Tax Reform: Estates and Trusts


A highlight of Congressional tax reform plans included tax benefits for pass-through entities, including partnerships, limited liability companies and S-corporations (see our website blog post of December 4, 2017 about the pass-through entity provisions). The House and Senate versions differed significantly in approach. The House bill included a rather complicated set of rules applying a maximum tax rate of 25% to a portion of an individual taxpayer’s business income from these pass-through entities. On the other hand, the Senate version granted a 23% deduction of the taxpayer’s pass-through business income and was somewhat simpler in its application. However, the Senate version denied this deduction to estates and trusts.

Ultimately, the Conference Committee chose the Senate structure, but surprisingly, and happily, extended its relief to estates and trusts. The reconciliation agreement settled on a 20% deduction rather than its original 23% deduction. Thus, an estate or trust would be able to deduct up to 20% of business income it receives from pass-through entities. This deduction will be especially valuable to estates and trusts with their compressed tax brackets that reach the maximum tax bracket quickly. Also, individual beneficiaries that receive distributions from an estate or trust that include pass-through business income would likewise be entitled to this new deduction. This deduction applies to tax years 2018 through 2025.

The tax rules that apply to estates and trusts that own S-corporation pass-throughs are already somewhat complicated and are now made somewhat more so due to the new pass-through tax rules. It is not clear, for instance, whether Electing Small Business Trusts (ESBTs) holding S-corporation stock will be entitled to the new deduction in view of the unique tax regime applicable to these ESBTs (see our website blog post of November 21, 2017 about ESBT v QSST). Hopefully, a technical corrections act will follow the enactment of tax reform to clarify uncertainties.

Speaking of ESBTs, the new law allows an ESBT to have non-resident beneficiaries and clarifies that the individual charitable contribution deduction limits apply to ESBTs rather than the estate and trust charitable deduction provisions of Section 642(c).

Estate Tax Exemption

While there was an effort toward a wholesale repeal of the estate tax during the tax reform proceedings, ultimately, the estate tax, along with the gift tax and the generation-skipping transfer tax have been retained. However, the exemption amount for all three taxes will be doubled for decedents dying, and gifts made, after 2017 through 2025. This would put the exemption at $11.2 million for 2018, and double that for a married couple. After 2025, the exemption will revert to the current exemption amount which would be $5.6 million in 2018 (indexed for inflation to 2025).

The new law would also protect the tax benefit of gifts made during the period of the increased exemption. Therefore, in view of the return of the lower exemption in 2026, it may be wise for taxpayers to make gifts up to the new exemption amount before 2026.

Also, the step-up in tax basis for property received from a decedent is retained.

Tax Rates & Exemptions

Estates and Trusts are still subject to the current highly compressed tax brackets under tax reform, but the applicable tax rates are generally reduced through 2025. The current 15% rate bracket will fall to 10%, the 25% and 28% brackets go to 24%, the current 33% bracket actually increases to 35% and the maximum 39.6% bracket is reduced to 37%. The taxes on capital gains and qualified dividends for estates and trusts will be slightly better than under current law with a new zero bracket break point at $2,600 and a 15% capital gain break point set to be $12,700. For taxable income in excess of these limits, capital gains and qualified dividends will be taxed at 20% for estates and trusts. It continues to make tax sense for estates and trusts to consider making distributions to carry DNI to individual beneficiaries with much more favorable tax brackets. The tax rate changes apply to 2018 through 2025.

While individual exemptions will be repealed by tax reform, the modest exemptions available to estates and trusts under current law will remain under the new tax plan. In addition, the alternative minimum tax, its current exemption and the exemption phase out amounts will continue at the same levels.

State & Local Taxes

For tax years 2018 through 2025, the Conference agreement disallows deductions for state and local taxes except for an amount up to $10,000 thereof (inclusive of property and income or sales taxes). Such taxes paid or incurred in a trade or business operated by the estate or trust (or a pass-through entity owned by the estate or trust) continue to be deductible.