The late Dr. Jerry Pournelle wrote a column in Byte magazine beginning in the early years of the “microcomputer” era (the term before IBM came out with their Personal Computer when the common reference became PCs) on using the devices.

Dr. Pournelle often used the term “real soon now” in his column to deal with some new feature a vendor promised was almost ready to be released, but which quite often would either take years to arrive or never actually see the light of day.  The term came to mind when I saw a story posted on Tax Notes Today Federal regarding the issue of IRS guidance on excess deductions on termination and comments made by Catherine Hughes, attorney-adviser, Treasury Office of Tax Legislative Counsel in response to questions at a District of Columbia Bar Conference on January 23.[1]

The questions arose regarding the impact of the changes made to IRC §67(g), which bars a deduction for miscellaneous itemized deductions, on the excess deductions passed out to beneficiaries under §642(h)(2) on termination of a trust or estate.

Reg. §1.642(h)-2(a) indicates that this amount is “is allowed only in computing taxable income and must be taken into account in computing the items of tax preference of the beneficiary; it is not allowed in computing adjusted gross income.”  As it is not listed in §67(b) as a deduction not allowed in computing adjusted gross income that is excluded from the miscellaneous classification, it appears to be barred as a deduction by IRC §67(g).

However, the introduction of §67(g) by the Tax Cuts and Jobs Act caused many advisers to take a second look at the question of whether Reg. §1.642(h)-2 came to the proper conclusion and suggest that such deductions should be allowed to the beneficiaries in the same way they would have been allowed to the trust or estate if there had been sufficient income at the trust or estate level to absorb it.  After all, since a trust or estate would not be allowed a deduction that was found to not be a miscellaneous itemized deduction, as it is subject to §67(g) itself, this seems to result in non-miscellaneous deductions being reclassified into the barred category at the termination of the trust or estate.

It appeared we might get some early resolution of this matter from the IRS, as in Notice 2018-61, issued on July 13, 2018, the IRS stated:

The Treasury Department and the IRS are studying whether section 67(e) deductions, as well as other deductions that would not be subject to the limitations imposed by sections 67(a) and (g) in the hands of the trust or estate, should continue to be treated as miscellaneous itemized deductions when they are included as a section 642(h)(2) excess deduction. Taxpayers should note that section 67(e) provides that appropriate adjustments shall be made in the application of part I of subchapter J of chapter 1 of the Code to take into account the provisions of section 67.

The Treasury Department and the IRS intend to issue regulations in this area and request 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 upon the termination of a trust or estate in light of sections 642(h) and 1.642(h)-2(a). In particular, the Treasury Department and the IRS request comments concerning whether the separate amounts comprising the section 642(h)(2) excess deduction, such as any amounts that are section 67(e) deductions, should be separately analyzed when applying section 67.[2]

These proposed regulations, presumably to come “real soon now,” would resolve this matter, hopefully in favor of the individual getting to claim the deduction with taxpayers allowed to rely on the proposed regulation pending their issuance in final form.

True to their “real soon now” status, though, these proposed regulations did not appear in the next few months to allow advisers to use them for tax planning.  Similarly, the April 17, 2019 original due date for the individuals affected by this also passed without these regulations appearing, so they couldn’t be relied upon when timely filing a return or even applying for an extension to await this promised guidance.  Ultimately the extension for the individual return would also not give enough time to see these regulations, as October 15 passed with no word.

Ms. Hughes was quoted in the Tax Notes Today Federal Story regarding the status of those regulations from comments she gave at a District of Columbia Bar conference. 

She described the basic issues as follows:

“In the existing regs that have been there since God created the world, it says that excess deductions on termination are a one-line entry for a miscellaneous itemized deduction,” Hughes said. In comments from the public, however, “we universally got the answer that we should say that they’re not miscellaneous itemized deductions and should be allowable to the beneficiary to the extent they were allowable in the hands of the trust or estate,” she said.[3]

Ms. Hughes goes on to state that the IRS had hoped to get these proposed regulations out by the due date of the fiduciary income tax returns for 2018.[4]  Whether she meant the original or extended due date, it’s clear that did not happen.

Ms. Hughes did indicate that final regulations are just around the corner (a close relative of “real soon now”) that will formally adopt the guidance on non-2% deductions at the trust and estate level provided for in Notice 2018-11.  But, more significant for most practitioners, these regulations will also give the IRS’s position on how to deal with those excess deductions on termination under §642(h)(2) on the beneficiaries’ returns.[5]

The article notes she stated that, due to this delay in issuing guidance, “some taxpayers might need to file amended returns.”[6]

Note that Ms. Hughes does not say that the IRS will go along with all the comments the agency received on this issue.  Presumably, though, prudence would have suggested she might have wanted to have avoided noting the unanimity of comments on the matter if the agency was going to decide they were not going to change Reg. §1.642-2(a) to change the classification of these expenses.  Nevertheless, until “real soon now” comes we will face some level of uncertainty on this issue as no clear authority under Reg. §1.6662-4(d) appears to exist to justify claiming the deduction, aside from trying to argue that the IRC demands this result—or, effectively, that the regulation has been in error since it was first issued.

[1] Jonathon Curry, “Coming Regs on Estate Fees to Settle Excess Deductions Question,” Tax Notes Today Federal, January 24, 2020, 2020 TNTF 16-6, https://www.taxnotes.com/tax-notes-today-federal/estate-gift-and-inheritance-taxes/coming-regs-estate-fees-settle-excess-deductions-question/2020/01/24/2c3cx (retrieved January 24, 2020, subscription required)

[2] Notice 2018-11, Section 4, July 13, 2018

[3] Jonathon Curry, “Coming Regs on Estate Fees to Settle Excess Deductions Question,” Tax Notes Today Federal, January 24, 2020

[4] Jonathon Curry, “Coming Regs on Estate Fees to Settle Excess Deductions Question,” Tax Notes Today Federal, January 24, 2020

[5] Jonathon Curry, “Coming Regs on Estate Fees to Settle Excess Deductions Question,” Tax Notes Today Federal, January 24, 2020

[6] Jonathon Curry, “Coming Regs on Estate Fees to Settle Excess Deductions Question,” Tax Notes Today Federal, January 24, 2020