Notice 2010-29 is — Internal Revenue Bulletin 2020-45

years beginning after December 31, 2017.

Special Analyses

This regulation is not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations.

Paperwork Reduction Act

The collection of information relating to the final regulations was submitted to the Office of Management and Budget for review under OMB Control Number 15450123 in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)).

In response to the Conference Report and comments on the proposed regulations, § 1.6012-2(c)(4), as revised by the final regulations, provides that an insurance company should include the insurance company’s annual statement (as defined in § 1.6012-2(c)(5)), or a portion thereof, with an electronically filed Federal income tax return (Form 1120-L for a life insurance company and Form 1120-PC for a nonlife insurance company) as required by the applicable forms or instructions. Federal income tax items of an insurance company are determined in part based upon the insurance company’s annual statement. Providing the annual statement, or a portion thereof, to the IRS with an electronically filed Federal income tax return will allow the IRS to better and more efficiently examine an insurance company’s Federal income tax return. However, until the applicable forms or instructions are revised, the current rules for including the annual statement with an electronically filed Federal income tax return continue to apply.

For purposes of the Paperwork Reduction Act, the burden for the collection of information associated with § 1.6012-2 of the final regulations will be reflected in the burden on the Form 1120-L and in the burden on the Form 1120-PC (OMB Control Number 1545-0123) when the burden for each is revised to reflect the collection of

information associated with § 1.6012-2 of the final regulations. The respondents to the collection of information are life insurance companies that file the Form 1120-L electronically and nonlife insurance companies that file the Form 1120-PC electronically. The Treasury Department and the IRS expect to consult with the life insurance industry before making any changes to these reporting requirements.

In accordance with section 807(e)(6), as added by the TCJA, § 1.807-3 of the final regulations provides that the IRS may require reporting on Form 1120-L of the opening balance and closing balance of items described in section 807(c) (for example, life insurance reserves) and the method of computing such items for purposes of determining income. Providing this information will allow the IRS to better examine an insurance company’s Federal income tax return. However, under § 1.807-3 of the final regulations, this information is not required to be provided on any prescribed forms, such as the Form 1120-L, until the relevant prescribed forms or instructions are revised to require the reporting of such information.

For purposes of the Paperwork Reduction Act, the burden for the collection of information associated with § 1.807-3 of the final regulations will be reflected in the burden on the Form 1120-L (OMB Control Number 1545-0123) when the burden is revised to reflect the collection of information associated with § 1.807-3 of the final regulations. The respondents to the collection of information are life insurance companies that file a Form 1120L. The Treasury Department and the IRS expect to consult with the life insurance industry before making any changes to these reporting requirements.

Regulatory Flexibility Act

It is hereby certified that the final regulations will not have a significant economic impact on a substantial number of small entities pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6).

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Section 13517 of the TCJA added section 807(e)(6) to the Code. Under section 807(e)(6), the Secretary may require reporting (at such time and in such manner as the Secretary shall prescribe) with respect to the opening balances and the closing balances of reserves and with respect to the method of computing reserves for purposes of determining income. Section 1.807-3 of the final regulations allows the IRS to require the reporting of this information on any prescribed forms, such as the Form 1120-L.

The Conference Report provides that, under existing authority, the Secretary may require an insurance company to provide its annual statement via a link, electronic copy, or other similar means. See Conference Report at 478-79. Section 1.6012-2(c)(4) of the final regulations provides that an insurance company should include the insurance company’s annual statement, or a portion thereof, with an electronically filed Federal income tax return (Form 1120-L for a life insurance company and Form 1120-PC for a nonlife insurance company) as required by the applicable forms or instructions. Under current procedures, an insurance company can only electronically file a Form 1120-L or Form 1120-PC if the insurance company is part of an affiliated group filing a consolidated return, the parent of which files a Form 1120. Although data are not readily available, the Treasury Department and the IRS expect that any reporting burden associated with § 1.6012-2(c) will fall primarily on financial and insurance firms with annual receipts greater than $41.5 million and, therefore, will not affect a substantial number of small entities. See 13 CFR 121.201, sector 52 (finance and insurance).

As stated in the preceding paragraph, the rule is not expected to affect a substantial number of small entities; however, even if a substantial number of small entities were affected, the economic impact of the regulation is not likely to be significant. Section 1.807-3 of the final regulations is limited in scope to time and manner of information reporting, and any economic impact associated with this regulation is expected to be minimal. Further, the information reported to the IRS is information that the insurance company has readily available and the Treasury Department and the IRS expect

to consult with the life insurance industry before making any changes to the reporting requirements. Accordingly, the Secretary certifies that the final regulations will not have a significant economic impact on a substantial number of small entities.

Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding the Final Regulations was submitted to the Chief Counsel for the Office of Advocacy of the Small Business Administration for comment on its impact on small business, and no comments were received from the Chief Counsel for the Office of Advocacy of the Small Business Administration.

Drafting Information

The principal author of these regulations is Ian Follansbee, Office of Associate Chief Counsel (Financial Institutions and Products), IRS. However, other personnel from the Treasury Department and the IRS participated in their development.

Statement of Availability of IRS Documents

The IRS notices, revenue procedures, and revenue rulings cited in this preamble are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding a sectional authority for § 1.807-3 in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.807-3 also issued under 26 U.S.C. 807(e)(6).

Par. 2. Section 1.338-11 is amended by:

Revising paragraph (d)(2).
In paragraph (d)(3)(i), removing the language “and (d)(3)(iii)” and adding “through (iv)” in its place.
Redesignating paragraph (d)(3)(iii) as paragraph (d)(3)(iv).
Adding a new paragraph (d)(3)(iii).
Revising newly redesignated paragraph (d)(3)(iv).
Adding paragraph (d)(7)(iii). The revisions and additions read as follows:

§ 1.338-11 Effect of section 338 election on insurance company targets.

(d) * * * (2) Exception . New target is not treated as receiving additional premium under paragraph (d)(1) of this section if it is under state receivership as of the close of the taxable year for which the increase in reserves occurs.

(3) * * * (iii) Increases in section 807(c) re- serves . The positive amount with respect to the items referred to in section 807(c) other than discounted unpaid loss reserves is the sum of the net increases in such items that are required to be taken into account under section 807(f).

(iv) Increases in other reserves. The positive amount with respect to reserves other than discounted unpaid loss reserves and other items referred to in section 807(c) is the net increase of those reserves due to changes in estimate, methodology, or other assumptions used to compute the reserves (including the adoption by new target of a methodology or assumptions different from those used by old target).

(7) * * *

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(iii) Application of paragraphs (d)(2) and (3) of this section . Paragraphs (d)(2) and (3) of this section apply to taxable years beginning after October 13, 2020. For taxable years beginning on or before such date, see paragraph (d) of this section as contained in 26 CFR part 1 revised as of April 1, 2020.

§ 1.381(c)(22)-1 [Amended]

Par. 3. In § 1.381(c)(22)-1, paragraph (b)(6) is removed and reserved.

§ 1.801-2 [Amended]

Par. 4. Section 1.801-2 is amended in the second sentence by removing the language “1.801-7” and adding “1.801-6” in its place.

§ 1.801-5 [Amended]

Par. 5. In § 1.801-5, paragraph (c) is removed and reserved.

§ 1.801-7 [Removed and reserved]

Par. 6. Section 1.801-7 is removed and reserved.

§ 1.801-8 [Amended]

Par. 7. In § 1.801-8, paragraph (e) is removed and reserved.

§ 1.806-4 [Removed]

Par. 8. Section 1.806-4 is removed. Par. 9. Section 1.807-1 is revised to read as follows:

§ 1.807-1 Computation of life insurance reserves .

