursuant to Sec. 1.642(h)-4,
the excess deductions are allocated in accordance with E's (75 percent)
and F's (25 percent) interests in the residuary estate. E's share of
the excess deductions is $8,250, all consisting of section 67(e)
deductions. F's share of the excess deductions is $2,750, also all
consisting of section 67(e) deductions.
(4) Separate statement. If the executor instead allocated $4,500 of
section 67(e) deductions to the remaining income of the estate, the
excess deductions on termination of the estate would be $11,000,
consisting of $7,500 of section 67(e) deductions and $3,500 of personal
property taxes. The non-miscellaneous itemized deduction for personal
property taxes may be subject to limitation on the returns of both B
and C's trust under section 164(b)(6)(B) and would have to be
separately stated as provided in Sec. 1.642(h)-2(b)(1).
(c) Applicability date. This section is applicable to taxable years
beginning after October 19, 2020. Taxpayers may choose to apply this
section to taxable years beginning after December 31, 2017, and on or
before October 19, 2020.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: September 16, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-21162 Filed 10-16-20; 8:45 am]
BILLING CODE 4830-01-P