Evening view of the US Capitol building in Washington DC, USA
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A version of this article first appeared in CNBC’s Inside Wealth with Robert Frank, a weekly guide to the high net worth investor and consumer. sign up to receive upcoming programs, straight to your inbox.
The “single good credit” came with many tax benefits for high earners, despite limiting how much they could deduct. However, lawyers and accountants for the wealthy say they have found a surprise buried in the footnotes of the tax rules guidance released last week by Congressional policy staff that could be double taxation.
The deduction cap is being placed on trusts and estates, experts say, which was unexpected. Even if a trust gives all of its income to its beneficiaries, it will have to pay taxes on a portion of that income, according to their definition in the document.
While the effects are sharper for trusts and estates of the wealthiest, trusts with as little as $16,000 in income could also be subject to additional taxes, experts said.
“There may be an element of double taxation,” said Dan Griffith, director of wealth planning at Huntington Bank. “This is something that’s going to affect a $400,000 special needs person. It’s not just going to be a $100 million dollar thing.”
Griffith said he is particularly concerned about trusts that are responsible for distributing all of their money. Trusts will have to sell assets to pay taxes, provide future investment returns, or reduce their distributions to beneficiaries, he said.
This provision creates a “mathematical nightmare” for tax attorneys and financial advisors, according to Justin Miller, national director of wealth planning at Evercore Wealth Management. Miller gave the example of a wealthy couple who wish to leave their estate to charity.
“If I have to pay income tax, that means I’m giving less money to charity because I’m giving money to the IRS. That means now I have to adjust my deductions more because less money will go to charity,” he said. “Did Congress intend to create an algebraic formula?”
Historically, trusts and estates have been able to deduct the income given to beneficiaries, and tax them at the individual level. This distributional deduction is designed to make sure that the income is tax-free only once.
However, the new deduction limit for high earners now applies to trusts and estates, according to a footnote in the Joint Committee on Taxation’s latest tax guide, better known as the Bluebook. The JCT is impartial and works to interpret the law.
The One Big Beautiful Bill Act’s limit on itemized deductions means that taxpayers in the highest brackets only get a deduction of 35 cents per dollar, instead of 37 cents. It works on the holdings of charities, and experts say it has had an impact on how high earners give.
Although the Bluebook is an explanation of the OBBBA rather than a law in itself, this provision is causing concern in the financial advisory community, according to Robert Keebler, a certified public accountant. For example, he often sets up trusts for clients in their second marriages that will provide income to their surviving spouses but leave it to the children of the first marriage.
Imagine a trust that distributes all $370,000 of income to a widow, he said. Applying the deduction limit to trusts means the trust can only deduct $350,000 of distributed income and $20,000 will be taxed, although the widow is taxed on the entire $370,000, according to Keebler. To pay the tax, the trust must enter its commission, reduce the children’s future benefits, or get permission to give less to your spouse, which may require going to court.
This offer applies to this tax year, according to Keebler.
The issue of double taxation can be resolved by an amendment by Congress, or, possibly, by guidance from the Treasury Department. Keebler eagerly plans for it to stop.
“We hope for the best but plan for the worst,” he said.
The Treasury Department did not respond to CNBC’s questions by press time.
Miller said it is “reasonable to hope” that the Treasury Department will issue guidance by the end of this year. However, the devil will be in the details when the department decides to limit the deductions, he said.
For example, the department could allow trusts to hold unlimited amounts from distributing income to beneficiaries such as family members, which would solve a major problem for financial advisers, Miller said. A footnote in the Bluebook mentions this catch.
But Miller noted that the Bluebook’s footnotes do not address deductions for contributions to trusts and estates. He told CNBC that he thinks the omission was intentional and that the Treasury Department is likely to maintain the limit on charitable donations to trusts and estates.
A person familiar with JCT procedures told CNBC that staff interpreted in the OBBBA that the deduction would be treated differently from other deductions. The person spoke on condition of anonymity because he was not authorized to speak publicly on the matter.
With six months to go until the end of the year, what advisers need most is clarity, Miller said.
“We need to know the rules,” he added. “At the end of the day, counselors want to do the right thing. Right now, we don’t know what that is.”
Correction: This article has been updated to correct the work of Robert Keebler. He is a certified public accountant.
