Effect of Section 67(g) on Trusts and Estates, 27693-27698 [2020-09801]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 91 (Monday, May 11, 2020)]
[Proposed Rules]
[Pages 27693-27698]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-09801]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-113295-18]
RIN 1545-BO87


Effect of Section 67(g) on Trusts and Estates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations clarifying that 
the following deductions allowed to an estate or non-grantor trust are 
not miscellaneous itemized deductions: Costs paid or incurred in 
connection with the administration of an estate or non-grantor trust 
that would not have been incurred if the property were not held in the 
estate or trust, the personal exemption of an estate or non-grantor 
trust, the distribution deduction for trusts distributing current 
income, and the distribution deduction for estates and trusts 
accumulating income. Therefore, these deductions are not affected by 
the suspension of the deductibility of miscellaneous itemized 
deductions for taxable years beginning after December 31, 2017, and 
before January 1, 2026. The proposed regulations also provide guidance 
on determining the character, amount, and allocation of deductions in 
excess of gross income succeeded to by a beneficiary on the termination 
of an estate or non-grantor trust. These proposed regulations affect 
estates, non-grantor trusts (including the S portion of an electing 
small business trust), and their beneficiaries.

DATES: Written or electronic comments and requests for a public hearing 
must be received by June 25, 2020.

ADDRESSES: Commenters are strongly encouraged to submit public comments 
electronically. Submit electronic submissions via the Federal 
eRulemaking Portal at www.regulations.gov (indicate IRS and REG-113295-
18) by following the online instructions for submitting comments. Once 
submitted to the Federal eRulemaking Portal, comments cannot be edited 
or withdrawn. The IRS expects to have limited personnel available to 
process public comments that are submitted on paper through mail. Until 
further notice, any comments submitted on paper will be considered to 
the extent practicable. The Department of the Treasury (Treasury 
Department) and the IRS will publish for public availability any 
comment submitted electronically, and to the extent practicable on 
paper, to its public docket.
    Send paper submissions to: CC:PA:LPD:PR (REG-113295-18), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044.
    Requests for a public hearing must be submitted as prescribed in 
the ``Comments and Requests for a Public Hearing'' section.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Margaret Burow, (202) 317-5279; concerning submissions of comments and/
or requests for a public hearing, Regina Johnson, (202) 317-5177 (not 
toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under sections 67 and 642 of the Internal 
Revenue Code (Code).

I. Section 67(g)

    Section 67(g) was added to the Code on December 22, 2017, by 
section 11045(a) of the Tax Cuts and Jobs Act, Public Law 115-97, 131 
Stat. 2054, 2088 (2017) (Act). Section 67(g) prohibits individual 
taxpayers from claiming miscellaneous itemized deductions for any 
taxable year beginning after December 31, 2017, and before January 1, 
2026.
    For purposes of subtitle A of the Code, an individual's adjusted 
gross income is defined in section 62(a) as gross income minus the 
deductions listed in section 62(a)(1) through (21). Individuals then 
may subtract itemized deductions from adjusted gross income to arrive 
at taxable income. See section 63(a). Section 63(d) defines itemized 
deductions as deductions allowable under chapter 1 of subtitle A of the 
Code, other than (1) deductions allowable in arriving at adjusted gross 
income, (2) deductions for personal exemptions provided by section 151, 
and (3) the deduction under section 199A. A subset of these itemized 
deductions, identified as miscellaneous itemized deductions, are 
subject to special rules. Prior to the Act, miscellaneous itemized 
deductions were allowable for any taxable year only if the sum of such 
deductions exceeded two percent of adjusted gross income. See section 
67(a). Section 67(b) defines miscellaneous itemized deductions as 
itemized deductions other than those listed in section 67(b)(1) through 
(12).

