Notice 2018-61, 2018-31 IRB
In a Notice, IRS has announced that it intends to issue regs that clarify the effect of Code Sec. 67(g)on the deductibility of certain expenses described in Code Sec. 67(b), Code Sec. 67(e)and Reg § 1.67-4, that are incurred by estates and non-grantor trusts. Code Sec. 67(g), which was added by the Tax Cuts and Jobs Act (TCJA, P.L. 115-97, 12/22/2017), provides for the suspension of the deduction for miscellaneous itemized deductions. Estates and non-grantor trusts may rely on the Notice for tax years beginning after Dec. 31, 2017.
Background. Code Sec. 67(a) provides that, in the case of an individual, miscellaneous itemized deductions for any tax year are allowed only to the extent that the aggregate of such deductions exceeds 2% of adjusted gross income. Code Sec. 67(b) defines “miscellaneous itemized deductions” as itemized deductions other than those listed in Code Sec. 67(b)(1) through Code Sec. 67(b)(12).
In general, Code Sec. 67(g) provides that, notwithstanding Code Sec. 67(a), no miscellaneous itemized deductions are allowed for any tax year beginning after Dec. 31, 2017, and before Jan. 1, 2026.
Code Sec. 67(e) provides that, for purposes of Code Sec. 67, the adjusted gross income of an estate or trust is computed in the same manner as that of an individual, except that the following 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) the deductions allowable under Code Sec. 642(b), Code Sec. 651, and Code Sec. 661.
Reg § 1.67-4(a) states that Code Sec. 67(e) provides an exception to the 2% floor on miscellaneous itemized deductions for costs that are paid or incurred in the administration of an estate or a trust not described in Reg § 1.67-2T(g)(1)(i) (a non-grantor trust) and that would not have been incurred if the property were not held in such estate or trust. A cost is subject to the 2% floor to the extent that it is included in the definition of miscellaneous itemized deductions under Code Sec. 67(b), is incurred by an estate or non-grantor trust, and commonly or customarily would be incurred by a hypothetical individual holding the same property.
Reg § 1.67-4(b) provides generally that, in analyzing a cost to determine whether it commonly or customarily would be incurred by a hypothetical individual owning the same property, it is the type of product or service rendered to the estate or non-grantor trust in exchange for the cost, rather than the description of the cost of that product or service, that is determinative. It further provides specific examples of costs that will be considered commonly or customarily incurred by individuals and those that will not.
Reg § 1.67-4(c) provides that, subject to certain exceptions, if an estate or non-grantor trust pays a single fee, commission, or other expense for both costs that are subject to the 2% floor and costs (in a more than de minimis amount) that are not, then, except to the extent provided otherwise by guidance published in the Internal Revenue Bulletin, the single fee, commission, or other expense (bundled fee) must be allocated, for purposes of computing the adjusted gross income of the estate or non-grantor trust in compliance with Code Sec. 67(e), between the costs that are subject to the 2% floor and those that are not.
Regs to be issued. In Notice 2018-61, IRS announced that it intends to issue regs that clarify the effect of Code Sec. 67(g) on the deductibility of certain expenses that are incurred by estates and non-grantor trusts. The regs will clarify that estates and non-grantor trusts may continue to deduct an expense that is described in Code Sec. 67(e)(1) or is allowable under Code Sec. 642(b), Code Sec. 651 or Code Sec. 661, including the appropriate portion of a bundled fee, in determining the estate or non-grantor trust’s adjusted gross income for all tax years, even while the application of Code Sec. 67(a) is suspended under Code Sec. 67(g). In addition, the regs will clarify that deductions enumerated in Code Sec. 67(b) and Code Sec. 67(e) continue to remain outside the definition of “miscellaneous itemized deductions” and thus are unaffected by Code Sec. 67(g).
IRS notes that commentators have suggested that Code Sec. 67(g) might be read to eliminate the ability of estates and non-grantor trusts to deduct any expenses described in Code Sec. 67(e)(1) and Reg § 1.67-4 for the tax years during which the application of Code Sec. 67(a) is suspended. However, IRS does not believe that this is a correct reading of Code Sec. 67(g).
