Final IRS Sect. 67(e) Regs for Estate and Trust Taxpayers: Applying - PowerPoint PPT Presentation

Final IRS Sect. 67(e) Regs for Estate and Trust Taxpayers: Applying the Required 2% Deduction Floor WEDNESDAY, OCTOBER 15, 2014, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Participate in the program on your own computer connection and phone line (no sharing) – if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover . Respond to verification codes presented throughout the seminar . If you have not printed out the “Official Record of • Attendance”, please print it now . (see “Handouts” tab in “Conference Materials” box on left -hand side of your computer screen). To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form . Complete and submit the “Official Record of Attendance for Continuing Education Credits,” which is available on the • program page along with the presentation materials. Instructions on how to return it are included on the form. • To earn full credit, you must remain on the line for the entire program. WHOM TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 (“star” zero) If you get disconnected during the program, you can simply call or log in using your original instructions and PIN.

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Final IRS Sect. 67(e) Regs for Estate and Trust Taxpayers Oct. 15, 2014 Tina D. Milligan Domingo P. Such, III HarrismyCFO Perkins Coie tina.milligan@harrismycfo.com dsuch@perkinscoie.com

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Final IRS Sect. 67(e) Regs for Estate and Trust Taxpayers: Applying the Required 2% Deduction Floor Domingo P. Such III, Partner Perkins Coie, Chicago Tina D. Milligan, Managing Director CTC | myCFO October 15, 2014

AGENDA 7

Agenda • Background: Court cases and Regulations prior to finalized I.R.C. Section 67(e) Regulations • Details on final Regulations • Practical examples and strategies 8

BACKGROUND 9

Evolution of the deductibility of investment advisory expenses • Section 23(a) of the Internal Revenue Code Act of 1928 – Predecessor to I.R.C. Section 162 – Trade or business expenses – Allowed deductions for both taxpayer’s trade or business and other profit -oriented expenses • Higgins v. Commissioner, 312 U.S. 212 (1941) – Ruled in favor of the IRS – Taxpayer not entitled to deduction for expenses incurred in a profit-oriented activity unless part of a trade or business – IRS revoked all prior guidance and authority permitting deduction for non-business, profit- oriented expenses • Section 23(a)(2) of the Internal Revenue Code (1942) – predecessor to I.R.C. Section 212 – Expenses for production of income 10

Overview of I.R.C. Section 212 • I.R.C. Section 212 – Deduction for all ordinary and necessary expenses paid or incurred during the taxable year: • For the production or collection of income; • For the management, conservation, or maintenance of property held for the production of income; or • In connection with the determination, collection or refund of any tax – Deductions are not included on the I.R.C. Section 67(b) list of non-miscellaneous deductions – Generally permits deductions for expenses, such as fiduciary fees, incurred in connection with the administration of an estate or trust. – Classifies trust or estate administration expenses, if not allowed in computing AGI under I.R.C. Sections 62(a) or 67(c), as miscellaneous itemized deductions subject to the 2% of AGI floor 11

Overview of I.R.C. Section 67 • Section 67(a) – Taxpayer’s “miscellaneous itemized deductions” may be deducted only to the extent such expenses exceed 2% of the taxpayer’s AGI – “2% floor” – Trusts and estate are subject to the same limitation • Section 67(b) defines “miscellaneous itemized deductions” as: – Not described in one of twelve categories of deductions listed in I.R.C. Subsections 67(b)(1)- (12) – A deduction not allowed in computing AGI, other than a personal exemption – Interest expenses under I.R.C. Section 163 are not miscellaneous itemized deductions – Certain taxes under I.R.C. Section164 are not miscellaneous itemized deductions 12

Overview of I.R.C. Section 67 • Section 67(e) will not apply to expenses paid or incurred in connection with administration of an estate or trust if would not have been incurred if the property were not held in such estate or trust. 13

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Overview of I.R.C. Section 68 • Section 68 – Reduces a taxpayer’s itemized deductions by an amount equal to the lesser of : • 3% multiplied by the excess of AGI over the applicable amount, or • 80% of the total itemized deduction otherwise allowable for such taxable year 15

Overview of I.R.C. Section 56 • Section 56 – No deduction is allowed for Section 212 expenses for purposes of AMT – Any amount deducted from AGI for miscellaneous itemized deductions will be “added back” into taxpayer’s AGI to compute AMT 16

Definition of AGI for a trust • Section 67(e) definition of AGI for a trust Gross income: All income from whatever source derived Less: Deductions • Deductions taken directly against gross income - “above the line” – Deductions that would be allowed in computing an individual’s AGI under section 62(a), » such as deductions attributable to a trade or business, or » to property held in the production of rents or royalties; – Deductions for distributions to beneficiaries under sections I.R.C. Sections 651 or 661; – Personal exemptions under I.R.C. 642(b); and – Deductions “for costs which are paid or incurred in connection with the administration of an estate or trust and which would not have been incurred if the property were not held in such trust or estate.” = Adjusted Gross Income • 17

Taxable income • Tax is imposed on “taxable income” of both individuals and trusts 1 Gross income: All income from whatever source derived Less: Deductions • Deductions taken directly against gross income - “above the line” = Adjusted Gross Income • Deductions taken from AGI - “below the line” (i.e. Investment advisory fees) = Taxable Income 18

Court cases • Split between Sixth Circuit and Fourth/Federal Circuit rulings • Knight v. Commissioner U.S. Supreme Court Decision – Knight V. Commissioner, 522 U.S. 181 (2008) – Criticized the Treasury’s interpretation of exception in Proposed Regulations – Proposed Regulations limit the Section 67(e) exception to costs which were “unique” to a trust or estate • costs that could not be incurred by an individual – The court held Treasury’s interpretation too narrow • Trust and estate expenses should not be subject to the 2% floor – if not “customarily or commonly incurred” by an individual • Even investment advisory fees could fall within the category of expenses not “customarily or commonly” incurred by individuals 19