Effect of Section 67(g) on Trusts and Estates

Citation85 FR 27693
Record Number2020-09801
Published date11 May 2020
CourtInternal Revenue Service
Federal Register, Volume 85 Issue 91 (Monday, May 11, 2020)
[Federal Register Volume 85, Number 91 (Monday, May 11, 2020)]
                [Proposed Rules]
                [Pages 27693-27698]
                From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
                [FR Doc No: 2020-09801]
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                DEPARTMENT OF THE TREASURY
                Internal Revenue Service
                26 CFR Part 1
                [REG-113295-18]
                RIN 1545-BO87
                Effect of Section 67(g) on Trusts and Estates
                AGENCY: Internal Revenue Service (IRS), Treasury.
                ACTION: Notice of proposed rulemaking.
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                SUMMARY: This document contains proposed 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 proposed 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. These proposed regulations affect
                estates, non-grantor trusts (including the S portion of an electing
                small business trust), and their beneficiaries.
                DATES: Written or electronic comments and requests for a public hearing
                must be received by June 25, 2020.
                ADDRESSES: Commenters are strongly encouraged to submit public comments
                electronically. Submit electronic submissions via the Federal
                eRulemaking Portal at www.regulations.gov (indicate IRS and REG-113295-
                18) by following the online instructions for submitting comments. Once
                submitted to the Federal eRulemaking Portal, comments cannot be edited
                or withdrawn. The IRS expects to have limited personnel available to
                process public comments that are submitted on paper through mail. Until
                further notice, any comments submitted on paper will be considered to
                the extent practicable. The Department of the Treasury (Treasury
                Department) and the IRS will publish for public availability any
                comment submitted electronically, and to the extent practicable on
                paper, to its public docket.
                 Send paper submissions to: CC:PA:LPD:PR (REG-113295-18), Room 5203,
                Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
                Washington, DC 20044.
                 Requests for a public hearing must be submitted as prescribed in
                the ``Comments and Requests for a Public Hearing'' section.
                FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
                Margaret Burow, (202) 317-5279; concerning submissions of comments and/
                or requests for a public hearing, Regina Johnson, (202) 317-5177 (not
                toll-free numbers).
                SUPPLEMENTARY INFORMATION:
                Background
                 This document contains proposed amendments to the Income Tax
                Regulations (26 CFR part 1) under sections 67 and 642 of the Internal
                Revenue Code (Code).
                I. Section 67(g)
                 Section 67(g) was added to the Code on December 22, 2017, by
                section 11045(a) of the Tax Cuts and Jobs Act, Public Law 115-97, 131
                Stat. 2054, 2088 (2017) (Act). 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.
                 For purposes of subtitle A of the Code, an individual's adjusted
                gross income is defined in section 62(a) as gross income minus the
                deductions listed in section 62(a)(1) through (21). Individuals then
                may subtract itemized deductions from adjusted gross income to arrive
                at taxable income. See section 63(a). Section 63(d) defines itemized
                deductions as deductions allowable under chapter 1 of subtitle A of the
                Code, other than (1) deductions allowable in arriving at adjusted gross
                income, (2) deductions for personal exemptions provided by section 151,
                and (3) the deduction under section 199A. A subset of these itemized
                deductions, identified as miscellaneous itemized deductions, are
                subject to special rules. Prior to the Act, miscellaneous itemized
                deductions were allowable for any taxable year only if 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).
                II. Section 67(e)
                 Section 67(e) provides that 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 trusts accumulating income). Accordingly, section 67(e)
                removes the deductions 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.
                 On July 13, 2018, the Treasury Department and the IRS issued Notice
                2018-61, 2018-31 I.R.B. 278, announcing that proposed regulations would
                be issued concerning the effect of section 67(g) on the deductibility
                of certain expenses described in section 67(b) and (e) incurred by
                estates and non-grantor trusts. The notice states that regulations
                would 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.
