Specialized Returns and Taxpayers · Trust and estate income tax

Exclusions, exemptions, and deductions

The deduction side of a fiduciary return is short and unforgiving. There are only a handful of provisions, most of them have conditions that are easy to fail, and one of the figures involved has stood unchanged since 1954 while the others moved. Nothing here rewards intuition.

The rule

The exemption. $600 for an estate, $100 for a trust generally, and $300 for a trust which under its governing instrument is required to distribute all of its income currently — none of the three indexed^TY2026 (IRC § 642(b)(1) and (2)). The fourth is different: $5,300 for a taxable year beginning in 2026 — the deduction for a qualified disability trust under IRC § 642(b)(2)(C)(i), which unlike the other three exemptions is indexed^TY2026 (IRC § 642(b)(2)(C); Rev. Proc. 2025-32 § 3.35).

The distribution deductions. where the income required to be distributed currently exceeds distributable net income, the IRC § 651 deduction is limited to distributable net income — computed for this purpose without items excluded from the trust’s gross income and the deductions allocable to them^TY2026 (IRC § 651(b)) for a simple trust; a complex trust or estate deducts the income required to be distributed currently plus any other amounts properly paid, credited or required to be distributed for the year — but not more than distributable net income^TY2026 (IRC § 661(a)) for a complex trust or estate. Both are capped at distributable net income — distributable net income is the taxable income of the estate or trust with modifications — no distribution deduction, no personal exemption, capital gains allocated to corpus excluded, tax-exempt interest added back net of allocable expenses, and the IRC § 1202 exclusion disregarded^TY2026 (IRC § 643(a)).

The charitable deduction is not IRC § 170. an estate or complex trust may deduct, without limitation, any amount of *gross income* which under the terms of the governing instrument is paid during the year for a purpose specified in IRC § 170(c) — in place of the IRC § 170(a) deduction, and with an election to treat a payment made by the end of the following year as made in the earlier one^TY2026 (IRC § 642(c)(1)), and it has two conditions that are routinely missed: the deduction is available only for amounts paid pursuant to the terms of the governing instrument and only out of gross income — a payment the trustee chooses to make without instrument authority, or one traced to corpus, is not deductible at all^TY2026.

Administration costs. costs paid or incurred in connection with the administration of an estate or trust which would not have been incurred if the property were not so held are allowable in arriving at adjusted gross income, along with the exemption and the distribution deductions^TY2026 (IRC § 67(e)), which matters because no miscellaneous itemized deduction is allowed for any taxable year beginning after 31 December 2017 — so a fiduciary expense that is not within the IRC § 67(e) carve-out is not deductible at all rather than merely floored^TY2026 (IRC § 67(h)).

And no double dipping with the estate tax. amounts allowable under IRC § 2053 or § 2054 as a deduction in computing the taxable estate may not also be deducted, or offset against the sales price of property, in computing the income tax of the estate or anyone else, unless a statement waiving the estate tax deduction is filed^TY2026 (IRC § 642(g)).

Current figures

How it works in practice

The exemption identifies the trust rather than rewarding it. The figures are trivial, but which one applies tells you what kind of trust you are looking at, and examiners use it that way. A trust claiming the higher of the two ordinary figures is asserting that its instrument requires all income to be distributed currently — which is the same terms test that makes it a simple trust — so the exemption and the distribution deduction have to be consistent with each other.

The charitable deduction has no percentage limit and two hard conditions. Unlike IRC § 170 there is no ceiling by reference to a contribution base, and there is no carryover. In exchange, the payment must be made pursuant to the terms of the governing instrument and must be made out of gross income. A trustee with a general power to make distributions who chooses to benefit a charity fails the first condition; a payment traced to corpus fails the second. Both failures are total.

Note who cannot use it at all. IRC § 642(c)(1) excludes a trust meeting the specifications of subpart B — a simple trust — which is consistent, because a trust whose instrument permits charitable payments can never be simple in the first place.

The set-aside limb is narrower than the payment limb. A deduction for amounts permanently set aside rather than paid is available to an estate and to certain older trusts, but not to most trusts created after 1969. Advising a modern trust on the basis of the set-aside language is a common error.

IRC § 67(e) is what keeps a fiduciary return deductible at all. Since IRC § 67(h) removed miscellaneous itemized deductions entirely rather than merely flooring them, the question for every fiduciary expense is whether it falls within § 67(e)(1) — costs which would not have been incurred if the property were not held in an estate or trust. Trustee fees, fiduciary accounting fees and probate costs generally qualify; investment advisory fees generally do not, because an individual holding the same portfolio would have incurred them too.

Read IRC § 642(g) as an election rather than a prohibition. The same expense — a funeral cost is not deductible either way, but administration expenses and casualty losses are — may be taken against the estate tax under IRC § 2053 or § 2054, or against the income tax of the estate, but not both. The fiduciary chooses, and choosing income tax requires filing a statement waiving the estate tax deduction. Where no estate tax return is due at all, the income tax deduction is the obvious choice and the statement is still needed.