(a) Tax reserve method . For purposes of determining the amount of life insurance reserves for a contract under section 807(d)(1), section 807(d)(2) requires the determination of the amount of the reserve for a contract using the tax reserve method applicable to the contract. Under section 807(d)(3), the tax reserve method applicable to the contract is the Commissioners’ Reserve Valuation Method (CRVM), the Commissioners’ Annuities Reserve

Valuation Method (CARVM), or other reserve method prescribed by the National Association of Insurance Commissioners (NAIC) that applies to the contract as of the date the reserve is determined. If the NAIC has not prescribed a reserve method that covers the contract, a reserve method that is consistent with the CRVM, the CARVM, or other NAIC-prescribed method as of the date the reserve is determined (whichever is most appropriate) must be used.

(b) No asset adequacy reserve . The life insurance reserve determined under section 807(d)(1) does not include any asset adequacy reserve.

(1) An asset adequacy reserve is— (i) Any reserve that is established as an additional reserve based upon an analysis of the adequacy of reserves that would otherwise be established in accordance with the requirements set forth in the NAIC Valuation Manual, such as the CRVM or CARVM as applicable, or

(ii) Any similar reserve. (2) In determining whether a reserve is a life insurance reserve, the label placed on such reserve is not determinative, provided, however, any reserve or portion of a reserve that would have been established pursuant to an asset adequacy analysis required by the NAIC’s Valuation Manual 30 as it existed on December 22, 2017, the date of enactment of Public Law 115-97, is an asset adequacy reserve.

Par. 10. Sections 1.807-3 and 1.807-4 are added before the undesignated center heading “Gain and Loss From Operations” to read as follows:

§ 1.807-3 Reporting of reserves .

(a) Reserve reporting . A life insurance company subject to tax under section 801 is required to make a return on Form 1120-L, U.S. Life Insurance Com- pany Income Tax Return . The Internal Revenue Service may require reporting with respect to the opening balance and closing balance of items described in section 807(c) and with respect to the method of computing such items for purposes of determining income. Such

reporting may provide for the manner in which separate account items are reported. (See section 6011 and § 301.6011-1 of this chapter.)

(b) Applicability date . The rules of this section apply to taxable years beginning after October 13, 2020.

§ 1.807-4 Adjustment for change in computing reserves .

(a) Requirement to follow administra- tive procedures . Under section 807(f), a change in basis of computing an item referred to in section 807(c) is a change in method of accounting. Accordingly, except as provided in § 1.446-1(e), a change in basis of computing an item referred to in section 807(c) is a change in method of accounting for purposes of § 1.446-1(e). Before computing such item under a new basis, a life insurance company must obtain the consent of the Commissioner of Internal Revenue or his delegate (Commissioner) pursuant to administrative procedures prescribed by the Commissioner. Similarly, an insurance company other than a life insurance company (a nonlife insurance company) that changes its basis of computing life insurance reserves must obtain the consent of the Commissioner pursuant to administrative procedures prescribed by the Commissioner.

(b) Section 481 adjustment —(1) In general . If the basis of computing any item referred to in section 807(c) as of the close of any taxable year (the year of change) differs from the basis of computing such item at the close of the preceding taxable year, then the difference between the amount of the item at the close of the taxable year computed on the new basis and the amount of the item at the close of the taxable year computed on the old basis that is attributable to contracts issued before the taxable year, is taken into account under section 481 and §§ 1.481-1 through 1.481-5 as an adjustment attributable to a change in method of accounting.

(2) Loss of company status . If for any taxable year a taxpayer that was an insurance company for the year of change is no longer an insurance company, then the taxpayer must take into account in the preceding taxable year (that is, the last

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taxable year it was an insurance company) the balance of any section 481(a) adjustment determined under paragraph (b) (1) of this section. A taxpayer that was an insurance company for the year of change does not accelerate the balance of any section 481(a) adjustment determined under paragraph (b)(1) of this section merely because it changes from a life insurance company to a nonlife insurance company or because it changes from a nonlife insurance company to a life insurance company.

(c) Effect on determining increase or decrease in reserves —(1) Effect under section 807(a) and (b) . If there is a change in basis of computing any item referred to in section 807(c) for a taxable year, then, for purposes of section 807(a) and (b), the closing balance for such item for the year of change with respect to contracts issued before the year of change is determined on the old basis and the opening balance for such item for the next taxable year for such contracts is computed on the new basis.

(2) Effect under section 832 . The following rules apply for purposes of section 832(b)(4): (i) For the year of change, life insurance reserves at the end of the year of change with respect to contracts issued before the year of change are determined on the old basis.

(ii) For the taxable year following the year of change, life insurance reserves at the end of the preceding taxable year (that is, the year of change) with respect to contracts issued before the year of change are determined on the new basis.

(d) Examples . The principles of paragraphs (a) through (c) of this section are illustrated by the following examples. For purposes of these examples and except as otherwise provided, IC is a life insurance company within the meaning of section 816(a) that issues life insurance and annuity contracts. IC is required to determine the amount of life insurance reserves under section 807(d) and to take net increases or decreases in the reserves into account in computing life insurance company taxable income. IC’s reserve for each insurance contract at issue exceeds the net surrender value for such contract and does not exceed the statutory reserve for such contract. IC is on an

accrual method and uses a calendar year as its taxable year.

(1) Example 1 —(i) Facts . In 2021, IC changed the basis of computing the amount of life insurance reserves for a certain type of life insurance contract as described in section 807(f). Both the basis used for computing the reserves for the relevant contracts at the close of the 2020 taxable year (old basis) and the basis of computing the reserves for the relevant type of contract at the close of the 2021 taxable year (new basis) are consistent with the applicable Commissioners’ Reserve Valuation Method. IC followed the administrative procedures prescribed by the Commissioner to obtain consent to change the basis of computing these reserves. IC determined that the life insurance reserves as of December 31, 2021, for the relevant contracts issued prior to 2021 were $110x if computed using the old method and $120x if computed using the new method. IC also determined that the life insurance reserves as of December 31, 2021, for the relevant contracts issued during 2021 were $15x using the new basis.

(ii) Analysis . IC must take into account under section 481 and the administrative procedures prescribed by the Commissioner the $10x difference between the reserves for the relevant contracts issued prior to 2021 computed under the old basis ($110x) and the reserves for such contracts computed under the new basis ($120x). For purposes of determining any net increase or net decrease in reserves in taxable year 2021 under section 807(a) or (b), IC’s closing balance of life insurance reserves computed under section 807(d) with respect to the relevant contracts is $110x for contracts issued prior to 2021 (computed on the old basis) and $15x for contracts issued during 2021 (computed on the new basis). IC’s opening balance in 2022 for life insurance reserves for the relevant contracts is $135x (computed on the new basis).

(2) Example 2 —(i) Facts . The facts are the same as in paragraph (d)(1) of this section (the facts in Example 1 ), except that IC is an insurance company that is not a life insurance company. IC is required to compute taxable income under section 832.

(ii) Analysis . IC must take into account under section 481 and the administrative procedures prescribed by the Commissioner the $10x difference between the reserves for the relevant contracts issued prior to 2021 computed under the old basis ($110x) and the reserves for such contracts computed under the new basis ($120x). For purposes of determining the premiums earned on insurance contracts during the taxable year as described in section 832(b)(4) for the year of change, the life insurance reserves at the end of the taxable year are $110x for contracts issued prior to 2021 (computed on the old basis) and $15x for contracts issued during 2021 (computed on the new basis). For purposes of determining the premiums earned on insurance contracts during the taxable year as described in section 832(b)(4) for the taxable year following the year of change, the life insurance reserves at the end of the preceding taxable year (the year of change) with respect to relevant contracts are $135x (computed on the new basis).