II. Section 67(e)

    Section 67(e) provides that an estate or trust computes its 
adjusted gross income in the same manner as that of an individual, 
except that the following additional deductions are treated as 
allowable in arriving at adjusted gross income: (1) The deductions for 
costs which are paid or incurred in connection with the administration 
of the estate or trust and which would not have been incurred if the 
property were not held in such estate or trust, and (2) deductions 
allowable under section 642(b) (concerning the personal exemption of an 
estate or non-grantor trust), section 651 (concerning the deduction for 
trusts distributing current income), and section 661 (concerning the 
deduction for trusts accumulating income). Accordingly, section 67(e) 
removes the deductions in section 67(e)(1) and (2) from the definition 
of itemized deductions under section 63(d), and thus from the 
definition of miscellaneous itemized deductions under section 67(b), 
and treats them as deductions allowable in arriving at adjusted gross 
income under section 62(a). Section 67(e) further provides regulatory 
authority to make appropriate adjustments in the application of part I 
of subchapter J of chapter 1 of the Code to take into account the 
provisions of section 67.
    On July 13, 2018, the Treasury Department and the IRS issued Notice 
2018-61, 2018-31 I.R.B. 278, announcing that proposed regulations would 
be issued concerning the effect of section 67(g) on the deductibility 
of certain expenses described in section 67(b) and (e) incurred by 
estates and non-grantor trusts. The notice states that regulations 
would clarify that expenses described in section 67(e) remain 
deductible in determining the adjusted gross income of an estate or 
non-grantor trust during the taxable years in which section 67(g) 
applies.

[[Page 27694]]

III. Section 642(h)

    Section 642(h) provides that if, on the termination of an estate or 
trust, the estate or trust has: (1) A net operating loss carryover 
under section 172 or a capital loss carryover under section 1212, or 
(2) for the last taxable year of the estate or trust, deductions (other 
than the deductions allowed under section 642(b) (relating to the 
personal exemption) or section 642(c) (relating to charitable 
contributions)) in excess of gross income for such year, then such 
carryover or such excess shall be allowed as a deduction, in accordance 
with the regulations prescribed by the Secretary of the Treasury or his 
delegate, to the beneficiaries succeeding to the property of the estate 
or trust.
    Net operating loss and capital loss carryovers under section 
642(h)(1) are used to compute adjusted gross income on the return of a 
beneficiary, formerly referred to as an above-the-line deduction. See 
Sec.  1.642(h)-1. The excess deduction under section 642(h)(2) is not, 
however, used to compute adjusted gross income on the return of a 
beneficiary. Instead, Sec.  1.642(h)-2(a) provides that the section 
642(h)(2) excess deduction is ``allowed only in computing taxable 
income and must be taken into account in computing the items of tax 
preference of beneficiaries; it is not allowed in computing adjusted 
gross income.'' As a result, under the existing regulations, excess 
deductions on termination of an estate or trust are treated as a single 
miscellaneous itemized deduction (section 642(h)(2) excess deduction) 
of the beneficiary subject to disallowance under section 67(g). See 
also sections 63(d) and 67(b).
    The section 642(h)(2) excess deduction may be comprised of several 
types of deductions including: (1) Those deductions allowable in 
arriving at adjusted gross income under sections 62 and 67(e); (2) 
itemized deductions under section 63(d) allowable in computing taxable 
income; and (3) miscellaneous itemized deductions currently disallowed 
under section 67(g). See section 67(b). Notice 2018-61 explained that 
the Treasury Department and the IRS were studying whether section 67(e) 
deductions, as well as other deductions not subject to the limitations 
imposed by sections 67(a) and (g) in the hands of the estate or trust, 
should continue to be treated as miscellaneous itemized deductions when 
included as a section 642(h)(2) excess deduction.
    Notice 2018-61 requested 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 on the termination of an estate 
or trust considering section 642(h) and Sec.  1.642(h)-2(a) and 
expressed the intent to address this issue in regulations. The Treasury 
Department and the IRS requested comments regarding whether the 
separate deductions comprising the section 642(h)(2) excess deduction, 
such as section 67(e) deductions, should be analyzed separately when 
applying section 67.
    The Treasury Department and the IRS received comments addressing 
issues concerning section 67(e), as well as excess deductions on 
termination of an estate or trust under section 642(h), as discussed in 
more detail in the Explanation of Provisions section of this preamble. 
All comments were considered and are available for public inspection. 
The Treasury Department and the IRS continue to study issues related to 
sections 67 and 642 that are beyond the scope of these proposed 
regulations and may discuss those comments in future guidance.

