Changing 1041's Ways: TCJA's Effect on Fiduciary Income Tax.

• Author: Downs, William
• Position: Regulatory update

the Tax Cuts and Jobs Act of 2017 has a fundamental impact on federal fiduciary income taxes. For tax years 2018-25, these restrictive rules will change the way Form 1041 fiduciary income tax returns work.

Two substantial changes involve the limitation on state and local tax deductions, and the elimination of deduction for miscellaneous expenses.

A complex trust that's accumulating income and not paying out income to a beneficiary may have to pay more tax, thanks to the TCJA. The limit on state and local taxes (SALT) deductions, and the elimination of most miscellaneous itemized deductions, will directly impact the bottom line on the 1041 return. A complex trust with significant amounts of those types of expenses will have more taxable income and more income tax.

But how does the TCJA affect a simple trust--or similarly, a complex trust for which the trustees have discretion and decide to pay out most or all of the accounting income? The answer: It's pretty hard to generalize.

Here are a few scenarios to demonstrate what may happen.

Cases in Point

Start with the most basic possibility, which would be a simple trust with no expenses at all. The gross income is required to be distributed to the income beneficiary, and the accounting income matches the distributable net income (DNI). With no deductions, the rules regarding SALT and miscellaneous deductions are moot.

Now change that basic example. Suppose this hypothetical simple trust has expenses for trustee fees, accounting fees and some legal fees, as well as no property taxes or miscellaneous itemized deductions. Under the Uniform Principal and Income Act (UPIA), half of those administrative expenses are required to be charged to income, and half to principal. The UPIA provision could be overruled by provisions in the trust document so be sure to read this thoroughly.

Thus, the net fiduciary accounting income will be higher than the DNI as calculated in Schedule B of Form 1041, and the beneficiary gets a reduction in income taxes. Fiduciary accounting income is higher because only half of those administrative expenses are charged to accounting income, while both halves are deductible on Form 1041. The deduction on the 1041 reduces DNI, the taxable income flowing from the trust to the beneficiary. (For a discussion of exempt income and the apportioning of expenses, see "10-4, Form 1041" in the August 2018 issue of California CPA.)

Consider a more involved example. Assume the same simple...