(e) Applicability date . The rules of this section apply to taxable years beginning

after October 13, 2020. However, a taxpayer may choose to apply the rules of this section for a taxable year beginning after December 31, 2017, the effective date of the revision of section 807 by Public Law 115-97, and on or before October 13, 2020, provided the taxpayer consistently applies the rules of this section to that taxable year and all subsequent taxable years. See section 7805(b)(7).

§ 1.809-2 [Removed and reserved]

Par. 11. Section 1.809-2 is removed and reserved.

§ 1.809-5 [Amended]

Par. 12. Section 1.809-5 is amended by removing the language “and § 1.810-3” from the last sentence of paragraph (a)(5) (iii).

§ 1.810-3 [Removed]

Par. 13. Section 1.810-3 is removed. Par. 14. Section 1.816-1 is added before the undesignated center heading “Miscellaneous Provisions” to read as follows:

§ 1.816-1 Life insurance reserves .

(a) Definition of life insurance re- serves . Except as provided in section 816(h), a reserve that meets the requirements of section 816(b)(1) and (2) will not be disqualified as a life insurance reserve solely because the method used to compute the reserve takes into account other factors, provided that the method used to compute the reserve is a tax reserve method as defined in section 807(d) (3) and that such reserve is not an asset adequacy reserve as described in § 1.8071(b). (b) Applicability date . The section applies to taxable years beginning after October 13, 2020. However, a taxpayer may choose to apply the rules of this section for a taxable year beginning after December 31, 2017, the effective date of the revision of section 807 by Public Law 115-97, and on or before October 13, 2020, provided the taxpayer consistently applies the rules of this section to that taxable year and all subsequent taxable years. See section 7805(b)(7).

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§ 1.817A-0 [Removed]

Par. 15. Section 1.817A-0 is removed. Par. 16. Section 1.817A-1 is amended by:

Removing paragraphs (a)(5) and (6).
Revising paragraph (b).
Removing paragraph (c).
Redesignating paragraph (d) as paragraph (c).
Revising newly designated paragraph (c).

The revisions read as follows:

§ 1.817A-1 Certain modified guaranteed contracts.

(b) Waiver of section 811(d) for certain non-equity-indexed modified guaranteed contracts . Section 811(d) is waived during the temporary guarantee period when applied to non-equity-indexed MGCs.

(c) Applicability dates . Paragraph (b) of this section applies to taxable years beginning after October 13, 2020. However, a taxpayer may choose to apply the rules of paragraph (b) of this section for a taxable year beginning after December 31, 2017, the effective date of the revision of section 807 by Public Law 115-97, and on or before October 13, 2020, provided the taxpayer consistently applies the rules of paragraph (b) of this section to that taxable year and all subsequent taxable years. See section 7805(b)(7). For taxable years beginning on or before October 13, 2020, see paragraph (b) of this section as contained in 26 CFR part 1 revised as of April 1, 2020.

§ 1.818-2 [Amended]

Par. 17. Section 1.818-2 is amended by removing paragraph (c).

§ 1.818-4 [Removed and reserved]

Par. 18. Section 1.818-4 is removed and reserved.

§ 1.848-1 [Amended]

Par. 19. Section 1.848-1 is amended in paragraph (b)(2)(i) by removing the language “section 807(e)(4)” and adding the language “section 807(e)(3)” in its place.

Par. 20. Section 1.6012-2 is amended by:

Revising paragraph (c)(4).
Revising paragraph (l). The revisions read as follows:

§ 1.6012-2 Corporations required to make returns of income.

(c) * * * (4) Special rule for insurance com- panies filing their Federal income tax returns electronically . If an insurance company described in paragraph (c)(1), (2), or (3) of this section files its Federal income tax return electronically, it must include on or with such return its annual statement (or pro forma annual statement), or a portion thereof, as and to the extent required by forms or instructions. If the full annual statement is not required to be included with the return, such statement must be available at all times for inspection by authorized Internal Revenue Service officers or employees and retained for so long as such statements may be material in the administration of any internal revenue law. See § 1.6001-1(e).

(l) Applicability date . Paragraph (c) of this section applies to any taxable year beginning after October 13, 2020. For taxable years beginning on or before October 13, 2020, see paragraph (c) of this section as contained in 26 CFR part 1 in effect on April 1, 2020.

PART 301—PROCEDURE AND ADMINISTRATION

Par. 21. The authority citation for part 301 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * *

Par. 22. Section 301.9100-6T is amended by:

Adding a title to the table in paragraph (a)(1).
Removing from the table in paragraph (a)(1) the three entries for “211” and the entries for “216(c)(1),” “216(c) (2),” “217(i),” and “217(l)(2)(B).”
Removing and reserving paragraph (a)(2)(iii).
Removing paragraph (a)(3)(v).
In paragraph (a)(4): i. Removing “211 (Code section 810(b) (3)), 216(c) (1) and (2), 217(l),” from the first sentence.

ii. Removing “211 (Code sections 806(d)(4), and 807(d)(4)(C)), 217(i),” from the second sentence.

iii. Removing the last sentence. The addition reads as follows:

§ 301.9100-6T Time and manner of making certain elections under the Deficit Reduction Act of 1984.

(a) * * * (1) * * * Table 1 to paragraph (a)(1)

Sunita Lough, Deputy Commissioner for Services

and Enforcement.

Approved September 1, 2020.

David J. Kautter, Assistant Secretary of the Treasury

(Tax Policy) .

(Filed by the Office of the Federal Register on October 09, 2020, 8:45 a.m., and published in the issue of the Federal Register for October 13, 2020, 85 FR 64386)

Section 152. — Dependent defined

26 CFR 1.152-2(b), (e); 26 CFR 1.24-1: Dependent Defined

T.D. 9913

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Dependent Defined

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

Bulletin No. 2020–45 975 November 2, 2020

SUMMARY: This document contains final regulations that clarify the definition of a “qualifying relative” for purposes of various provisions of the Internal Revenue Code (Code) for taxable years 2018 through 2025. These regulations generally affect taxpayers who claim Federal income tax benefits that require a taxpayer to have a qualifying relative.

DATES: Effective Date : These regulations are effective on October 13, 2020.

Applicability Date : Sections 1.24-1 and 1.152-2(b) of these regulations apply to taxable years beginning on or after October 13, 2020. Section 1.152-2(e) of these regulations applies to taxable years ending after August 28, 2018, the date the Department of the Treasury (Treasury Department) and the IRS issued Notice 2018-70, 2018-38 I.R.B. 441.

FOR FURTHER INFORMATION CONTACT: Victoria J. Driscoll at (202) 3174718 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26 CFR part 1) under sections 24 and 152 of the Code relating to statutory amendments enacted in Public Law 115-97, 131 Stat. 2054 (2017), commonly referred to as the Tax Cuts and Jobs Act (TCJA).

Section 152(a) generally defines a “dependent” as a “qualifying child” or a “qualifying relative.” The definition of a qualifying relative in section 152(d)(1) includes the requirement that the individual have gross income for the calendar year that is less than the “exemption amount” as defined in section 151(d) (exemption amount). Such an individual also must satisfy the requirement of section 152(d)(1) (C) that the individual receive more than one-half of his or her support from the taxpayer claiming the individual as a qualifying relative (support test). As described in parts I through IV of this Background, these final regulations provide that, in determining whether an individual is a qualifying relative for purposes of various provisions of the Code that refer to sec

tion 152 in years in which the exemption amount is zero, the section 151(d) exemption amount will be the inflation-adjusted section 152(d)(1)(B) exemption amount in the annual revenue procedure setting forth inflation-adjusted items that is published in the Internal Revenue Bulletin.