For the tax years during which it is effective, Code Sec. 67(g) denies a deduction for miscellaneous itemized deductions. IRS reasoned that Code Sec. 67(b) defines miscellaneous itemized deductions as itemized deductions other than those listed therein. Code Sec. 63(d) defines itemized deductions by excluding personal exemptions, the Code Sec. 199A deduction, and deductions used to arrive at adjusted gross income. Accordingly, IRS concluded that neither the above-the-line deductions used to arrive at adjusted gross income nor the expenses listed in Code Sec. 67(b)(1) – Code Sec. 67(b)(12) are miscellaneous itemized deductions.
Code Sec. 62(a) defines adjusted gross income of an individual, and Code Sec. 67(e) provides that the adjusted gross income of a trust or estate is determined in the same way as for an individual, except that expenses described in Code Sec. 67(e)(1) and deductions under Code Sec. 642(b), Code Sec. 651, and Code Sec. 661 are allowable as deductions in arriving at adjusted gross income. Thus, Code Sec. 67(e) removes the expenses described in Code Sec. 67(e)(1) from the category of itemized deductions (and thus necessarily also from the subset of miscellaneous itemized deductions) and instead treats them as above-the-line deductions allowable in determining adjusted gross income under Code Sec. 62(a). Therefore, IRS concluded that the suspension of the deductibility of miscellaneous itemized deductions under Code Sec. 67(a) does not affect the deductibility of payments described in Code Sec. 67(e)(1).
However, an expense that commonly or customarily would be incurred by an individual (including the appropriate portion of a bundled fee) is affected by Code Sec. 67(g) and thus is not deductible to the estate or non-grantor trust during the suspension of Code Sec. 67(a). Nothing in Code Sec. 67(g) impacts the determination of what expenses are described in Code Sec. 67(e)(1).
In addition, IRS found that nothing in Code Sec. 67(g) affected the ability of the estate or trust to take a deduction listed under Code Sec. 67(b). These deductions remain outside of the definition of “miscellaneous itemized deduction.” For example, Code Sec. 691(c) deductions (relating to the deduction for estate tax on income in respect of the decedent), which are identified in Code Sec. 67(b)(7), remain unaffected by the enactment of Code Sec. 67(g).
Comments requested. Reg § 1.642(h)-1(b) provides, in part, that net operating loss carryovers and capital loss carryovers are taken into account when determining adjusted gross income. Therefore, they are above-the-line deductions and thus are not miscellaneous itemized deductions on the returns of beneficiaries. Conversely, Reg § 1.642(h)-2(a) provides that if, on the termination of an estate or trust, the estate or trust has for its last tax year deductions (other than the deductions allowed under Code Sec. 642(b) (relating to personal exemption) or Code Sec. 642(c) (relating to charitable contributions)) in excess of gross income, the excess is allowed under Code Sec. 642(h)(2) as a deduction (Code Sec. 642(h)(2) excess deduction) to the beneficiaries. However, the Code Sec. 642(h)(2) excess deduction is allowed only in computing the taxable income of the beneficiaries and must be taken into account in computing the items of tax preference of the beneficiaries. Therefore, a Code Sec. 642(h)(2) excess deduction is not used in computing the beneficiaries’ adjusted gross income and is treated as a miscellaneous itemized deduction of the beneficiaries.
IRS requested comments regarding the effect of Code Sec. 67(g) on the ability of the beneficiary to deduct amounts comprising the Code Sec. 642(h)(2) excess deduction upon the termination of a trust or estate in light of Code Sec. 642(h) and Reg § 1.642(h)-2(a). In particular, IRS requested comments on whether the separate amounts comprising the Code Sec. 642(h)(2) excess deduction, such as any amounts that are Code Sec. 67(e) deductions, should be separately analyzed when applying Code Sec. 67.
Effective date. Notice 2018-61 is effective July 13, 2018. However, estates and non-grantor trusts may rely on Notice 2018-61 for tax years beginning after Dec. 31, 2017.
References: For miscellaneous itemized deductions, see FTC 2d/FIN ¶A-2711 et seq.; United States Tax Reporter ¶674.