Explanation of Provisions

I. Section 1.67-4

    Commenters agreed with the statements in Notice 2018-61 that 
deductions described in section 67(e)(1) and (2) are not miscellaneous 
itemized deductions subject to disallowance by section 67(g) and asked 
that the language in Sec.  1.67-4 be amended to clarify this position. 
This document contains proposed regulations amending Sec.  1.67-4 to 
clarify that section 67(g) does not deny an estate or non-grantor trust 
(including the S portion of an electing small business trust) a 
deduction for expenses described in section 67(e)(1) and (2) because 
such deductions are allowable in arriving at adjusted gross income and 
are not miscellaneous itemized deductions under section 67(b).
    One commenter asked that the regulations address the treatment of 
expenses and deductions described in section 67(e)(1) and (2) in 
determining an estate or non-grantor trust's income for alternative 
minimum tax (AMT) purposes. The commenter requested that regulations 
provide that such expenses and deductions continue to be deductible for 
AMT purposes. The treatment of expenses and deductions described in 
section 67(e) for purposes of determining AMT is outside the scope of 
these proposed regulations concerning the effects of section 67(g); 
therefore, these proposed regulations do not address the AMT.

II. Regulations Under Section 642(h)

A. Character and Amount of the Excess Deductions
    Commenters opined that the Treasury Department and the IRS have and 
should exercise their regulatory authority not to treat the section 
642(h)(2) excess deduction as a single miscellaneous itemized 
deduction. Commenters noted that the regulations under Sec.  1.642(h)-2 
were written before the concept of miscellaneous itemized deductions 
was added to the Code and need to be updated.
    In response to the request for comments in Notice 2018-61 
concerning analysis of the separate deductions that comprise the 
section 642(h)(2) excess deduction, commenters stated that the Treasury 
Department and the IRS should provide regulations for the segregation 
of the section 642(h)(2) excess deduction into its components to 
determine the character, computation, and deductibility of costs. One 
commenter said that failure to provide for such segregation could 
result in either the prolonged administration of estates or trusts, or 
the sale of assets, to fully utilize deductible costs at the estate or 
trust level. Another commenter stated that the portion of the section 
642(h)(2) excess deduction that qualifies as section 67(e)(1) expenses 
should remain deductible in arriving at a beneficiary's adjusted gross 
income and that the remaining section 642(h)(2) excess deduction should 
be treated as a single itemized deduction, which would avoid having to 
further separate out the individual costs comprising the excess 
deduction to determine deductibility at the beneficiary level. Other 
commenters proposed treating the section 642(h)(2) excess deduction as 
allowable in full in arriving at the beneficiary's adjusted gross 
income similar to the treatment of a section 67(e) deduction.
    Another commenter requested more specific guidance on the character 
of the excess deductions. The commenter recommended that the fiduciary 
be required to separate deductions into at least three categories: (1) 
Deductions allowed in arriving at adjusted gross income, (2) non-
miscellaneous itemized deductions, and (3) miscellaneous itemized 
deductions. This commenter stated that the character of the deductions 
should not change when succeeded to by the beneficiaries on termination 
of the estate or trust. Further, the commenter suggested that 
regulations require that deductions subject to limitation when claimed 
by a beneficiary be separately identified (for example, the limitation 
on state and local property and income tax