I. Exemption Amount

Generally, section 151 allows a taxpayer to claim a deduction equal to the exemption amount for each of the taxpayer and his or her spouse, and for any dependents. Prior to the TCJA, section 151(d) provided for an exemption amount of $2,000 that was adjusted annually for inflation beginning with calendar year 1990. Before the enactment of the TCJA, the IRS had determined that the exemption amount for taxable year 2018 was $4,150. Rev. Proc. 2017-58, 2017-45 I.R.B. 489, modified and superseded by Rev. Proc. 2018-18, 2018-10 I.R.B. 392. Section 11041(a)(2) of the TCJA added section 151(d)(5) to provide special rules for taxable years 2018 through 2025 regarding the exemption amount. Section 151(d)(5)(A) provides that, for a taxable year beginning after December 31, 2017, and before January 1, 2026, the exemption amount is zero, thereby suspending the deductions for personal exemptions and the dependency exemption. H.R. Rep. No. 115-466, at 202-204 (2017) (Conference Report). However, section 151(d)(5)(B) provides that the reduction of the exemption amount to zero is not taken into account in determining whether a deduction under section 151 is allowed or allowable to a taxpayer, or whether a taxpayer is entitled to a deduction under section 151, for purposes of any other provision of the Code. The Conference Report states that this provision clarifies that the reduction of the personal exemption to zero “should not alter the operation of those provisions of the Code which refer to a taxpayer allowed a deduction . . . under section 151,” including the child tax credit in section 24(a). Id . at 203 n.16. For example, the definition of head of household in section 2(b) (1)(A) includes the requirement that the taxpayer maintain as his or her home a household for a qualifying individual for a specified period of time. A qualifying

individual under section 2(b)(1)(A)(ii) includes a person who is a qualifying relative under section 152(d) if the taxpayer is entitled to a deduction under section 151 for the person for the taxable year.

II. Support Test

The section 152(d)(1)(C) support test requires that an individual receive more than one-half of his or her support from the taxpayer to be claimed as a qualifying relative of that taxpayer. Prior to the TCJA, payments of alimony or separate maintenance paid to a spouse or former spouse were not treated as support of a dependent provided by the payor spouse. Additionally, alimony and separate maintenance payments were deductible by the payor spouse and includible in income by the recipient spouse under sections 61(a) (8), 71(a), and 215(a) of the Code. Under section 71(c), child support payments were not treated as alimony includible in income.

Section 11051 of the TCJA repealed sections 61(a)(8), 71 and 215, and, in a conforming change, also repealed section 682 of the Code for any divorce or separation instrument executed after 2018, and for any instrument executed before 2019 and later modified to apply the provisions of the TCJA. Consistent with prior law, the TCJA provides that payments of alimony or separate maintenance paid to a spouse or former spouse are not treated as support of a dependent provided by the payor spouse. To conform with the repeal of sections 71 and 682 by the TCJA, section 11051(b)(3)(B) of the TCJA amended section 152(d)(5) of the Code regarding the source of a qualifying relative’s support by revising the language of section 152(d)(5) to eliminate references to former sections 71 and 682.

III. Credit for Other Dependents

Section 11022(a) of the TCJA amended section 24 of the Code to create a $500 credit for certain dependents of a taxpayer other than a qualifying child described in section 24(c) for whom the child tax credit is allowed. The $500 credit applies to two categories of dependents: (1) Qualifying children for whom a child tax credit is not allowed, and (2) qualifying

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relatives as defined in section 152(d). Section 24(h)(4)(A) and (C). Like the amendment to section 151(d) reducing the exemption amount to zero, this new credit applies for taxable years 2018 through 2025. The Conference Report explains that “[t]he credit is further modified to temporarily provide for a $500 nonrefundable credit for qualifying dependents other than qualifying children. The provision generally retains the present-law definition of dependent.” H.R. Rep. No. 115-466, at 227.

IV. Administrative Action

On August 28, 2018, the Treasury Department and the IRS issued Notice 201870. This notice announced the intent to issue proposed regulations providing that the reduction of the exemption amount to zero under section 151(d)(5)(A) for taxable years 2018 through 2025 will not be taken into account in determining whether an individual meets the requirement of section 152(d)(1)(B) to be a qualifying relative. Notice 2018-70 also stated that, before the issuance of the proposed regulations described in the notice, a taxpayer may rely on the rules described in the notice.

On June 9, 2020, the Treasury Department and the IRS published a notice of proposed rulemaking (REG-118997-19) in the Federal Register (85 FR 35233) proposing regulations under sections 24 and 152 (proposed regulations). Consistent with Notice 2018-70, the proposed regulations provide that, in determining whether an individual is a qualifying relative for purposes of various provisions of the Code that refer to section 152 in taxable years in which the exemption amount is zero, the section 151(d) exemption amount will be the inflation-adjusted section 152(d)(1)(B) exemption amount in the annual revenue procedure setting forth inflation-adjusted items that is published in the Internal Revenue Bulletin. Thus, the exemption amount to be used for this purpose is $4,150 for taxable year 2018 (section 3.24 of Rev. Proc. 2017-58, 2017-45 I.R.B. 489, modified and superseded by Rev. Proc. 2018-18, 2018-10 I.R.B. 392); $4,200 for taxable year 2019 (section 3.25 of Rev. Proc. 2018-57, 2018-49 I.R.B. 827); and $4,300 for taxable year 2020

(section 3.25 of Rev. Proc. 2019-44, 201947 I.R.B. 1093). Section 1.152-3(c)(3) and (d)(2) of the proposed regulations were proposed as changes to an earlier notice of proposed rulemaking (REG-137604-07) also providing rules regarding the definition of a dependent under section 152, which was published in the Federal Register (82 FR 6370) on January 19, 2017 (January 2017 Proposed Regulations). Section 1.1523(d)(2) of the January 2017 Proposed Regulations, which have not yet been finalized, originally included references to sections 71 and 682. Accordingly, the proposed regulations withdrew §1.152-3(d) (2) of the January 2017 Proposed Regulations and replaced it with a proposed rule to reflect the amendments to section 152(d)(5) discussed in part II of this Background.

Summary of Comments and Explanation of Provisions

The Treasury Department and the IRS received three comments in response to the proposed regulations through the Federal eRulemaking Portal. As no request for a public hearing was received, no hearing was held.

Although two of the comments received did not relate to the proposed regulations, the third comment generally asked for additional clarity regarding the definition of a qualifying relative. As described in the Background, these regulations implement specific changes to the law enacted in the TCJA, which did not modify the definition of qualifying relative in section 152(d) other than to make conforming changes to section 152(d)(5) to account for the repeal of sections 71 and 682. When the January 2017 Proposed Regulations are finalized, they will provide additional clarity to the regulations under section 152 and related provisions.

The third comment also suggested that, because the final regulations would not be published earlier than 2020, it was not necessary to reference the exemption amount for purposes of section 152 for taxable years 2018 and 2019. Although these final regulations are being published in 2020, §1.152-2(e) of these final regulations applies to taxable years ending after August 28, 2018, the

date the Treasury Department and the IRS issued Notice 2018-70, pursuant to section 7805(b)(1)(C). Further, the Treasury Department and the IRS determined it appropriate to clarify that, in defining qualifying relative for purposes other than determining the amount allowable as a deduction under section 151(a), the exemption amount is not zero, but is the inflation-adjusted section 152(d)(1)(B) exemption amount in the annual revenue procedure setting forth inflation-adjusted items that is published in the Internal Revenue Bulletin.

This document adopts the proposed regulations as final regulations with no substantive change. However, because §1.152-3(c)(3) and 1.152-3(d)(2) of the proposed regulations originally were proposed as changes to provisions of the January 2017 Proposed Regulations, which have not yet been finalized, the proposed regulations have been redesignated in the final regulations to coordinate with the existing regulations. Specifically, proposed §1.152-3(c)(3)(i) and (ii) is finalized as new §1.152-2(e)(1) and (2) and proposed §1.152-3(d)(2) is finalized as §1.152-2(b). When the January 2017 Proposed Regulations are finalized, the provisions again will be appropriately redesignated.

