Pub. 2 2020 Issue 6

N O V E M B E R / D E C E M B E R 2 0 2 0 12 nebraska cpas PROPOSED REGS CLARIFY EXCESS DEDUCTIONS ON FORM 1041 & THE YEAR OF THE ENTITY’S TERMINATION BY SHARON KREIDER, CPA AND MARY KAY FOSS , CPA C P A I N S I D E R At a Glance: • Proposed regs clarify treatment of “excess deductions” at the termination of an estate or non-grantor trust. • Conf licting instructions abounded for 2018 Forms 1041 K1 and 1040 Schedule A. Practitioners report even software vendors were muddying the waters. • IRS response to conf lict between instructions: “We’re working on it.” • Proposed regulations clarify two items: administration expenses and excess deductions. • The proposed regulations are very favorable. Section 642(h) allows beneficiaries succeeding to an estate or trust property to deduct the carryover or excess if, upon termination, the estate or trust has: 1) a net operating loss carryover or a capital loss carryover; or 2) deductions for its last tax year that exceed gross income for the year—otherwise known as “excess deductions.” Before the Tax Cuts and Jobs Act (TCJA), excess deductions on termination were passed out to residuary beneficiaries on a Schedule K-1, and then deducted by the beneficiary on Schedule A as a miscellaneous itemized deduction subject to the 2% of AGI limitation. In 2018, TCJA provided that miscellaneous itemized deductions subject to the 2% limitation were not deductible. If excess deductions are miscellaneous deductions subject to the 2% limit, then excess deductions are lost to our beneficiary. Can that be right? Or was it an unintended consequence of TCJA changes? Conflicting Instructions. Someone read the instructions for the 2018 Form1041 K-1 and the instructions for the 2018 Form1040 Schedule A. The Form 1041 Schedule K-1 instructions directed the beneficiary to claim the excess deductions on Form 1040 Schedule A. The instructions for the 2018 Form 1040 Schedule A listed the miscellaneous deductions that were deductible (those not subject to the 2% limit). Excess deductions were not on the list. To confuse matters even more, practitioners reported that various software vendors were treating excess deductions differently. Some claimed a state deduction only; some were claiming a deduction for both federal and state; some were not claiming a deduction for either federal or state.