With Congress home for the elections, the opportunity for tax policy wins shifts to Treasury and the regulatory process. Here’s some good news on that front — Treasury’s Priority Guidance Plan unveiled this week highlights their plan to clarify the Section 68 haircut and its application to deductions particular to trusts and estates.
To recap, the new Section 68 contains a potential tax trap for trusts and estates that own S corporation shares and other assets. Our earlier piece included more detail on how we got here, but the bottom line is simple: if Section 68 applies to the deductions trusts and estates take when distributing income, a portion of their income would effectively be taxed twice.
This concern isn’t limited to large businesses. The Section 68 haircut applies to taxpayers in the top individual tax bracket only, but trusts hit that rate with just $16,000 of income, meaning the new deduction limitation can kick in very quickly for modestly sized businesses. Trusts are commonly used for succession planning for businesses of all sizes, while the process of disposing of an estate can take months or even years following the death of a business owner.
That’s why S-Corp recently urged Treasury to clarify that Section 68 does not apply to these distribution deductions. As our letter read:
The impact of this issue is particularly significant for closely held businesses (including S corporations) that are frequently owned through trust structures. Trusts play a critical role in facilitating family ownership, succession planning, and long-term stewardship of S corporation businesses. Moreover, decedent estates often own stock of S corporations when founders and other shareholders die, whether unexpectedly or otherwise. Applying the new IRC Section 68 limitation to trigger taxation of more than 100% of income would increase the effective tax burden on normal pass-through business income and undermine long-standing tax policy favoring a single level of tax for both S corporations and trusts and estates.
We’re not alone in our position. Most recently, the American Bankers Association also wrote to Treasury. As their letter notes:
ABA members serve as trustees, executors, custodians, wealth managers, and fiduciaries for trusts, estates, charitable organizations, and individual taxpayers throughout the United States. Because banks and other financial institutions administer a substantial share of fiduciary assets, prompt guidance is essential to ensure consistent application of Section 68 and to avoid unintended distortions within Subchapter J.
The ABA’s new comments are consistent with previous letters from the American College of Trust and Estate Counsel and the American Institute of Certified Public Accountants.
Getting onto Treasury’s priority list is an important step towards solving the problem. Treasury has both the opportunity and a strong case for ensuring Section 68 works as Congress intended, without creating an unintended harm to trusts, estates, and the Main Street businesses they own.