Therefore, the provisions of the proposed regulations are adopted without substantive change to: (1) provide that the exemption amount, for purposes other than a deduction for a personal or dependency exemption under section 151, is $4,150 for taxable year 2018, and for taxable years 2019 through 2025, the exemption amount, as adjusted for inflation, is the section 152(d)(1)(B) exemption amount, as set forth in guidance published in the Internal Revenue Bulletin; and (2) describe certain payments to a payee spouse for purposes of the support test without references to repealed sections 71 and 682.

Finally, these regulations clarify an issue raised regarding a statutory cross reference in section 24(h)(4) to “a qualifying child described in subsection (c).” As was proposed in the proposed regulations, these regulations clarify in §1.24-1 that the statutory cross reference is a reference to section 24(c), rather than to section 152(c).

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Applicability Date

Section 7805(b)(1) of the Code generally provides that no temporary, proposed, or final regulation relating to the internal revenue laws may apply to any taxable period ending before the earliest of (A) the date on which the regulation is filed with the Federal Register, or (B) in the case of a final regulation, the date on which a proposed or temporary regulation to which the final regulation relates was filed with the Federal Reg- ister . However, section 7805(b)(1)(C) provides that a regulation may apply to a taxable period ending after the date on which any notice substantially describing the expected contents of a regulation is issued to the public.

Accordingly, §§1.24-1 and 1.1522(b) of these regulations apply to taxable years beginning on or after October 13, 2020. Section 1.152-2(e) of these regulations applies to taxable years ending after August 28, 2018, the date the Treasury Department and the IRS issued Notice 2018-70.

Special Analyses

These regulations are not subject to review under section 6(b) of Executive Order 12866, pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget, regarding the review of tax regulations.

Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is certified that these regulations will not have a significant economic impact on a substantial number of small entities. These regulations primarily affect individuals and therefore will not have a significant economic impact on a substantial number of small entities. Accordingly, the Secretary of the Treasury’s delegate certifies that the rule will not have a significant economic impact on a substantial number of small entities.

Pursuant to section 7805(f), the proposed regulations preceding these regulations were submitted to the Office of the Chief Counsel for the Office of Advocacy of the Small Business Administration for comment on its impact on small business, and no comments were received.

Drafting Information

The principal author of the final regulations is Victoria Driscoll of the Office of Associate Chief Counsel (Income Tax and Accounting). However, other personnel from the Treasury Department and the IRS participated in their development.

Statement of Availability of IRS Documents

IRS notices and other guidance cited in this preamble are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at http://www.irs.gov.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.24-1 is added to read as follows:

§1.24-1 Partial credit allowed for certain other dependents .

(a) In general . For purposes of section 24(h)(4)(A), a taxpayer may be eligible to increase the credit determined under section 24(a) by $500 for a dependent of the taxpayer, as defined in section 152, other than a qualifying child described in section 24(c).

(b) Applicability date . This section applies to taxable years beginning on or after October 13, 2020.

Par. 3. Section 1.152-2, is amended by:

Revising paragraph (b); and

Sunita Lough, Deputy Commissioner for Services

and Enforcement

Adding paragraph (e). The revision and addition read as follows:

§1.152-2 Rules relating to general definition of dependent .

(b)(1) A payment to a spouse (payee spouse) of alimony or separate maintenance is not treated as a payment by the payor spouse for the support of any dependent. Similarly, the distribution of income of an estate or trust to a divorced or legally separated payee spouse is not treated as a payment by the payor spouse for the support of any dependent. The preceding sentence will not apply, however, to the extent that such a distribution is in satisfaction of the amount or portion of income that, by the terms of a divorce decree, a written separation agreement, or the trust instrument is fixed as payable for the support of the minor children of the payor spouse.

(2) Paragraph (b)(1) of this section applies to taxable years beginning on or after October 13, 2020.

(e)(1) In defining a qualifying relative for taxable year 2018, the exemption amount in section 152(d)(1)(B) is $4,150. For taxable years 2019 through 2025, the exemption amount, as adjusted for inflation, is set forth in annual guidance published in the Internal Revenue Bulletin . See §601.601(d)(2) of this chapter.

(2) Paragraph (e)(1) of this section applies to taxable years ending after August 28, 2018.

Approved: September 8, 2020

David J. Kautter Assistant Secretary of the Treasury

(Tax Policy)

(Filed by the Office of the Federal Register on October 09, 2020, 8:45 a.m., and published in the issue of the Federal Register for October 13, 2020, 85 F.R. 64386)

November 2, 2020 978 Bulletin No. 2020–45

IRS continue to study comments on issues related to sections 67 and 642(h) that are beyond the scope of these regulations, which may be discussed in future guidance if guidance on those issues is published. The scope of the proposed regulations and these regulations is limited to the effect of section 67(g) on the deductibility of certain expenses described in section 67(b) and (e) that are incurred by estates and non-grantor trusts and the treatment of excess deductions on termination of an estate or trust under section 642(h). This Summary of Comments and Explanation of Revisions also describes each of the final rules contained in this document.

A. Section 67

Section 67(g) was added to the Code on December 22, 2017, by section 11045(a) of Public Law 115–97, 131 Stat. 2054, 2088 (2017), commonly referred to as the Tax Cuts and Jobs Act (TCJA). Section 67(g) prohibits individual taxpayers from claiming miscellaneous itemized deductions for any taxable year beginning after December 31, 2017, and before January 1, 2026. Prior to the TCJA, miscellaneous itemized deductions were allowable for any taxable year only to the extent that the sum of such deductions exceeded two percent of adjusted gross income. See section 67(a). Section 67(b) defines miscellaneous itemized deductions as itemized deductions other than those listed in section 67(b)(1) through (12). Section 67(e) provides that, for purposes of section 67, an estate or trust computes its adjusted gross income in the same manner as that of an individual, except that the following additional deductions are treated as allowable in arriving at adjusted gross income: (1) the deductions for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such estate or trust, and (2) deductions allowable under section 642(b) (concerning the personal exemption of an estate or non-grantor trust), section 651 (concerning the deduction for trusts distributing current income), and section 661 (concerning the deduction for estates and trusts accumulating income). Accordingly, section 67(e) removes the

26 CFR 1.67-4; 26 CFR 1.642(h)-2

T.D. 9918

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Effect of Section 67(g) on Trusts and Estates

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations clarifying that the following deductions allowed to an estate or non-grantor trust are not miscellaneous itemized deductions: costs paid or incurred in connection with the administration of an estate or non-grantor trust that would not have been incurred if the property were not held in the estate or trust, the personal exemption of an estate or non-grantor trust, the distribution deduction for trusts distributing current income, and the distribution deduction for estates and trusts accumulating income. Therefore, these deductions are not affected by the suspension of the deductibility of miscellaneous itemized deductions for taxable years beginning after December 31, 2017, and before January 1, 2026. The final regulations also provide guidance on determining the character, amount, and allocation of deductions in excess of gross income succeeded to by a beneficiary on the termination of an estate or non-grantor trust. The final regulations affect estates, non-grantor trusts (including the S portion of an electing small business trust), and their beneficiaries.

DATES : Effective date : These regulations are effective on October 19, 2020.

Applicability dates : For dates of applicability, see §§ 1.67–4(d), 1.642(h)–2(f) and 1.642(h)-5(c).