Scenarios

Traps

How this has changed

The exemptions have not moved since the 1954 Code, which is unusual enough to be worth noticing: a figure set when it was worth something now serves only to identify the type of trust. The qualified disability trust exemption, added in 2001 and tied to the personal exemption amount, is the one that moves, and it is restated annually — for 2026 by Rev. Proc. 2025-32 § 3.35.

The deduction side changed materially in 2018. IRC § 67(g), now § 67(h) after Pub. L. 119-21 § 70110(b)(2) redesignated it, suspended miscellaneous itemized deductions entirely, and Pub. L. 119-21 § 70110(a) made the suspension permanent. That threw weight onto IRC § 67(e)(1), whose scope had been settled by the Supreme Court in Knight v. Commissioner in 2008 and by regulations in 2014: the test is whether the cost would commonly or customarily have been incurred by an individual holding the same property. Regulations issued in 2020 confirmed that the § 67(e) deductions survive the suspension and that excess deductions on termination retain their character in the beneficiaries’ hands.

The charitable provisions in IRC § 642(c) have been stable, but the set-aside limb has narrowed by attrition: it has applied only to a shrinking population of trusts since the 1969 reforms, so a modern trust relying on it is almost always wrong.

Exam focus

Memorise all four exemption figures and know that only the disability trust figure is indexed. Be ready to say which exemption identifies which kind of trust.

Know the two conditions on the IRC § 642(c) deduction — pursuant to the terms of the governing instrument, and out of gross income — and that a simple trust cannot use it at all.

Know that a fiduciary takes the § 642(c) deduction “in lieu of” IRC § 170(a), so failing § 642(c) leaves no fallback.

For expenses, know the IRC § 67(e)(1) test in its own words and be able to sort common fiduciary costs by it. Trustee commissions and fiduciary accounting work generally pass; investment advisory fees generally do not.

Finally, treat IRC § 642(g) as an election requiring a waiver statement, and know it covers IRC § 2053 and § 2054 amounts and reaches offsets against sales price as well as deductions.

Check yourself

1. A trust’s instrument requires all income to be distributed currently and it makes no charitable payments. What exemption does it claim, and what does that tell an examiner?

Answer: The current-distribution figure of $300 under IRC § 642(b)(2)(B), which is available to a trust that under its governing instrument is required to distribute all of its income currently. It tells an examiner that the trust is asserting the same terms test that IRC § 651(a) uses for simple trust status — so the exemption claimed, the distribution deduction section used and the treatment of any corpus distribution all have to be consistent. Claiming $300 while deducting under IRC § 661 is a visible inconsistency.

2. A complex trust whose instrument directs the trustee to pay 10 percent of income annually to a named charity pays $40,000 to that charity, of which $12,000 is traced to a sale of corpus assets. What is deductible?

Answer: $28,000. IRC § 642(c)(1) allows a deduction for any amount of the gross income which pursuant to the terms of the governing instrument is paid for an IRC § 170(c) purpose, without limitation. The instrument condition is met for the whole payment, but the gross income condition is not: the $12,000 traced to corpus is not paid out of gross income and is not deductible. There is no IRC § 170(a) fallback, because IRC § 642(c) applies in lieu of it.

3. A trustee pays a bank $9,000 for investment management and $4,000 for fiduciary accounting and tax preparation. How much is deductible?

Answer: $4,000. IRC § 67(e)(1) allows costs paid in connection with administration which would not have been incurred if the property were not held in the trust — fiduciary accounting and tax preparation qualify, because an individual holding the same assets would not incur them. Investment management would commonly have been incurred by such an individual, so it falls outside § 67(e)(1) and is a miscellaneous itemized deduction, which IRC § 67(h) disallows entirely for years beginning after 2017.

4. An estate with no estate tax liability incurs $60,000 of administration expenses. May it deduct them on the income tax return without filing anything?

Answer: No. IRC § 642(g) denies the income tax deduction for amounts allowable under IRC § 2053 unless a statement is filed, in the time and manner the Secretary prescribes, that the amounts have not been allowed as estate tax deductions. The word is allowable, not allowed, so the bar applies even though no estate tax is payable and no benefit would have been obtained. The statement is a formality but it is a condition of the deduction.

5. Why does the IRC § 642(c) charitable deduction have no percentage limitation when the individual deduction does?

Answer: Because it operates on a different base and for a different reason. IRC § 170 limits an individual’s deduction by reference to a contribution base to prevent the deduction eliminating liability, and provides carryovers to soften that. IRC § 642(c) instead allows a fiduciary to deduct any amount of the gross income paid for a charitable purpose under the terms of the instrument — without limitation and without carryover — because the payment is not a discretionary gift by the taxpayer at all: it is the trust doing what the settlor directed with income the settlor devoted to that purpose. The two conditions replace the percentage limit as the constraint.