                [[Page 27694]]
                III. Section 642(h)
                 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 such excess shall be allowed as a deduction, in accordance
                with the regulations prescribed by the Secretary of the Treasury or his
                delegate, to the beneficiaries succeeding to the property of the estate
                or trust.
                 Net operating loss and capital loss carryovers under section
                642(h)(1) are used to compute adjusted gross income on the return of a
                beneficiary, formerly referred to as an above-the-line deduction. See
                Sec. 1.642(h)-1. The excess deduction under section 642(h)(2) is not,
                however, used to compute adjusted gross income on the return of a
                beneficiary. Instead, Sec. 1.642(h)-2(a) provides that the section
                642(h)(2) excess deduction is ``allowed only in computing taxable
                income and must be taken into account in computing the items of tax
                preference of beneficiaries; it is not allowed in computing adjusted
                gross income.'' As a result, under the existing regulations, excess
                deductions on termination of an estate or trust are treated as a single
                miscellaneous itemized deduction (section 642(h)(2) excess deduction)
                of the beneficiary subject to disallowance under section 67(g). See
                also sections 63(d) and 67(b).
                 The section 642(h)(2) excess deduction may be comprised of several
                types of deductions including: (1) Those deductions allowable in
                arriving at adjusted gross income under sections 62 and 67(e); (2)
                itemized deductions under section 63(d) allowable in computing taxable
                income; and (3) miscellaneous itemized deductions currently disallowed
                under section 67(g). See section 67(b). Notice 2018-61 explained that
                the Treasury Department and the IRS were studying whether section 67(e)
                deductions, as well as other deductions not subject to the limitations
                imposed by sections 67(a) and (g) in the hands of the estate or trust,
                should continue to be treated as miscellaneous itemized deductions when
                included as a section 642(h)(2) excess deduction.
                 Notice 2018-61 requested comments regarding the effect of section
                67(g) on the ability of the beneficiary to deduct amounts comprising
                the section 642(h)(2) excess deduction on the termination of an estate
                or trust considering section 642(h) and Sec. 1.642(h)-2(a) and
                expressed the intent to address this issue in regulations. The Treasury
                Department and the IRS requested comments regarding whether the
                separate deductions comprising the section 642(h)(2) excess deduction,
                such as section 67(e) deductions, should be analyzed separately when
                applying section 67.
                 The Treasury Department and the IRS received comments addressing
                issues concerning section 67(e), as well as excess deductions on
                termination of an estate or trust under section 642(h), as discussed in
                more detail in the Explanation of Provisions section of this preamble.
                All comments were considered and are available for public inspection.
                The Treasury Department and the IRS continue to study issues related to
                sections 67 and 642 that are beyond the scope of these proposed
                regulations and may discuss those comments in future guidance.
                Explanation of Provisions
                I. Section 1.67-4
                 Commenters agreed with the statements in Notice 2018-61 that
                deductions described in section 67(e)(1) and (2) are not miscellaneous
                itemized deductions subject to disallowance by section 67(g) and asked
                that the language in Sec. 1.67-4 be amended to clarify this position.
                This document contains proposed regulations amending Sec. 1.67-4 to
                clarify that 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).
                 One commenter asked that the regulations address the treatment of
                expenses and 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 commenter requested that regulations
                provide that such expenses and deductions continue to be deductible for
                AMT purposes. The treatment of expenses and deductions described in
                section 67(e) for purposes of determining AMT is outside the scope of
                these proposed regulations concerning the effects of section 67(g);
                therefore, these proposed regulations do not address the AMT.
                II. Regulations Under Section 642(h)
                A. Character and Amount of the Excess Deductions
                 Commenters opined that the Treasury Department and the IRS have and
                should exercise their regulatory authority not to treat the section
                642(h)(2) excess deduction as a single miscellaneous itemized
                deduction. Commenters noted that the regulations under Sec. 1.642(h)-2
                were written before the concept of miscellaneous itemized deductions
                was added to the Code and need to be updated.