[[Page 27695]]

deductions under section 164(b)(6)). The commenter also requested 
guidance on how each item of deduction offsets items of income of the 
estate or trust in the final year of administration for purposes of 
determining the character of the excess deductions. The character of 
the excess deductions will vary based on how an executor or trustee 
allocates deductions against the income of the estate or trust. The 
same commenter suggested that the rules under Sec.  1.652(b)-3, which 
are used for determining the character of distributable net income to 
beneficiaries under sections 652 and 662, be used as a model to 
determine how deductions are allocated to offset income in the final 
year of administration of the estate or trust for purposes of 
determining the character of the section 642(h)(2) excess deduction.
    The Treasury Department and the IRS adopt the more specific 
suggestion from commenters of preserving the tax character of the three 
categories of expenses, rather than the suggestion of grouping all non-
section 67(e) expenses together, to allow for such expenses to be 
separately stated and to facilitate reporting to beneficiaries. Thus, 
under these proposed regulations, each deduction comprising the section 
642(h)(2) excess deduction retains its separate character, 
specifically: As an amount allowed in arriving at adjusted gross 
income; a non-miscellaneous itemized deduction; or a miscellaneous 
itemized deduction. The character of these deductions does not change 
when succeeded to by a beneficiary on termination of the estate or 
trust. Further, these proposed regulations require that the fiduciary 
separately state (that is, separately identify) deductions that may be 
limited when claimed by the beneficiary as provided in the instructions 
to Form 1041, U.S. Income Tax Return for Estates and Trusts and the 
Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, 
Credit, etc.
    The proposed regulations adopt the suggestion that the principles 
under Sec.  1.652(b)-3 be used to allocate each item of deduction among 
the classes of income in the year of termination for purposes of 
determining the character and amount of the excess deductions under 
section 642(h)(2). Section 1.652(b)-3(a) provides that deductions 
directly attributable to one class of income are allocated to that 
income. Any remaining deductions that are not directly attributable to 
a specific class of income, as well as any deductions that exceed the 
amount of directly attributable income, may be allocated to any item of 
income (including capital gains), but a portion must be allocated to 
tax-exempt income, if any. See Sec.  1.652(b)-3(b) and (d). The 
proposed regulations provide that the character and amount of each 
deduction remaining after application of Sec.  1.652(b)-3 comprises the 
excess deductions available to the beneficiaries succeeding to the 
property as provided under section 642(h)(2).
    These proposed regulations incorporate a new example to illustrate 
the rule for determining the character of excess deductions in proposed 
Sec.  1.642(h)-2. The proposed regulations also update the current 
example in Sec.  1.642(h)-5 to account for changes in the Code since 
this example was last modified on June 16, 1965, in T.D. 6828, 1965-2 
C.B. 264.
B. Allocation of the Excess Deduction Among Beneficiaries
    One commenter requested guidance on allocating the excess 
deductions among multiple beneficiaries and suggested that the 
allocation could be made generally, in proportion to the entire amount 
of deductions, or specifically, based on the burden the beneficiary 
bears as to each deduction. The commenter noted, however, that a 
specific allocation may increase fiduciary reporting and IRS 
administrative burdens and may not be worth the added complexity.
    Existing regulations under Sec.  1.642(h)-4 provide that carryovers 
and excess deductions to which section 642(h) applies are allocated 
among the beneficiaries succeeding to the property of an estate or 
trust proportionately according to the share of each in the burden of 
the loss or deduction. A person who qualifies as a beneficiary 
succeeding to the property of an estate or trust with respect to one 
amount and who does not qualify with respect to another amount is a 
beneficiary succeeding to the property of the estate or trust as to the 
amount with respect to which the beneficiary qualifies. These proposed 
regulations do not change the allocation method among beneficiaries set 
forth in Sec.  1.642(h)-4.
    One commenter asked that the Treasury Department and the IRS 
address the treatment of suspended deductions on the termination of a 
trust, such as those under section 163(d) for investment interest, and 
asked that such suspended deductions be treated in the same manner as 
the excess deduction under section 642(h). While the Treasury 
Department and the IRS acknowledge the comment, addressing suspended 
deductions under section 163(d) and other Code sections is beyond the 
scope of these proposed regulations.

