The impact of tax reform is far reaching. Not only do businesses and individuals need to consider how the new legislation impacts their situation, but reviewing how the Tax Cuts and Jobs Act affects trusts and estates is also important because modifications may need to be made to ensure the best possible outcome. This insight outlines a few key considerations for trusts and estates.
The tax rates and brackets for trusts and estates are changing. The new tax rates, which are shown below, are to be used for taxable years beginning after December 31, 2017, and through 2025. Unless revised by future legislation, the rates and brackets will revert back to 2017 levels after 2025. For those trusts and estates utilizing a fiscal year-end, there is not a requirement to use a blended 2017 and 2018 tax rate or bracket. A comparison of the 2017 rates and brackets to the 2018 rates and brackets are as follows:
|2017 Estate and Trust Income Tax Rates|
|If taxable income is:||The tax is:|
|Not over $2,550||15% of taxable income|
|Over $2,550 but not over $6,000||$382.50 plus 25% of the excess over $2,550|
|Over $6,000 but not over $9,150||$1,245 plus 28% of the excess over $6,000|
|Over $9,150 but not over $12,500||$2,127 plus 33% of the excess over $9,150|
|Over $12,500||$3,232.50 plus 39.6% of the excess over $12,500|
|2018 Estate and Trust Income Tax Rates|
|If taxable income is:||The tax is:|
|Not over $2,550||10% of taxable income|
|Over $2,550 but not over $9,150||$255 plus 24% of the excess over $2,550|
|Over $9,150 but not over $12,500||$1,839 plus 35% of the excess over $9,150|
|Over $12,500||$3,011.50 plus 37% of the excess over $12,500|
Guidance will still be needed from the IRS on deductions for state income taxes and real estate taxes being limited to $10,000 (same limitation as individual taxpayers), but an exception for property taxes that are incurred in a trade or business appears to have been provided. However, miscellaneous deductions will be disallowed. These are the deductions which were previously subject to the 2 percent limitation on fiduciary returns. An example of this type of deduction is investment fees/expenses. In addition, administration expenses incurred by an estate/trust, including fiduciary fees, legal fees and tax preparation fess may still be deductible depending on the underlying purpose of the expense being related to an income producing activity.
Estates and trusts which pay a “bundled” fee to a corporate trustee will need to allocate the total fee between investment expense and fiduciary fee. Corporate trustees should review their allocation of the bundled fee, since the investment fee is now nondeductible, rather than subject to the prior 2 percent limitation.
Qualified Business Income
Estates and trusts are able to take advantage of the 20 percent deduction for qualified business income (Section 199A). For tax years beginning after December 31, 2017, the act generally allows a new deduction for individuals, trusts and estates of 20 percent of the domestic qualified business income generated by certain sole-proprietorships and pass-through entities (partnerships, S corporations and LLCs). Depending on taxable income, the deduction may be subject to a limit based on wages paid by the business or wages paid plus a capital amount, and certain service business activities may not qualify for the deduction. This new deduction is slated to expire after 2025 like most other individual tax provisions in the act. In those instances where the full 20 percent deduction is available, the top federal tax rate for pass-through owners drops from 37 percent (the new top rate for individuals, as well as, trusts and estates under the act) to 29.6 percent. In light of the tax rate changes, and the effect on owners, pass-through entities may decide to re-evaluate the pros and cons of their current business structure.
Net Operating Losses
Net operating losses can no longer be carried back. The losses can only be carried forward indefinitely. In addition, net operating losses can only offset 80 percent of taxable income in carryover years.
As you can tell, there are many estate and trust tax reform changes that need to be discussed and considered. Contact your Eide Bailly professional or a member of our wealth and transition services team for a review of your situation.