                 In response to the request for comments in Notice 2018-61
                concerning analysis of the separate deductions that comprise the
                section 642(h)(2) excess deduction, commenters stated that the Treasury
                Department and the IRS should provide regulations for the segregation
                of the section 642(h)(2) excess deduction into its components to
                determine the character, computation, and deductibility of costs. One
                commenter said that failure to provide for such segregation could
                result in either the prolonged administration of estates or trusts, or
                the sale of assets, to fully utilize deductible costs at the estate or
                trust level. Another commenter stated that the portion of the section
                642(h)(2) excess deduction that qualifies as section 67(e)(1) expenses
                should remain deductible in arriving at a beneficiary's adjusted gross
                income and that the remaining section 642(h)(2) excess deduction should
                be treated as a single itemized deduction, which would avoid having to
                further separate out the individual costs comprising the excess
                deduction to determine deductibility at the beneficiary level. Other
                commenters proposed treating the section 642(h)(2) excess deduction as
                allowable in full in arriving at the beneficiary's adjusted gross
                income similar to the treatment of a section 67(e) deduction.
                 Another commenter requested more specific guidance on the character
                of the excess deductions. The commenter recommended that the fiduciary
                be required to separate deductions into at least three categories: (1)
                Deductions allowed in arriving at adjusted gross income, (2) non-
                miscellaneous itemized deductions, and (3) miscellaneous itemized
                deductions. This commenter stated that the character of the deductions
                should not change when succeeded to by the beneficiaries on termination
                of the estate or trust. Further, the commenter suggested that
                regulations require that deductions subject to limitation when claimed
                by a beneficiary be separately identified (for example, the limitation
                on state and local property and income tax
                [[Page 27695]]
                deductions under section 164(b)(6)). The commenter also requested
                guidance on how each item of deduction offsets items of income of the
                estate or trust in the final year of administration for purposes of
                determining the character of the excess deductions. The character of
                the excess deductions will vary based on how an executor or trustee
                allocates deductions against the income of the estate or trust. The
                same commenter suggested that the rules under Sec. 1.652(b)-3, which
                are used for determining the character of distributable net income to
                beneficiaries under sections 652 and 662, be used as a model to
                determine how deductions are allocated to offset income in the final
                year of administration of the estate or trust for purposes of
                determining the character of the section 642(h)(2) excess deduction.
                 The Treasury Department and the IRS adopt the more specific
                suggestion from commenters of preserving the tax character of the three
                categories of expenses, rather than the suggestion of grouping all non-
                section 67(e) expenses together, to allow for such expenses to be
                separately stated and to facilitate reporting to beneficiaries. Thus,
                under these proposed regulations, each deduction comprising the section
                642(h)(2) excess deduction retains its separate character,
                specifically: As an amount allowed in arriving at adjusted gross
                income; a non-miscellaneous itemized deduction; or a miscellaneous
                itemized deduction. The character of these deductions does not change
                when succeeded to by a beneficiary on termination of the estate or
                trust. Further, these proposed regulations require that the fiduciary
                separately state (that is, separately identify) deductions that may be
                limited when claimed by the beneficiary 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.
                 The proposed regulations adopt the suggestion that the principles
                under Sec. 1.652(b)-3 be 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). Section 1.652(b)-3(a) provides that deductions
                directly attributable to one class of income are allocated to that
                income. Any remaining deductions that are not directly attributable to
                a specific class of income, as well as any deductions that exceed the
                amount of directly attributable income, may be allocated to any item of
                income (including capital gains), but a portion must be allocated to
                tax-exempt income, if any. See Sec. 1.652(b)-3(b) and (d). The
                proposed regulations provide that the character and amount of each
                deduction remaining after application of Sec. 1.652(b)-3 comprises the
                excess deductions available to the beneficiaries succeeding to the
                property as provided under section 642(h)(2).
                 These proposed regulations incorporate a new example to illustrate
                the rule for determining the character of excess deductions in proposed
                Sec. 1.642(h)-2. The proposed regulations also update the current
                example in Sec. 1.642(h)-5 to account for changes in the Code since
                this example was last modified on June 16, 1965, in T.D. 6828, 1965-2
                C.B. 264.
