Trust and Estate Excess Deductions on Termination

In its final year, an estate or trust will generally have no tax liability since all income is distributed and capital gains which would ordinarily be taxed to the entity are allocated to the beneficiaries. If an estate or trust has deductions in excess of gross income in its final year, the excess deductions are allowed as deductions on the beneficiary’s tax return [Reg. §1.642(h)-2]. Charitable deductions and the personal exemption are not allowed as excess deductions. The excess deductions are taken on Schedule A of Form 1040 as miscellaneous itemized deductions subject to the 2% AGI limitation. The deduction is allowed only in the taxable year the estate or trust terminates. The beneficiary cannot carry the deduction over to the following year. A capital loss may also be distributed to the beneficiaries in the final year and deducted on Schedule D of Form 1040. A loss received from a trust or estate can be carried over by the taxpayer if not fully used in the termination year. The timing of expenses such as attorney fees should be planned so that they occur in the final year of the estate. Excess deductions in years prior to the final year are lost and cannot be carried forward (except for NOLs, capital losses, and investment interest expenses).