Proposed Applicability Date

    These proposed regulations apply to taxable years beginning after 
the date these regulations are published as final regulations in the 
Federal Register. However, estates, non-grantor trusts, and their 
beneficiaries may rely on these proposed regulations under section 67 
for taxable years beginning after December 31, 2017, and on or before 
the date these regulations are published as final regulations in the 
Federal Register. Taxpayers may also rely on the proposed regulations 
under section 642(h) for taxable years of beneficiaries beginning after 
December 31, 2017, and on or before the date these regulations are 
published as final regulations in the Federal Register in which an 
estate or trust terminates.
    One commenter asked that the Treasury Department and the IRS 
clarify that expenses incurred during an estate's fiscal year beginning 
before January 1, 2018, which properly are characterized as 
miscellaneous itemized deductions, remain deductible as such even if 
some of the costs were paid after January 1, 2018. Section 67(g) 
applies to taxable years beginning after December 31, 2017; therefore 
section 67(g) would not apply to an estate's or trust's taxable years 
beginning before that date.

Special Analyses

    This regulation is not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations. Therefore, a regulatory 
impact assessment is not required.
    Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it 
is hereby certified that these regulations will not have a significant 
economic impact on a substantial number of small entities. This 
certification is based on the fact that the amount of time necessary to 
report the required information will be minimal in that it requires 
fiduciaries of estates and trusts to provide information already 
maintained and reported to the IRS on Form 1041, on the Schedule K-1 
(Form 1041) issued to beneficiaries. Moreover, it should take an estate 
or trust no more than 2 hours to satisfy the information requirement in 
these regulations. Pursuant to section 7805(f) of the Code, this notice 
of proposed rulemaking has been submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small businesses.

[[Page 27696]]

Paperwork Reduction Act

    The collection of information related to these proposed regulations 
under section 642(h) is reported on Schedule K-1 (Form 1041), 
Beneficiary's Share of Income, Deductions, Credits, etc., and has been 
reviewed in accordance with the Paperwork Reduction Act (44 U.S.C. 
3507) and approved by the Office of Management and Budget under control 
number 1545-0092. Comments concerning the collection of information and 
the accuracy of estimated average annual burden and suggestions for 
reducing this burden should be sent to the Office of Management and 
Budget, Attn: Desk Officer for the Department of the Treasury, Office 
of Information and Regulatory Affairs, Washington, DC 20503, with 
copies to the Internal Revenue Service, IRS Reports Clearance Officer, 
SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the burden 
associated with this collection of information must be received by July 
10, 2020.
    The collection of information in these proposed regulations is in 
proposed Sec.  1.642(h)-2(b)(1). The IRS requires this information to 
ensure that excess deductions on an estate's or trust's termination 
that are subject to additional applicable limitations retain their 
character when taken into account by beneficiaries on their returns. 
The respondents will be estates, trusts and their fiduciaries.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a valid 
control number assigned by the Office of Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by section 6103.

Comments and Requests for Public Hearing

    Before these proposed amendments to the regulations are adopted as 
final regulations, consideration will be given to comments that are 
submitted timely to the IRS as prescribed in the preamble under the 
ADDRESSES section. The Treasury Department and the IRS request comments 
on all aspects of the proposed regulations. Any electronic comments 
submitted, and to the extent practicable any paper comments submitted, 
will be made available at www.regulations.gov or upon request.
    A public hearing will be scheduled if requested in writing by any 
person who timely submits electronic or written comments. Requests for 
a public hearing are also encouraged to be made electronically. If a 
public hearing is scheduled, notice of the date and time for the public 
hearing will be published in the Federal Register. Announcement 2020-4, 
2020-17 IRB 1, provides that until further notice, public hearings 
conducted by the IRS will be held telephonically. Any telephonic 
hearing will be made accessible to people with disabilities.

