If you are involved in any way with a trust or estate which is required to file Form 1041, U.S. Income Tax Return for Estates and Trusts, you may be interested in a change in the way these entities compute their tax.
The Internal Revenue Service, in final regulations issued in 2014, clarifies issues such as: fees paid to an investment advisor by a nongrantor trust or estate are generally miscellaneous itemized deductions subject to a floor of 2% of adjusted gross income, as is the case for individuals filing Form 1040. Other types of costs which would be subject to the 2% limitation if paid by an individual taxpayer will be required to be so treated by a trust or estate.
Fiduciaries (for the most part trustees or administrators and executors of estates) will be required to separate the amount of their “bundled” fees—in other words, “unbundle” them into the portion which is attributable to investment advice, and the portion which is not. The investment advice portion will be included with any other costs subject to the 2% limitation, and the rest will be fully deductible, except for:
- Payments made to a third party out of the bundled fee that would have been subject to the 2% floor if paid directly by the trust or estate, and
- Separately assessed expenses in addition to usual or basic fees or commissions, that are commonly or customarily incurred by an individual
The regulations also allow the use of any reasonable method to make the allocation to investment advice, and include a listing of the facts that may be considered in determining whether an allocation is reasonable.
While the final regulations initially called for the “unbundling” rule to be effective for tax years beginning on or after May 9, 2014, they have delayed its effective date to cover tax years beginning on or after December 31, 2014. This was in response to comment which indicated that insufficient time was given to allow fiduciaries to implement changes.
While this rule will largely affect corporate or professional fiduciaries, it is required by any individual trustee of a non-grantor trust, and any other fiduciary, such as the executor of an estate.
In addition to the “fee unbundling” rules, the regulations clarify several other matter of interest to fiduciaries of trusts and estates, specifically costs are subject to the 2% floor to the extent the cost is (1) included in the definition of miscellaneous itemized deductions; (2) incurred by an estate or nongrantor trust; and (3) commonly incurred by a hypothetical individual holding the same property. Some examples are:
- Appraisal fees other than for determining the value of assets (1) as of a decedent’s date of death, or the alternate valuation date. (2) for making distributions, (3) as required to prepare tax returns or a generation-skipping transfer tax return.
- Costs incurred to defend a claim against the estate, decedent, or nongrantor trust that are unrelated to the estate’s or trust’s existence, validity, or administration.
If these new regulations may impact you, be sure to contact Potts & Company for more information and details specific to your situation.