                B. Allocation of the Excess Deduction Among Beneficiaries
                 One commenter requested guidance on allocating the excess
                deductions among multiple beneficiaries and suggested that the
                allocation could be made generally, in proportion to the entire amount
                of deductions, or specifically, based on the burden the beneficiary
                bears as to each deduction. The commenter noted, however, that a
                specific allocation may increase fiduciary reporting and IRS
                administrative burdens and may not be worth the added complexity.
                 Existing regulations under Sec. 1.642(h)-4 provide that carryovers
                and excess deductions to which section 642(h) applies are allocated
                among the beneficiaries succeeding to the property of an estate or
                trust proportionately according to the share of each in the burden of
                the loss or deduction. A person who qualifies as a beneficiary
                succeeding to the property of an estate or trust with respect to one
                amount and who does not qualify with respect to another amount is a
                beneficiary succeeding to the property of the estate or trust as to the
                amount with respect to which the beneficiary qualifies. These proposed
                regulations do not change the allocation method among beneficiaries set
                forth in Sec. 1.642(h)-4.
                 One commenter asked that the Treasury Department and the IRS
                address the treatment of suspended deductions on the termination of a
                trust, such as those under section 163(d) for investment interest, and
                asked that such suspended deductions be treated in the same manner as
                the excess deduction under section 642(h). While the Treasury
                Department and the IRS acknowledge the comment, addressing suspended
                deductions under section 163(d) and other Code sections is beyond the
                scope of these proposed regulations.
                Proposed Applicability Date
                 These proposed regulations apply to taxable years beginning after
                the date these regulations are published as final regulations in the
                Federal Register. However, estates, non-grantor trusts, and their
                beneficiaries may rely on these 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 regulations in the
                Federal Register. 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 these regulations are
                published as final regulations in the Federal Register in which an
                estate or trust terminates.
                 One commenter asked that the Treasury Department and the IRS
                clarify that expenses incurred during an estate's fiscal year beginning
                before January 1, 2018, which properly are characterized as
                miscellaneous itemized deductions, remain deductible as such even if
                some of the costs were paid after January 1, 2018. Section 67(g)
                applies to taxable years beginning after December 31, 2017; therefore
                section 67(g) would not apply to an estate's or trust's taxable years
                beginning before that date.
                Special Analyses
                 This regulation is 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 information already
                maintained and reported to the IRS on Form 1041, on the Schedule K-1
                (Form 1041) issued to beneficiaries. Moreover, it should take an estate
                or trust no more than 2 hours to satisfy the information requirement in
                these regulations. Pursuant to section 7805(f) of the Code, this notice
                of proposed rulemaking has been submitted to the Chief Counsel for
                Advocacy of the Small Business Administration for comment on its impact
                on small businesses.
                [[Page 27696]]
                Paperwork Reduction Act
                 The collection of information related to these proposed 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. Comments concerning the collection of information and
                the accuracy of estimated average annual burden and suggestions for
                reducing this burden should be sent to the Office of Management and
                Budget, Attn: Desk Officer for the Department of the Treasury, Office
                of Information and Regulatory Affairs, Washington, DC 20503, with
                copies to the Internal Revenue Service, IRS Reports Clearance Officer,
                SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the burden
                associated with this collection of information must be received by July
                10, 2020.
                 The collection of information in these proposed regulations is in
                proposed 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.
                Comments and Requests for Public Hearing
                 Before these proposed amendments to the regulations are adopted as
                final regulations, consideration will be given to comments that are
                submitted timely to the IRS as prescribed in the preamble under the
                ADDRESSES section. The Treasury Department and the IRS request comments
                on all aspects of the proposed regulations. Any electronic comments
                submitted, and to the extent practicable any paper comments submitted,
                will be made available at www.regulations.gov or upon request.
