Tax lawyers have identified a provision in Trump's 'One Big Beautiful Bill Act' that creates potential double taxation for trusts and estates, according to analysis of a tax law guide released last week by Congress' Joint Committee on Taxation. The deduction cap, which limits how much top earners can deduct, unexpectedly applies to trusts and estates, meaning trusts could pay taxes on income even after distributing it to beneficiaries who are also taxed on that income. The provision affects trusts with as little as $16,000 in income and applies to this tax year, creating what tax advisors call a 'mathematical nightmare' for wealth planning.
Deduction Cap Creates Double Taxation for Trust Income
The deduction limitation on top-earning individuals now applies to trusts and estates, according to a footnote in the Joint Committee on Taxation's Bluebook. The JCT is nonpartisan and serves to explain legislation.
Historically, trusts and estates have been able to deduct income given to beneficiaries, which is then taxed on the individual level. This distribution deduction is designed to make sure income is only taxed once.
The One Big Beautiful Bill Act's limit on itemized deductions means that taxpayers in the top bracket only get a deduction benefit of 35 cents for every dollar, rather than 37 cents.
"There is potentially an element of double taxation," said Dan Griffith, director of wealth strategy at Huntington Bank.
Lawyer Robert Keebler provided a concrete example: Consider a trust that distributes all $370,000 of its net income to a widow. Applying the deduction limit to trusts means that the trust can only deduct $350,000 from its distributable net income and $20,000 would be subject to taxes, even though the widow is taxed on the entire $370,000, according to Keebler.
Tax Lawyers Cite Impact on Special-Needs and Dynasty Trusts
"This is something that is going to affect somebody with a $400,000 special-needs trust. It's not just going to be something that $100 million dynasty trusts suffer with," Griffith said.
Griffith said he is especially concerned about trusts that are obligated to distribute all their income. Trusts will either have to sell assets to pay the taxes, sacrificing future investment returns, or reduce their distributions to beneficiaries, he said.
Justin Miller, national director of wealth planning at Evercore Wealth Management, said this provision creates a "mathematical nightmare" for tax lawyers and financial advisors. Miller gave the example of a wealthy couple wishing to leave their estate to charity.
"If I have to pay income taxes, that means I'm giving less money to charity because I'm giving money to the IRS. That means I now have to adjust my deduction even more because less money is going to charity," he said. "Did Congress really intend to create an algebraic formula?"
Treasury Department Guidance Could Address Provision
The double taxation issue could be resolved by an amendment by Congress, or, more likely, guidance from the Department of the Treasury, according to tax lawyers.
Miller said the Treasury Department might issue guidance by the end of this year. The department might allow trusts to take unlimited deductions on distributing income to beneficiaries such as family members, which would resolve the biggest concern for financial advisors, Miller said. The footnote in the Bluebook mentions this deduction.
Miller noted that the Bluebook's footnote does not mention charitable deductions for trusts and estates. He told CNBC that he thought the omission was intentional and that it is possible the Treasury will keep the deduction limit on charitable giving for trusts and estates.
A person familiar with the JCT's procedures told CNBC that staff had interpreted from the OBBBA that the charitable deduction would be treated differently from other deductions.
Keebler is planning with the anticipation that the provision will stand. "We hope for the best but plan for the worst," he said.
The Department of the Treasury did not answer CNBC's questions by press time.
FAQ
What is the double taxation issue affecting trusts in Trump's tax bill?
The deduction cap in Trump's One Big Beautiful Bill Act now applies to trusts and estates, according to the Joint Committee on Taxation's Bluebook. This means trusts can only deduct a portion of income distributed to beneficiaries, even though beneficiaries are taxed on the full amount. For example, a trust distributing $370,000 can only deduct $350,000, leaving $20,000 subject to taxes at the trust level despite the beneficiary paying taxes on the entire $370,000.
Which trusts are affected by this provision?
Tax lawyers say trusts with as little as $16,000 in income are subject to additional taxes under this provision. Dan Griffith, director of wealth strategy at Huntington Bank, stated the provision affects "somebody with a $400,000 special-needs trust" and is "not just going to be something that $100 million dynasty trusts suffer with." The provision applies to this tax year.