Drafting Information

    The principal author of these proposed regulations is Margaret 
Burow of the Office of Associate Chief Counsel (Passthroughs and 
Special Industries). Other personnel from the Treasury Department and 
the IRS, however, participated in their development.

Statement of Availability of IRS Documents

    The IRS notice cited in this document is published in the Internal 
Revenue Bulletin and available from the Superintendent of Documents, 
U.S. Government Publishing Office, Washington, DC 20402, or by visiting 
the IRS website at https://www.irs.gov.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding an 
entry for Sec.  1.67-4 and an entry for Sec. Sec.  1.642(h)-2 and 
1.642(h)-5 in numerical order to read in part as follows:

    Authority:  26 U.S.C. 7805 * * *
    Section 1.67-4 also issued under 26 U.S.C. 67(e).
* * * * *
    Sections 1.642(h)-2 and 1.642(h)-5 also issued under 26 U.S.C. 
642(h).
* * * * *
0
Par. 2. Section 1.67-4 is amended by revising paragraph (a) and the 
heading of paragraph (d) and adding a sentence at the end of paragraph 
(d) to read as follows:


Sec.  1.67-4  Costs paid or incurred by estates or non-grantor trusts.

    (a) In general--(1) Section 67(e) deductions. (i) An estate or 
trust (including the S portion of an electing small business trust) not 
described in Sec.  1.67-2T(g)(1)(i) (a non-grantor trust) shall compute 
its adjusted gross income in the same manner as an individual, except 
that the following deductions (Section 67(e) deductions) are allowed in 
arriving at adjusted gross income:
    (A) Costs that are paid or incurred in connection with the 
administration of the estate or trust, which would not have been 
incurred if the property were not held in such estate or trust; and
    (B) Deductions allowable under section 642(b) (relating to the 
personal exemption) and sections 651 and 661 (relating to 
distributions).
    (ii) Section 67(e) deductions are not itemized deductions under 
section 63(d) and are not miscellaneous itemized deductions under 
section 67(b). Therefore, section 67(e) deductions are not disallowed 
under section 67(g).
    (2) Deductions subject to 2-percent floor. A cost is not a section 
67(e) deduction and thus is subject to both the 2-percent floor in 
section 67(a) and section 67(g) to the extent that it is included in 
the definition of miscellaneous itemized deductions under section 
67(b), is incurred by an estate or non-grantor trust (including the S 
portion of an electing small business trust), and commonly or 
customarily would be incurred by a hypothetical individual holding the 
same property.
* * * * *
    (d) Applicability date. * * * Paragraph (a) of this section applies 
to taxable years beginning after [date these regulations are published 
as final in the Federal Register].

0
Par. 3. Section 1.642(h)-2 is amended by:
0
1. Revising paragraph (a).
0
2. Redesignating paragraph (b) as paragraph (d) and adding a heading 
for newly redesignated paragraph (d).
0
3. Redesignating paragraph (c) as paragraph (e) and adding a heading 
for newly redesignated paragraph (e).
0
4. Adding new paragraphs (b), (c), and (f).
    The revisions and additions read as follows:


Sec.  1.642(h)-2  Excess deductions on termination of an estate or 
trust.

    (a) In general. If, on the termination of an estate or trust, the 
estate or trust has for its last taxable year deductions (other than 
the deductions allowed under section 642(b) (relating to the personal 
exemption) or section 642(c) (relating to charitable contributions)) in 
excess of gross income, the excess deductions are allowed under section 
642(h)(2) as items of deduction to the beneficiaries succeeding to the 
property of the estate or trust.