                 A public hearing will be scheduled if requested in writing by any
                person who timely submits electronic or written comments. Requests for
                a public hearing are also encouraged to be made electronically. If a
                public hearing is scheduled, notice of the date and time for the public
                hearing will be published in the Federal Register. Announcement 2020-4,
                2020-17 IRB 1, provides that until further notice, public hearings
                conducted by the IRS will be held telephonically. Any telephonic
                hearing will be made accessible to people with disabilities.
                Drafting Information
                 The principal author of these proposed 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.
                Statement of Availability of IRS Documents
                 The IRS notice cited in this document is published in the Internal
                Revenue Bulletin and available from the Superintendent of Documents,
                U.S. Government Publishing Office, Washington, DC 20402, or by visiting
                the IRS website at http://www.irs.gov.
                List of Subjects in 26 CFR Part 1
                 Income taxes, Reporting and recordkeeping requirements.
                Proposed Amendments to the Regulations
                 Accordingly, 26 CFR part 1 is proposed to be amended as follows:
                PART 1--INCOME TAXES
                0
                Paragraph 1. The authority citation for part 1 is amended by adding an
                entry for Sec. 1.67-4 and an entry for Sec. Sec. 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).
                * * * * *
                 Sections 1.642(h)-2 and 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 a sentence at the end of paragraph
                (d) to read as follows:
                Sec. 1.67-4 Costs paid or incurred by estates or non-grantor trusts.
                 (a) In general--(1) Section 67(e) deductions. (i) 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) shall 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, which 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) 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 [date these regulations are published
                as final in the Federal Register].
                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), (c), and (f).
                 The revisions and additions read as follows:
                Sec. 1.642(h)-2 Excess deductions on termination of an estate or
                trust.
                 (a) 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 are allowed under section
                642(h)(2) as items of deduction to the beneficiaries succeeding to the
                property of the estate or trust.
                [[Page 27697]]
                 (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 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.
                 (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 B's other
                deductions) 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) and (b) of this section
                apply to taxable years beginning after [date these regulations are
                published as final in the Federal Register].
                 Par. 4. Section 1.642(h)-5 is revised to read as follows:
                Sec. 1.642(h)-5 Examples.
                 The following examples 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 expense 5,000
                 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) 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 the
                taxable year, with the allowance of any net operating loss and loss
                carryover to B and the trust determined under section 172. 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) 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).
                 (3) Section 642(h)(2) excess deductions. The $7,300 of
                deductions not taken into account in 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 carryovers 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 carryovers and excess deductions, however, C may
                receive an indirect benefit from the carryovers 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
                Rents................................................. 2,000
                Capital Gain.......................................... 1,000
                 ---------
                 Total Income...................................... 6,500
                ------------------------------------------------------------------------
                 Table 5 to Paragraph (b)(1)
                ------------------------------------------------------------------------
                
                ------------------------------------------------------------------------
                Deductions
                Section 67(e) deductions:
                 Probate fees........................................ 1,500
                 Estate tax preparation fees......................... 8,000
                 Legal fees.......................................... 4,500
                 ---------
                 Total Section 67(e) deductions.................... 14,000
                Itemized deductions:
                 Real estate taxes on rental property................ 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
                [[Page 27698]]
                Sec. 1.652(b)-3. Under Sec. 1.652(b)-3(a), $2,000 of real estate
                taxes 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) and
                (d), D's executor allocates $4,500 of section 67(e) deductions to
                the remaining $4,500 of income. As a result, the excess deductions
                on termination of the estate are $11,000, consisting of $9,500 of
                section 67(e) deductions and $1,500 of itemized 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, consisting of $7,125 of
                section 67(e) deductions and $1,125 of real estate taxes. F's share
                of the excess deductions is $2,750, consisting of $2,375 of section
                67(e) deductions and $375 of real estate taxes. The real estate
                taxes on rental property must 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 [date these regulations are published as final in the
                Federal Register].
                Sunita Lough,
                Deputy Commissioner for Services and Enforcement.
                [FR Doc. 2020-09801 Filed 5-7-20; 4:15 pm]
                 BILLING CODE 4830-01-P
                

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