Prior to the TCJA, the tax rate schedule for estates and trusts was as follows (inflation-adjusted for 2017):
The new tax bracket combines two brackets from the previous schedule into one, and taxes the income of the combined bracket less than the previous two brackets (24% vs. 25% and 28%), but increases the rate in one of the middle brackets. Overall, however, the TCJA causes the taxable income of estates and trusts to be taxed less.
Capital gains tax rates are also structured much differently for trusts and estates than for individuals. While individuals will benefit from the expanded zero capital gains rate up to $75,900 for joint filers and $37,950 for single filers, trusts and estates have a very compressed zero percent bracket, with only up to $2,550 taxed at a zero rate. Trusts will pay a 15% capital gains rate on gains over that amount up to $12,500 and 25% on gains exceeding $12,500. The 20% capital gains rate for individuals does not come into play until taxable gains reach $470,700 for joint filers and $418,400 for single filers. This is a significant difference in how trusts and estates are taxed versus an individual. It will be important that trustees and executors pay close attention to the activity inside of the trust where capital gains are generally recognized as well as document language which could allow some distribution of capital gains and other taxable income in certain circumstances. It may be beneficial to make such distributions when documents allow for it since the tax rates could be much lower if the income can be taxed on the beneficiaries’ tax returns instead of the trust or estate return.
Like individuals, trusts and estates have the ability to deduct certain expenses in order to reduce their taxable income. Some of those expenses are similar to the miscellaneous itemized deductions which were previously allowed for individuals and are no longer allowed under the TCJA. The IRS has recently issued a notice in this area which indicates that certain costs such as trustee fees and tax return preparation fees, which were already not subject to a 2% floor, will continue to be deductible by trusts and estates. These costs are generally considered expenses which are incurred by an estate or trust and that would not have been incurred if the property were not held in such estate or trust. We will continue to monitor IRS guidance in this area, but for now, it appears that certain deductions (legal fees, tax prep fees and trustee fees) will remain for trusts and estates, while those such as investment advisor fees will be eliminated just as they are for individuals.