The Joint Committee on Taxation released a tax law guide last week, clarifying that the deduction limit established by the One Big Beautiful Bill Act applies to trusts and estates. The guide's footnote states that the new deduction limitation is applicable to these entities for the current tax year.
Historically, trusts and estates have deducted income distributed to beneficiaries to ensure the income is taxed only at the individual level. The One Big Beautiful Bill Act limits itemized deductions for taxpayers in the top bracket to 35 cents for every dollar and applies to charitable deductions.
Dan Griffith, a wealth strategy director, said, "There is potentially an element of double taxation. This is something that is going to affect somebody with a $400,000 special-needs trust. It is not just going to be something that $100 million dynasty trusts suffer with." Griffith said, "Trusts will either have to sell assets to pay the taxes, sacrificing future investment returns, or reduce their distributions to beneficiaries."
Robert Keebler, an attorney, explained that applying the deduction limit to a trust distributing $370,000 in net income would necessitate the trust deducting only $350,000 and paying taxes on the remaining $20,000. He said that to pay the resulting tax, a trust would either have to reduce its principal or obtain court permission to decrease distributions to a surviving spouse. Keebler stated, "We hope for the best but plan for the worst."
Justin Miller, a wealth planning director, said, "If I have to pay income taxes, that means I am giving less money to charity because I am giving money to the Internal Revenue Service. That means I now have to adjust my deduction even more because less money is going to charity. Did Congress really intend to create an algebraic formula?"
The potential double taxation issue could be addressed through a Congressional amendment or guidance from the Department of the Treasury. Miller said the Treasury Department is expected to issue guidance on the provision by the end of the year. He suggested the Treasury Department could allow trusts to take unlimited deductions for distributing income to beneficiaries. Miller also stated that the guide's footnote does not mention charitable deductions for trusts and estates, and he stated that this omission may be intentional, indicating the department might maintain the limit for trusts and estates.