FOR FURTHER INFORMATION CONTACT : Margaret Burow at (202) 317–5279 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to Income Tax Regulations (26 CFR part 1) under sections 67 and 642 of the Internal Revenue Code (Code). On May 11, 2020, the Department of Treasury (Treasury Department) and the IRS published a notice of proposed rulemaking (REG-113295-18) in the Federal Regis- ter (85 FR 27693) containing proposed regulations under sections 67 and 642(h) (proposed regulations). The Summary of Comments and Explanation of Revisions section of this preamble summarizes the provisions of sections 67 and 642(h) and the provisions of the proposed regulations, which are explained in greater detail in the preamble to the proposed regulations.

On July 17, 2020, the Treasury Department and the IRS published in the Federal Register (85 FR 43512) a notice of public hearing on the proposed regulations scheduled for August 12, 2020. The Treasury Department and the IRS received no requests to speak at a hearing in response to that notice. On August 5, 2020, the Treasury Department and the IRS published in the Federal Register (85 FR 47323) a cancellation of the notice of public hearing.

The Treasury Department and the IRS received written and electronic comments in response to the proposed regulations. All comments were considered and are available at www.regulations.gov or upon request. After full consideration of the comments received, this Treasury decision adopts the proposed regulations with modifications described in the Summary of Comments and Explanation of Revisions.

Summary of Comments and Explanation of Revisions

Most of the comments addressing the proposed regulations are summarized in this Summary of Comments and Explanation of Revisions. Comments merely summarizing or interpreting the proposed regulations or recommending statutory revisions are not discussed in this preamble. The Treasury Department and the

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deductions described in section 67(e) (1) and (2) from the definition of itemized deductions under section 63(d), and thus from the definition of miscellaneous itemized deductions under section 67(b), and treats them as deductions allowable in arriving at adjusted gross income under section 62(a). Section 67(e) further provides regulatory authority to make appropriate adjustments in the application of part I of subchapter J of chapter 1 of the Code to take into account the provisions of section 67.

The proposed regulations under § 1.67-4 clarify that expenses described in section 67(e) remain deductible in determining the adjusted gross income of an estate or non-grantor trust during the taxable years in which section 67(g) applies. Accordingly, section 67(g) does not deny an estate or non-grantor trust (including the S portion of an electing small business trust) a deduction for expenses described in section 67(e)(1) and (2) because such deductions are allowable in arriving at adjusted gross income and are not miscellaneous itemized deductions under section 67(b). Commenters agreed with the proposed amendments. These regulations adopt the proposed regulations under § 1.67-4 without modification. Two commenters requested that the regulations address the treatment of deductions described in section 67(e)(1) and (2) in determining an estate or non-grantor trust’s income for alternative minimum tax (AMT) purposes. The commenters suggested that such deductions are allowable as deductible in computing the AMT. The treatment of deductions described in section 67(e) for purposes of determining the AMT is outside the scope of these regulations concerning the effects of section 67(g); therefore, these regulations do not address the AMT. Further, no conclusions should be drawn from the absence of a discussion of the AMT in these regulations regarding the treatment of deductions described in section 67(e) for purposes of determining the AMT.

One commenter suggested that the Treasury Department and the IRS exercise their regulatory authority under section 67(e) to exempt cemetery trusts under section 642(i) and qualified funeral trusts (QFTs) under section 685 from the application of section 67(g). The commenter

stated that the primary type of expense incurred by these trusts is investment advisory expenses, the tax treatment of which differs under the Code from management expenses. That is, trust management expenses generally are allowable in computing adjusted gross income under section 67(e)(1), while trust investment advisory expenses are miscellaneous itemized deductions. See § 1.67-4(b)(4). The commenter asserted that it was not the intent of Congress to disallow investment advisory expenses incurred by cemetery and funeral trusts when Congress enacted section 67(g).

The commenter suggested that exercising the regulatory authority under section 67(e) in this manner would be consistent with the exercise of regulatory authority under section 1411 to exempt section 642(i) cemetery perpetual care funds and QFTs. See § 1.1411-3(b)(1) (providing that certain types of trusts, including section 642(i) cemetery perpetual care funds, are excepted from the net investment income tax) and § 1.14113(b)(2) (providing a special rule for QFTs that, for purposes of calculating any tax under section 1411, section 1411 and the regulations thereunder are applied to each QFT by treating each beneficiary’s interest in the trust as a separate trust). As stated in the preamble to TD 9644 (78 FR 72393), the Treasury Department and the IRS exercised their regulatory authority under section 1411 to exclude cemetery trusts from the net investment income tax because, by benefiting an operating company, such trusts are considered similar to the business trusts that are excluded from the operation of section 1411. The preamble also states that QFTs are not excluded from the application of the net income investment tax, but that the section 1411 tax is calculated consistent with the taxation of QFTs under chapter 1. The commenter noted that they advocated for the treatment of each beneficiary’s interest in the QFT as a separate trust because such treatment reduces the likelihood of the QFT beneficiaries being subject to the net investment income tax. The Treasury Department and the IRS continue to consider these comments but providing an exemption for cemetery and funeral trusts under section 67(g) is outside the scope of these regulations.

B. Section 642(h)

In general

Section 642(h) provides that if, on the termination of an estate or trust, the estate or trust has: (1) a net operating loss carryover under section 172 or a capital loss carryover under section 1212, or (2) for the last taxable year of the estate or trust, deductions (other than the deductions allowed under section 642(b) (relating to the personal exemption) or section 642(c) (relating to charitable contributions)) in excess of gross income for such year, then such carryover or excess will be allowed as a deduction, in accordance with the regulations prescribed by the Secretary of the Treasury or his delegate (Secretary), to the beneficiaries succeeding to the property of the estate or trust.

Section 1.642(h)-2(a), as articulated in the proposed regulations and these final regulations, provides that if, on termination of an estate or trust, the estate or trust has for its last taxable year deductions (other than the deductions allowed under section 642(b) or section 642(c)) in excess of gross income, the excess deductions are allowed under section 642(h)(2) as items of deduction to the beneficiaries succeeding to the property of the terminated estate or trust.

Character and amount of excess deductions

Section 1.642(h)-2(b)(1) of the proposed regulations provides that each deduction comprising the excess deductions under section 642(h)(2) retains, in the hands of the beneficiary, its character (specifically, as allowable in arriving at adjusted gross income, as a non-miscellaneous itemized deduction, or as a miscellaneous itemized deduction) while in the estate or trust. The character of these deductions does not change when succeeded to by a beneficiary on termination of the estate or trust. Furthermore, an item of deduction succeeded to by a beneficiary remains subject to any limitation applicable under the Code in the computation of the beneficiary’s tax liability.

One commenter noted that section 642(h) states that excess deductions on termination of an estate or trust are to be “al

November 2, 2020 980 Bulletin No. 2020–45

lowed as a deduction, in accordance with regulations prescribed by the Secretary” and that there is no express authority to treat excess deductions as miscellaneous or non-miscellaneous itemized deductions (or tax preference items for AMT purposes). The Treasury Department and the IRS disagree with this comment. The characterization of these excess deductions as a single miscellaneous itemized deduction in the current regulations was made before the enactment of section 67(g) and served as an administrative convenience. Making a change to that characterization is now appropriate to reflect the temporary disallowance of miscellaneous itemized deductions under section 67(g) since the regulations were written and is a proper exercise of the Secretary’s specific grant of regulatory authority in section 642(h).

