The New Tax Law – A Good Deal for Estates. . .or Maybe Not so Good

Most of the buzz surrounding the new tax law effective this year has been on corporate income tax rate reductions, treatment of pass through entities, limitations on state and local deductions and other higher profile income-tax related changes.  For estates, the one big change is the increase of the Estate, Gift and Generation Skipping Tax exemption to $10 million, $20 Million for married individuals. This is a good thing for very high net worth families, but for the vast majority of Americans, the $5 million plus exemption already in place worked just fine.  The new tax act, however, has another provision relating to trusts and estates which doesn’t work out so well for anybody, and that’s the suspension of the deduction for miscellaneous expenses subject to the 2% floor.

Heretofore, individuals could take as itemized deductions on their 1040 certain miscellaneous expenses to extent they exceed in the aggregate 2% of the taxpayers adjusted gross income. These expenses include employee business expenses, investment management fees, tax preparation fees and many others. In this group of expenses one relating directly to trusts and estates is excess deductions on termination of estates and trusts that can be passed through to estate and trust beneficiaries.

Estates and trusts are taxpayers and must report and pay tax on net income earned or pass that income through to estate or trust beneficiaries.  To arrive at net income estates and trusts may deduct among other items attorney fees and fiduciary fees like executor and trustee commissions.  In the estate context attorney and fiduciary fees are very often the largest expenses of an estate and can exceed income by a wide margin, especially where there are few income producing assets or they have been sold or distributed during the tax year. If this disparity occurs in the final tax year of the estate, the excess deductions can be passed through to the beneficiaries and added to their other miscellaneous expenses and deducted to the extent they all exceed 2% of AGI.  That is until 2018.

Note attorney and fiduciary fees are also deductible against Federal  Estate Tax as well as against estate income, but not both.  An estate must choose between deducting them on the Estate Tax return, or on the income tax return. In past years, when the many more estates were subject to Federal Estate Tax and the estate tax rates were higher, the choice was more often to deduct against estate tax. Now, with increase in the estate tax exemption to $5 million in 2011 and now $10 million, many more estates will deduct these fees against income.  However, the added tax benefit of excess deductions on termination passed through to estate beneficiaries enjoyed by many more of them in recent years, is now, unfortunately, lost.