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The Tax Cuts and Jobs Act of 2017 (Pub. L. No. 115-97) ("TCJA") eliminated the deduction for miscellaneous itemized deductions, at least temporarily, until 2025. This means that expenses incurred for the production of income described in IRC Section 212, such as those incurred to manage investments and tax preparation fees, are no longer deductible by individuals, estates, and trusts beginning in 2018, even if they exceed 2% of the taxpayer's adjusted gross income (a threshold required under prior law). See IRC Section 67(g). With respect to trusts and estates, this apparently created a conflict with IRC Section 67(e)(1). That provision deals with costs such as fiduciary fees and other costs and fees incurred solely as a result of the fact that the taxpayer is an estate or trust. Under this subsection, those costs were permissible "above-the-line" deductions in arriving at the adjusted gross income of the estate or trust. Further, and per regulations, this particular class of deductions was also excluded from the 2% of adjusted gross income limitation (Treas. Regs. Section 1.67-4).
Now, in Notice 2018-61 (July 13, 2018), the IRS has clarified that the temporary elimination of miscellaneous deductions was not intended to affect trusts and estates to the extent of those costs described in IRC 67(e)(1). Under the notice, the IRS says that it will prepare proposed regulations confirming this result. The IRS notes, however, that there will still be areas that require special scrutiny and resolution. One such area involves where trusts and estates terminate and excess and unused deductions are distributed to beneficiaries, so that the beneficiaries can potentially deduct some or all of the deductions on their personal tax returns. Trust and estate taxation specialists had predicted that the IRS would issue this clarification.
The investment management deduction issue has received additional timely and interesting treatment in a Tax Court case issued just a few days before the TCJA was signed. In Lender Management, LLC v. Commissioner, T.C. Memo. 2017-24 (December 13, 2017), the U.S. Tax Court held that a family office organized as an LLC was “carrying on a trade or business” as an investment manager rather than serving as a passive investor and therefore was entitled to deduct its expenses under IRC Section 162 (ordinary trade or business expenses) as opposed to Section 212. The Lender court was dealing with pre-TCJA law where the stakes were whether the expenditures at issue were subject to the 2% of AGI cutback and unfavorable alternative minimum tax addback treatment. With the passage of IRC Section 67(g), the stakes of Lender have been raised for all taxpayers: Under the theory of Lender, the elimination of miscellaneous deductions can potentially be avoided so long as those deductions can be converted into trade or business deductions under IRC Section 162.
Mr. Phillips has dealt with many aspects of the taxation of the costs and expenses of managing trusts and estates, both in and outside of the family office context. If you wish to know more about how you can successfully avoid the expense suspensions under the TCJA and perhaps structure your endeavors to take advantage of the principles set forth in the Lender case, contact him at firstname.lastname@example.org.