Another commenter requested that non-miscellaneous itemized deductions included in excess deductions be fully deductible by the beneficiary and not subject to a second level of limitation applicable on the beneficiary’s return, because the amounts already would have been subject to limitation on the return of the estate or trust. The commenter provided an example of a terminated trust that paid $25,000 of state income tax, for which the trust is limited to a $10,000 deduction under section 164(b)(6)(B) for taxable years beginning after December 31, 2017, and before January 1, 2026. In the commenter’s example, the entire amount of the allowable $10,000 deduction was passed through to the beneficiary as an excess deduction on termination of the trust. The excess of state income tax over the $10,000 limitation ($15,000) would not pass through as an excess deduction to the beneficiaries in this circumstance because the excess amount was not deductible to the trust. Excess state income tax on termination of the estate or trust may, however, pass through to a beneficiary if the estate or trust had insufficient income to absorb the entire $10,000 of state income tax deduction. In that circumstance, the commenter opined that the limitation under section 164(b) (6)(B), having already been applied at the trust level, should not again be applied at the beneficiary level. The Treasury Department and the IRS carefully considered the comment but determined that beneficiaries remain subject to the limitation in

section 164(b)(6)(B). The Treasury Department and the IRS found no authority to exempt such items from the application of any limitations applicable to the beneficiary under the Code. The excess deductions retain their character in the hands of the beneficiary on termination of the trust, and all applicable limitations apply to all of the beneficiary’s items of that character, regardless of their origin.

One commenter noted that, under § 1.641(c)-1(j), if an electing small business trust (ESBT) election terminates or is revoked and the S portion has a net operating loss or capital loss carryover or deductions in excess of gross income, then any such loss, carryover or excess deductions are allowed as a deduction, in accordance with the regulations under section 642(h), to the trust or to the beneficiaries succeeding to the property of the trust if the entire trust terminates. However, the commenter also noted that under the TCJA, section 641(c)(2)(E) was amended to provide that ESBT charitable contributions are deductible under section 170, rather than under section 642(c), so that, unlike other trust charitable deductions, an ESBT’s charitable deduction could constitute part of the excess deductions on termination of the trust. The commenter stated that neither the legislative history nor the explanation of the staff of the Joint Committee on Taxation addressed whether this result was intended. The Treasury Department and the IRS note that charitable contribution deductions under both sections 170 and 642(c) are non-miscellaneous itemized deductions under sections 63(d) and 67(b) (4) to the estate or trust and maintain that such character is retained in the hands of the beneficiary in these regulations. Although the Treasury Department and the IRS continue to consider the application of section 170 to ESBT charitable contributions under section 641(c)(2)(E), this issue is outside the scope of these regulations.

Another commenter requested clarification of whether an excess deduction on termination of a trust or estate that is allowed in determining the net investment income under section 1411 of the estate or trust remains deductible in the hands of the beneficiary in determining the net investment income of the beneficiary under section 1411. These final regula

tions provide that each excess deduction retains its separate character as a section 67(e) deduction, non-miscellaneous itemized deduction, or miscellaneous itemized deduction in the hands of the beneficiary. Whether a deduction retains its character as allowable in computing the net investment income of the beneficiary, however, is outside the scope of these regulations.

Reporting of excess deductions

Section 1.642(h)-2(b)(1) of the proposed regulations provides that an item of deduction succeeded to by a beneficiary remains subject to any additional applicable limitation under the Code and must be separately stated if it could be so limited, as provided in the instructions to Form 1041, U.S. Income Tax Return for Estates and Trusts, and the Schedule K-1 (Form 1041), Beneficiary’s Share of Income, Deductions, Credit, etc . Commenters requested that the Treasury Department and the IRS provide guidance on how the excess deductions are to be reported by both the terminated estate or trust and by its beneficiaries. The Treasury Department and the IRS released instructions for beneficiaries that chose to claim excess deductions on Form 1040 in the 2019 or 2018 taxable year based on the proposed regulations. In addition, the Treasury Department and the IRS plan to update the instructions for Form 1041, Schedule K-1 (Form 1041), and Form 1040, U.S. Indi- vidual Income Tax Return, for the 2020 and subsequent tax years to provide for the reporting of excess deductions that are section 67(e) expenses or non-miscellaneous itemized deductions.

The Treasury Department and the IRS are aware that the income tax laws of some U.S. states do not conform to the Code with respect to section 67(g), such that beneficiaries may need information on miscellaneous itemized deductions of a terminated estate or trust. However, because miscellaneous itemized deductions are currently not allowed for Federal income tax purposes, that information is not needed for Federal income tax purposes. Therefore, it would not be appropriate to modify Federal income tax forms to require or accommodate the collection of such information while this deduction is

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suspended. Estates, trusts, and beneficiaries are advised to consult the relevant state taxing authority for information about deducting miscellaneous itemized expenses on their state tax returns.

Determinations of deductions in year of termination of the estate or trust

Section 1.642(h)-2(b)(2) of the proposed regulations provides that the provisions of § 1.652(b)–3 are used to allocate each item of deduction among the classes of income in the year of termination for purposes of determining the character and amount of the excess deductions under section 642(h)(2). Accordingly, the amount of each separate deduction remaining after application of § 1.652(b)–3 comprises the excess deductions available to the beneficiaries succeeding to the property of the estate or trust as provided under section 642(h)(2). In addition, as previously explained, an item of deduction succeeded to by a beneficiary remains subject to any additional applicable limitation under the Code. Furthermore, § 1.642(h)-2(c) of the proposed regulations provides that excess deductions are allowable only in the taxable year of the beneficiary in which or with which the estate or trust terminates. That is, excess deductions of a terminated estate or trust may not carry over to a subsequent year of the beneficiary.

One commenter requested that these regulations provide an ordering rule clar ifying whether excess deductions on ter mination of an estate or trust allowed as a deduction to the beneficiary are claimed before, after, or ratably with the beneficiary’s other deductions, particularly when the amount of the excess deductions and other deductions exceed the beneficiary’s gross income. These final regulations clarify that beneficiaries may claim all or part of the excess deductions under section 642(h)(2) before, after, or together with the same character of deductions separately allowable to the beneficiary under the Code.

That commenter also requested that the final regulations include an exception for investment interest expense under section 163(d) from the general rule that excess deductions on termination of a trust or estate may be claimed only in the beneficiary’s taxable year during which the trust

or estate terminated. That section permits the carryforward of investment interest under section 163(d)(2) to the taxpayer’s subsequent taxable years if the taxpayer is unable to deduct the investment interest in the current taxable year. The commenter stated that the disallowance of the carryover of section 642(h)(2) excess deductions should not apply to those excess deductions that are no longer treated as miscellaneous itemized deductions under the proposed regulations, and that carryover should be permitted to the extent otherwise permitted under the Code. The preamble to the proposed regulations states that addressing suspended deductions under section 163(d) is beyond the scope of the regulations and the same is true of these final regulations.

A commenter requested that the amount of a beneficiary’s net operating loss carryover to a later taxable year under section 172 should include all of the beneficiary’s section 642(h)(2) excess deductions that are section 67(e) deductions, as deductions that are attributable to the beneficiary’s trade or business and thus deductions attributable to a trade or business under section 172(d) (4). Section 642(h) makes it clear that a net operating loss carryover under paragraph (1) of that section is separate and distinct from the excess deductions on termination described in paragraph (2) of that section. Furthermore, § 1.642(h)-2(d) provides that a deduction based upon a net operating loss carryover generally will not be allowed to beneficiaries under both paragraphs (1) and (2) of section 642(h). Therefore, an excess deduction allowable to the beneficiary under section 642(h)(2) is not a net operating loss carryover succeeded to by the beneficiary under section 642(h)(1) and (with one exception) a net operating loss carryover is not an excess deduction on termination. Moreover, these regulations provide that it is the character of the excess deductions as section 67(e) deductions, non-miscellaneous itemized deductions, and miscellaneous itemized deductions, and not the character of a deduction as attributable to a trade or business, that is retained in the hands of the beneficiary. Thus, whether section 642(h)(2) excess deductions that are section 67(e) deductions may be included in a beneficiary’s net operating loss carryovers under section 172, separate from those it succeeds to from a terminated

estate or trust, is beyond the scope of these regulations. Because § 1.642(h)-2(a) is clear that excess deductions on termination of an estate or trust are not carried over to future years and that such deductions are separate from a net operating loss carryover from the estate or trust, the Treasury Department and the IRS do not adopt this comment.

