Trust and Estate Income Tax Considerations After the Tax Cuts and Jobs Act of 2017 (article)
The new tax law known as the Tax Cuts and Jobs Act (the TCJA) will impact income tax planning for trusts and estates, at least until Dec. 31, 2025 when many of the provisions are scheduled to expire.
Some tax planning opportunities to consider for executors, trustees, and beneficiaries of trusts, as well as those considering the creation of new trusts, are:
- For clients residing in states with high income tax rates, the limitation on state and local tax (SALT) deductions may be a compelling reason to increase the use of non-grantor trusts having situs in a low-tax (or no-tax) jurisdiction. Income-generating assets that otherwise would be subject to income tax under the particular tax laws of a state with high income tax rates can benefit from the lower income tax rates of jurisdictions under which these non-grantor trusts have situs. Since trusts reach the maximum income tax bracket at $12,500, the income of the trust will need to be monitored.
- Remember that the 3.8 percent Net Investment Income Tax (NIIT) was left undisturbed by the TCJA. You can minimize the NIIT by distributing trust income to a child. While the child's unearned income tax rate will be 37 percent under the new Kiddie Tax rules for amounts in excess of $12,500, the child's NIIT threshold is still $200,000, as opposed to the trust's NIIT threshold of $12,500.
- The new 20 percent Qualified Business Income (QBI) deduction under IRC Section 199A is available to trusts. The QBI deduction is subject to various limitations, where trusts appear to be subject to those limitations that otherwise are applicable to single taxpayers. The QBI deduction is not dependent on active participation in a trade or business, so trusts funded with interests in pass-through entities (such as LLCs, Partnerships, and Subchapter S Corporations) can expect to benefit from the new QBI deduction. The rules for determining QBI deduction eligibility and the computation of the actual deduction are complex, but will significantly alter income tax planning for tax deposits and tax liabilities of trusts and trust beneficiaries.
- Although the TCJA repeals an individual's miscellaneous itemized deductions subject to the two percent of AGI floor, deductions unique to trusts that are allowed under IRC Section 67(e), such as administration costs, continue to be available and are not subject to the two percent floor. Similarly, the deduction under IRC Section 691(c) for net federal estate tax paid on the right to income in respect to a decedent (IRD) continues to be available, whether for an estate, trust or an individual who includes the IRD in gross income. These deductions should factor into ongoing projections and calculations for tax deposits and tax liabilities of trusts and trust beneficiaries.
- A trust's deduction for mortgage interest expense and for state and local taxes (SALT) are subject to the same limitations that are applicable to individuals under the TCJA. A split of a trust into multiple separate trusts may achieve a greater SALT deduction for the same underlying amount, since each trust could utilize its own $10,000 limitation. For example, a single trust that pays $20,000 each year in real property taxes would be limited under the TCJA to a $10,000 deduction each year. If the property instead was held by two trusts, each trust would be able to deduct $10,000 each year, and the full amount of real estate tax ultimately would be deductible.
Regarding this strategy, the Uniform Trust code provides the following at section 417:
Accordingly, one must also consider IRC section 643(f), which provides as follows:
After notice to the qualified beneficiary or beneficiaries, a trustee may…divide a trust into two or more separate trusts, if the new trusts do not impair the rights of any beneficiary, or adversely affect the purposes of the trust.
This poses a significant challenge to the aforementioned strategy. If the split of a trust is desirable, there are ways to avoid the application of Section 643(f) by careful drafting of the new trust documents such that the first condition under Section 643(f) will not be applicable. However, on other occasions there are valid non-tax reasons for the retention of a single combined trust that outweigh the potential tax benefits of this strategy. The viability of this strategy also is subject to regulatory guidance from the IRS that may be issued.
"….[U]nder regulations prescribed by the Secretary, 2 or more trusts shall be treated as 1 trust if –(1) such trusts have the same grantor or grantors, and substantially the same beneficiary or beneficiaries, and (2) a principal purpose of such trusts is the avoidance of the tax imposed by this chapter. For purposes of the preceding sentence a husband and wife shall be treated as 1 person…"
- A continuation of the prior strategy is equally relevant in regard to the TCJA's new limitation for excess business losses. Individual taxpayers are limited to business losses (including those allocated from "pass-through" entities) in the amount of $250,000 for single filers ($500,000 for married taxpayers filing joint returns). It appears trusts will be subject to the $250,000 threshold for single filers. However, each trust has a separate threshold, where allocated business losses from pass-through entities could fall below this threshold if allocated among multiple trusts. This could allow for unlimited losses from businesses, notwithstanding the same concerns as noted previously under Section 643(f) and under regulatory guidance from the IRS that may be issued. Additionally, the efficiency of this strategy must consider the compressed tax brackets of trusts that are applicable in the profitable years of the pass-through entities.
As you can see, trusts and estates need to plan carefully with a keen eye toward the upcoming expiration of the TCJA provisions in 2026. This expiration factors into the decision to choose a jurisdiction other than the domicile of the grantor, a decision to split a trust, the timing or amount of distributions, or a decision to accumulate income. These potential tax efficiencies must be counter-balanced against the overall tax objectives of our clients.
Remember, never change your documents without first consulting your estate planning attorneys. If you have any questions regarding these planning initiatives, please contact your local CBIZ MHM tax professional to learn more about the effects these provisions will have on your trusts and estates.
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