[[Page 27697]]

    (b) Character and amount of excess deductions--(1) Character. The 
character and amount of the excess deductions on termination of an 
estate or trust will be determined as provided in this paragraph (b). 
Each deduction comprising the excess deductions under section 642(h)(2) 
retains, in the hands of the beneficiary, its character (specifically, 
as allowable in arriving at adjusted gross income, as a non-
miscellaneous itemized deduction, or as a miscellaneous itemized 
deduction) while in the estate or trust. An item of deduction succeeded 
to by a beneficiary remains subject to any additional applicable 
limitation under the Code and must be separately stated if it could be 
so limited, as provided in the instructions to Form 1041, U.S. Income 
Tax Return for Estates and Trusts and the Schedule K-1 (Form 1041), 
Beneficiary's Share of Income, Deductions, Credit, etc., or successor 
forms.
    (2) Amount. The amount of the excess deductions in the final year 
is determined as follows:
    (i) Each deduction directly attributable to a class of income is 
allocated in accordance with the provisions in Sec.  1.652(b)-3(a);
    (ii) To the extent of any remaining income after application of 
paragraph (b)(2)(i) of this section, deductions are allocated in 
accordance with the provisions in Sec.  1.652(b)-3(b) and (d); and
    (iii) Deductions remaining after the application of paragraph 
(b)(2)(i) and (ii) of this section comprise the excess deductions on 
termination of the estate or trust. These deductions are allocated to 
the beneficiaries succeeding to the property of the estate of or trust 
in accordance with Sec.  1.642(h)-4.
    (c) Year of termination--(1) In general. The deductions provided 
for in paragraph (a) of this section are allowable only in the taxable 
year of the beneficiary in which or with which the estate or trust 
terminates, whether the year of termination of the estate or trust is 
of normal duration or is a short taxable year.

    (2) Example. Assume that a trust distributes all its assets to B 
and terminates on December 31, Year X. As of that date, it has 
excess deductions of $18,000, all characterized as allowable in 
arriving at adjusted gross income under section 67(e). B, who 
reports on the calendar year basis, could claim the $18,000 as a 
deduction allowable in arriving at B's adjusted gross income for 
Year X. However, if the deduction (when added to B's other 
deductions) exceeds B's gross income, the excess may not be carried 
over to any year subsequent to Year X.

    (d) Net operating loss carryovers. * * *
    (e) Items included in net operating loss or capital loss 
carryovers. * * *
    (f) Applicability date. Paragraphs (a) and (b) of this section 
apply to taxable years beginning after [date these regulations are 
published as final in the Federal Register].
    Par. 4. Section 1.642(h)-5 is revised to read as follows:

Sec.  1.642(h)-5 Examples.

    The following examples illustrate the application of section 
642(h).

    (a) Example 1. Computations under section 642(h) when an estate 
has a net operating loss--(1) Facts. On January 31, 2020, A dies 
leaving a will that provides for the distribution of all of A's 
estate equally to B and an existing trust for C. The period of 
administration of the estate terminates on December 31, 2020, at 
which time all the property of the estate is distributed to B and 
the trust. For tax purposes, B and the trust report income on a 
calendar year basis. During the period of administration, the estate 
has the following items of income and deductions:

                       Table 1 to Paragraph (a)(1)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Income
Taxable interest......................................            $2,500
Business income.......................................             3,000
                                                                --------
    Total income......................................             5,500
                                                                ========
------------------------------------------------------------------------


                       Table 2 to Paragraph (a)(1)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Deductions
Business expenses (including administrative expense       5,000
 allocable to business income)........................
Administrative expenses not allocable to business         9,800
 income that would not have been incurred if property
 had not been held in a trust or estate (section 67(e)
 deductions)..........................................
                                                       ---------
    Total deductions..................................            14,800
------------------------------------------------------------------------

    (2) Computation of net operating loss. (i) Under section 
642(h)(1), B and the trust are each allocated $1,000 of the $2,000 
unused net operating loss carryover of the terminated estate in the 
taxable year, with the allowance of any net operating loss and loss 
carryover to B and the trust determined under section 172. The 
amount of the net operating loss carryover is computed as follows:

