Late evening view of the United States Capitol building in Washington DC, United States
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A version of this article first appeared in CNBC’s Inside Wealth newsletter with Robert Frank, a weekly guide for wealthy investors and consumers. Register to receive future editions, straight to your inbox.
The “big, nice bill” included numerous tax benefits for high earners, despite the limited amount they can deduct. However, lawyers and accountants for the wealthy said they discovered a surprise buried in the footnotes of a tax law guide released last week by congressional policy staffers that could amount to double taxation.
The deduction cap is imposed on trusts and estates, experts said, which was unexpected. Even if a trust gave all of its income to its beneficiaries, it would have to pay taxes on a portion of that income, depending on their interpretation of the document.
Although the consequences would be more severe for trusts and estates of the ultra-wealthy, trusts with income of up to $16,000 would also be subject to additional taxes, experts said.
“There is potentially an element of double taxation,” said Dan Griffith, director of wealth strategy at Huntington Bank. “This is something that’s going to affect someone with a $400,000 special needs trust. It’s not just going to be something that the $100 million dynasty trusts will suffer from.”
Griffith said he was particularly concerned about trusts that are forced to distribute all of their income. Trusts will either have to sell assets to pay taxes, sacrificing 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 wanting 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?”
Historically, trusts and estates were able to deduct income paid to beneficiaries, which was then taxed at the individual level. This distribution deduction is intended to ensure that income is only taxed once.
However, the new deduction limit for higher-income individuals now applies to trusts and estates, according to a footnote in the Joint Committee on Taxation’s recent tax explanatory document, better known as the Bluebook. The JCT is non-partisan and serves to explain legislation.
The limit on itemized deductions imposed by the One Big Beautiful Bill Act means that top-bracket taxpayers only get a 35-cent deduction benefit on the dollar, instead of 37 cents. This applies to charitable deductions, and experts say it has already influenced how top earners give.
Although the Bluebook is an interpretation of the OBBBA rather than the law itself, this provision raises concerns in the financial advisory community, according to Robert Keebler, a CPA. For example, he frequently creates trusts for clients in their second marriage, which will provide income to their surviving spouse but leave the remainder to the children of the first marriage.
Consider a trust that distributes all of $370,000 of its net income to a widow, he said. Applying the deduction cap to trusts means the trust can only deduct $350,000 of its distributable net income and $20,000 would be subject to tax, even if the widow is taxed on the entire $370,000, according to Keebler. To pay the tax, the trust must either draw down on its corpus, thereby reducing the children’s future benefit, or obtain permission to give less to the spouse, which may require going to court.
This provision applies to this fiscal year, according to Keebler.
The double taxation problem could be resolved by a Congressional amendment or, more likely, by guidance from the Treasury Department. Keebler plans with the hope that this will continue.
“We hope for the best but plan for the worst,” he said.
The Treasury Department did not respond to CNBC’s questions at the time of publication.
Miller said it’s “reasonable to hope” the Treasury Department will issue guidance by the end of this year. However, the devil will be in the details of what deductions the department decides to limit, he said.
For example, the department could allow trusts to make unlimited deductions on the distribution of income to beneficiaries such as family members, which would address financial advisors’ biggest concern, Miller said. The Bluebook footnote mentions this deduction.
But Miller noted that the Bluebook footnote does not mention charitable deductions for trusts and estates. He told CNBC that he believed the omission was intentional and that it was possible that Treasury would maintain the deduction cap on charitable donations for trusts and estates.
A person familiar with JCT procedures told CNBC that staff interpreted OBBBA that the charitable deduction would be treated differently from other deductions. The person spoke on condition of anonymity because they were not authorized to speak publicly on the matter.
With six months until the end of the year, what advisors need most is clarity, Miller said.
“We just need to know the rules,” he added. “At the end of the day, councilors just want to do the right thing. Right now we don’t know what that is.”
Correction: This article has been updated to correct Robert Keebler’s profession. He is a chartered accountant.