Fiduciary income tax questions showcased in recent comment letter
The Tax Section of the State Bar of Texas recently submitted comments regarding the proposed regulations under section 199A, the provision implementing the new 20 percent deduction for pass-through entities and sole proprietors. Carol Warley, RSM Partner, Private Client Services and RSM’s Corey Junk and Cindy Hull participated in formulating and drafting the State Bar’s comments with respect to the proposed regulations’ impact on fiduciary income tax compliance and planning. The full State Bar of Texas’ comment letter can be found here. We will highlight below some of the comments that are most noteworthy for fiduciaries and their advisors.
Treatment of multiple trusts – proposed regulation section 1.643(f)-1
The proposed regulations would preclude taxpayers from setting up multiple trusts (each with income below the $157,500 threshold) in an attempt to circumvent the various limitations associated with the section 199A deduction, such as the specified service trade or business income restriction. The precluded trusts would be those that have substantially the same grantor(s) and substantially the same primary beneficiary or beneficiaries, and were set up for the principal purpose of avoiding federal income taxes. Any such trusts will be aggregated and treated as a single trust for purposes of determining the section 199A deduction.
The IRS should provide further guidance on whether multiple trusts have substantially the same primary beneficiary or beneficiaries. The proposed regulations provide an example where the IRS concludes that the trusts have substantially the same primary beneficiaries, despite the presence of significantly different rights under separate trust agreements. It would be helpful for the IRS to provide more examples (or more detailed guidelines) on this point.
Comments regarding trusts and estates – proposed regulation section 1.199A-6
The Distribution Deduction Should Be Considered in Determining Whether the Taxable Income of Trusts and Estates Exceeds the Threshold Amount
The proposed regulations state that the $157,500 taxable income threshold amount for a trust is to be determined at the trust level, without taking into account any distribution deductions, presumably to preclude manipulation of the threshold amount. However, this perceived incentive for abuse may be largely mitigated by fiduciary duties that trustees owe to beneficiaries, which would likely not include making distributions to plan around the threshold. Also, this treatment unfairly penalizes fiduciaries and their beneficiaries because the taxable income is attributed to both.
Negative QBI Should Not Be Allocated to an Estate or Trust Beneficiary Based on Its Relative Proportion of Distributable Net Income
Except in the year of termination, losses are not distributed to beneficiaries of an estate or trust. Instead, they are retained at the entity level. Accordingly, the treatment of negative QBI (losses) under the proposed regulations fundamentally differs from the general rules regarding the treatment of losses for estates or trusts.
Taxable Beneficiaries of Charitable Remainder Trusts and Charitable Lead Trusts Should Be Eligible for the Section 199A Deduction
The proposed regulations request comments from taxpayers and practitioners as to whether taxable beneficiaries of charitable remainder trusts and charitable lead trusts should be eligible for the section 199A deduction. Legislative history of section 199A indicates that trusts (with no distinction as to any specific type) should be eligible for the deduction. Therefore, additional rules should be promulgated in the final regulations to provide guidance as to the calculation of this deduction.
Stay tuned for more information and insight as these proposed regulations advance through the rulemaking process towards final regulations.
For more information on the fiduciary income tax provisions of these proposed regulations, see our prior alert: Implications of the 199A proposed regulations on planning with trusts.