IRS Issues Final Regulations on Miscellaneous Itemized Deductions of Trusts & Estates

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The IRS has issued final regulations with guidance for determining which costs incurred by estates and non-grantor trusts are subject to the 2-percent floor for miscellaneous itemized deductions under Code Sec. 67(a) (T.D. 9664). The final regulations adopt regulations proposed in 2011 (NPRM REG-128224-06) with minor modifications. The regulations apply to tax years beginning on or after May 9, 2014

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IRS Issues Final Regulations on Miscellaneous Itemized Deductions of Trusts & Estates

  1. 1. 1 | P a g e May 21, 2014 IRS Issues Final Regulations on Miscellaneous Itemized Deductions of Trusts and Estates The IRS has issued final regulations with guidance for determining which costs incurred by estates and non-grantor trusts are subject to the 2-percent floor for miscellaneous itemized deductions under Code Sec. 67(a) (T.D. 9664). The final regulations adopt regulations proposed in 2011 (NPRM REG-128224-06) with minor modifications. The regulations apply to tax years beginning on or after May 9, 2014. Miscellaneous itemized deductions of estates and trusts are generally subject to the 2-percent floor, but Code Sec. 67(e) provides an exception for administration costs that would not have been incurred if the property in question were not held in the estate or trust. The proposed regulations had been issued, in part, in response to Michael J. Knight, Trustee of the William L. Rudkin Testamentary Trust, S Ct, 2008-1 USTC ¶50,132, in which the Supreme Court held that fees paid to an investment advisor by an estate or trust generally are subject to the 2-percent floor. The court ruled that determining whether an expense of an estate or trust is subject to the 2-percent floor depends on whether a hypothetical individual who held the same property outside of a trust would customarily or commonly incur the expense. Since the Knight decision, the IRS has provided and extended interim guidance on the treatment of a "bundled fee," which is generally a single fee consisting of both costs that are subject to the 2-percent floor and costs that are not (Notice 2011-37, I.R.B. 2011-20, 785). The interim guidance applied to tax years beginning before the date that the IRS published final regulations. Under the final regulations, a cost is subject to the 2-percent floor to the extent that it is included in the definition of miscellaneous itemized deduction under Code Sec. 67(b), is incurred by an estate or non-grantor trust, and would commonly or customarily be incurred by a hypothetical individual holding the same property, based on the type of product or service rendered to the estate or trust. The IRS removed a provision in the proposed regulations stating that costs do not depend on the identity of the payor (i.e., whether the payor is an individual or an estate or trust). Ownership costs, which are costs chargeable to or incurred by a property owner simply by reason of being the owner, are commonly or customarily incurred by a hypothetical individual owner, and thus are subject to the 2-percent floor. Such costs include, but are not limited to, partnership costs deemed to be passed through to and reportable by a partner if they are defined as miscellaneous itemized deductions, condominium fees, insurance premiums, maintenance and lawn services, and automobile registration and insurance costs. The final regulations clarify that other expenses incurred merely by reason of property ownership, such as real estate taxes and trade or business expenses, may still be fully deductible under other tax code provisions. The final regulations provide an exclusive list of tax return preparation costs that are not subject to the 2-percent floor: specifically, costs relating to estate and generation-skipping transfer tax returns, fiduciary income tax returns, and the decedent's final individual income tax return. The cost to prepare any other tax return, including a gift tax return, is subject to the 2-percent floor. Fees for investment advice, including related services that would be provided to an individual investor as part of an advisory fee, are subject to the 2-percent floor. However, the final regulations carve out an exception for the portion of an investment advisory fee that exceeds the fee generally charged to an individual, due to an estate or trust’s unusual investment objective or a required specialized balancing of various parties’ interests. The final regulations require a bundled fee to be allocated between its component costs that are subject to the 2-percent floor and costs that are not. If a bundled fee is not computed on an hourly basis, only the portion attributable to investment advice is subject to the 2-percent floor. However, payments made to third parties out of the bundled fee that would have been subject to the 2-percent floor if they had been paid directly, and payments for expenses separately assessed by the fiduciary or other service provider that are commonly or customarily incurred by an individual, are subject to the 2-percent floor. Further, a bundled fee may be allocated by any reasonable method; the final regulations provide a nonexclusive list of facts to consider in determining whether an allocation is reasonable. The regulations also state that the IRS may provide exceptions to the allocation requirement in future published guidance. Finally, the final regulations identify certain appraisal fees, and provide a nonexclusive list of fiduciary expenses, that are not subject to the 2-percent floor.
  2. 2. 2 | P a g e Copyright © 2014, CCH INCORPORATED. All Rights Reserved. Contents of this publication may not be reproduced without the express written consent of CCH and CBIZ. To ensure compliance with requirements imposed by the IRS, we inform you that-unless specifically indicated otherwise-any tax advice in this communication (and any attachments) is not written with the intent that it be used, and in fact it cannot be used, to avoid penalties under the Internal Revenue Code, or to promote, market, or recommend to another person any tax related matter. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. CBIZ MHM is the brand name for CBIZ MHM, LLC and other Financial Services subsidiaries of CBIZ, Inc. (NYSE: CBZ) that provide tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies.

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