                     Table 3 to Paragraph (a)(2)(i)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Gross income..........................................            $5,500
Total deductions......................................   14,800
  Less adjustment under section 172(d)(4) (allowable      7,300
   non-business expenses ($9,800) limited to non-
   business income ($2,500))..........................
                                                       ---------
Deductions as adjusted................................             7,500
                                                                ========
    Net operating loss................................             2,000
------------------------------------------------------------------------

    (ii) Neither B nor the trust can carry back any of the net 
operating loss of A's estate made available to them under section 
642(h)(1).
    (3) Section 642(h)(2) excess deductions. The $7,300 of 
deductions not taken into account in determining the net operating 
loss of the estate are excess deductions on termination of the 
estate under section 642(h)(2). Under Sec.  1.642(h)-2(b)(1), such 
deductions retain their character as section 67(e) deductions. Under 
Sec.  1.642(h)-4, B and the trust each are allocated $3,650 of 
excess deductions based on B's and the trust's respective shares of 
the burden of each cost.
    (4) Consequences for C. The net operating loss carryovers and 
excess deductions are not allowable directly to C, the trust 
beneficiary. To the extent the distributable net income of the trust 
is reduced by the carryovers and excess deductions, however, C may 
receive an indirect benefit from the carryovers and excess 
deductions.
    (b) Example 2. Computations under section 642(h)(2)--(1) Facts. 
D dies in 2019 leaving an estate of which the residuary legatees are 
E (75%) and F (25%). The estate's income and deductions in its final 
year are as follows:

                       Table 4 to Paragraph (b)(1)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Income
Dividends.............................................   $3,000
Taxable Interest......................................      500
Rents.................................................    2,000
Capital Gain..........................................    1,000
                                                       ---------
    Total Income......................................             6,500
------------------------------------------------------------------------


                       Table 5 to Paragraph (b)(1)
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Deductions
Section 67(e) deductions:
  Probate fees........................................    1,500
  Estate tax preparation fees.........................    8,000
  Legal fees..........................................    4,500
                                                       ---------
    Total Section 67(e) deductions....................   14,000
Itemized deductions:
  Real estate taxes on rental property................    3,500
        Total deductions..............................            17,500
------------------------------------------------------------------------

    (2) Determination of character. Pursuant to Sec.  1.642(h)-
2(b)(2), the character and amount of the excess deductions is 
determined by allocating the deductions among the estate's items of 
income as provided under

[[Page 27698]]

Sec.  1.652(b)-3. Under Sec.  1.652(b)-3(a), $2,000 of real estate 
taxes is allocated to the $2,000 of rental income. In the exercise 
of the executor's discretion pursuant to Sec.  1.652(b)-3(b) and 
(d), D's executor allocates $4,500 of section 67(e) deductions to 
the remaining $4,500 of income. As a result, the excess deductions 
on termination of the estate are $11,000, consisting of $9,500 of 
section 67(e) deductions and $1,500 of itemized deductions.
    (3) Allocations among beneficiaries. Pursuant to Sec.  1.642(h)-
4, the excess deductions are allocated in accordance with E's (75 
percent) and F's (25 percent) interests in the residuary estate. E's 
share of the excess deductions is $8,250, consisting of $7,125 of 
section 67(e) deductions and $1,125 of real estate taxes. F's share 
of the excess deductions is $2,750, consisting of $2,375 of section 
67(e) deductions and $375 of real estate taxes. The real estate 
taxes on rental property must be separately stated as provided in 
Sec.  1.642(h)-2(b)(1).

    (c) Applicability date. This section is applicable to taxable years 
beginning after [date these regulations are published as final in the 
Federal Register].

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2020-09801 Filed 5-7-20; 4:15 pm]
 BILLING CODE 4830-01-P