Example 1

Section 1.642(h)-5(a), Example 1, of the proposed regulations ( Example 1 ) updates an existing example illustrating computations under section 642(h) when there is a net operating loss. Section 1.642-5(a)(2)(ii) of Example 1 explains that the beneficiaries of the estate cannot carry back any of the net operating loss of the terminating estate that was made available to them under section 642(h)(1).

Two commenters requested that Ex- ample 1 be revised to take into account the amendments to section 172(b)(1)(D) under sec. 2302(b) of the Coronavirus Aid, Relief, and Economic Security Act, Public Law 116-136, 134 Stat. 281 (2020) (CARES Act), by allowing a beneficiary to carry back the net operating loss carryover the beneficiary succeeds to under section 642(h)(1) for net operating losses arising in taxable years beginning after December 31, 2017, and before January 1, 2021. Under section 2303 of the CARES Act, net operating losses arising in taxable years beginning after December 31, 2017, and before January 1, 2021, generally may be carried back five years before being carried forward. One of these commenters further requested confirmation that a beneficiary is allowed a carryback of the net operating loss under section 642(h)(1) for net operating losses of an estate or trust arising in taxable years ending before January 1, 2018, to the extent the beneficiary succeeds to a net operating loss carryover attributable to those net operating losses on a termination of the estate or trust between January 1, 2018, and December 31, 2020. Unless otherwise provided under the Code, a net operating loss incurred by a taxpayer may only be used as a deduction by that taxpayer and cannot be transferred to another taxpayer for use by that other taxpayer. Calvin v. U.S . 354 F.2d 202 (10th Cir. 1965), Mellott v. U.S ., 257 F.2d 798 (3d

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Cir. 1958). As an exception to this general principle, section 642(h) provides that if, on termination of an estate or trust, the estate or trust has a net operating loss carryover under section 172, then such carryover is allowed as a deduction, in accordance with the regulations prescribed by the Secretary, to the beneficiaries succeeding to the property of the estate or trust. Section 1.642(h)1(a) provides that if, on the termination of an estate or trust, a net operating loss carryover under section 172 would be allowable to the estate or trust in a taxable year subsequent to the taxable year of termination but for the termination, a carryover is allowed under section 642(h)(1) to the beneficiaries succeeding to the property of the estate or trust. In addition, § 1.642(h)-1(b) provides that the first taxable year of the beneficiary to which the net operating loss will be carried over is the taxable year of the beneficiary in which or with which the estate or trust terminates.

Section 642(h)(1) provides a specific rule that allows the beneficiary to succeed to a net operating loss carryover of the estate or trust and deduct the amount of the net operating loss over the remaining carryover period that would have been allowable to the estate or trust but for the termination of the estate or trust. The phrase in section 642(h)(1) “the estate or trust has a net operating loss carryover ’” means that the estate or trust incurred a net operating loss and either already carried it back to the earliest allowable year under section 172 or elected to waive the carryback period under section 172(b)(3), and now is limited to carrying over the remaining net operating loss. Accordingly, because the net operating loss is a carryover for the estate or trust, the beneficiary succeeding to that net operating loss may, under section 642(h)(1), only carry it forward. The CARES Act amendments to section 172(b) mentioned by the commenters allow taxpayers a five-year carryback of certain net operating losses incurred by that taxpayer. The CARES Act amendments do not change the result that a beneficiary succeeding to the net operating loss carryover of a terminated estate or trust may only carryover that net operating loss in the same manner as the terminated estate or trust, but for the termination. Consequently, the Treasury Department and the IRS do not adopt these comments and add a citation to

§ 1.642(h)-1 to reference the rule that a beneficiary that succeeds to a net operating loss carryover of a terminated estate or trust may only carry forward the net operating loss.

Example 2

Section § 1.642(h)-5(b), Example 2, of the proposed regulations ( Example 2 ) demonstrates computations under section 642(h)(2). The expenses in Example 2 include rental real estate taxes in an attempt to illustrate a deduction subject to limitation under section 164(b)(6) to the beneficiary that must be separately stated as provided in § 1.642(h)-2(b)(1).

Multiple commenters noted that Ex- ample 2 raises several issues that could be potentially relevant to that example, such as whether the decedent was in a trade or business and the application of section 469 to estates and trusts. To avoid these issues, which are extraneous to the point being illustrated, one commenter suggested that the example be revised so that the entire amount of real estate expenses on rental property equals the amount of rental income. The Treasury Department and the IRS did not intend to raise such issues in the example and consider both issues to be outside the scope of these regulations. Accordingly, the Treasury Department and the IRS adopt the suggestion by the commenter and modify Example 2 to avoid these issues by having rental real estate expenses entirely offset rental income with no unused deduction.

Commenters also noted that Example 2 does not properly allocate rental real estate expenses because the example characterizes the rental real estate taxes as itemized deductions. These commenters asserted that real estate taxes on property held for the production of rental income are not itemized deductions but instead are allowed in computing gross income and cited to section 62(a)(4) as providing that ordinary and necessary expenses paid or incurred during the taxable year for the management, conservation, or maintenance of property held for the production of income under section 212(2) that are attributable to property held for the production of rents are deductible as above-the-line deductions in arriving at adjusted gross income. One commenter suggested that, if the goal of Example 2 is to illustrate state and local taxes passing through to the beneficiary, then the exam

ple should include state income taxes rather than real estate taxes on rental real estate. The Treasury Department and the IRS have revised this example in the final regulations to include personal property tax paid by the trust rather than taxes attributable to rental real estate.

Lastly, commenters noted that Example 2 does not demonstrate the broad range of trustee discretion in § 1.652(b)-3(b) and (d) for deductions that are not directly attributable to a class of income, or deductions that are, but which exceed such class of income, respectively. In response to these comments, the Treasury Department and the IRS have modified Example 2 to illustrate the application of trustee discretion as found in § 1.652(b)-3(b) and (d).

C. Applicability Dates

The proposed regulations provide that the changes to §§ 1.67-4, 1.642(h)-2, and 1.642(h)-5 apply to taxable years beginning after the date the regulations are published as final. The preamble to the proposed regulations explains that estates, non-grantor trusts, and their beneficiaries may rely on the proposed regulations under section 67 for taxable years beginning after December 31, 2017, and on or before the date these regulations are published as final. Taxpayers may also rely on the proposed regulations under section 642(h) for taxable years of beneficiaries beginning after December 31, 2017, and on or before the date the regulations are published as final, in which an estate or trust terminates.

One commenter requested that § 1.642(h)-2 of the proposed regulations be applied retroactively not only to taxable years beginning after December 31, 2017, but to all open years. The commenter as serted that the existing regulation treating excess deductions on termination of an estate or trust as a miscellaneous itemized deduction was in error. As an example, the commenter argues that the current regulations mistakenly describe section 67(e) expenses as an exception to the rules applicable to miscellaneous itemized deductions, and therefore requested that the final regulations be applicable to all open years. The Treasury Department and the IRS have the authority to treat an excess deduction on termination of an estate or trust as a single miscellaneous itemized deduction. See

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section 642(h). The suspension under section 67(g) of miscellaneous itemized deductions caused the Treasury Department and the IRS to reconsider the treatment of excess deductions under section 642(h)(2) because the Treasury Department and the IRS do not interpret section 67(g) as suspending such deductions allowable under section 642(h)(2). The Treasury Department and the IRS interpret section 67(g) as not disallowing excess deductions succeeded to beneficiaries from terminated estates and trusts under section 642(h)(2). Therefore, taxpayers may rely on these regulations as of the effective date of section 67(g), but not for earlier periods. The final regulations apply to taxable years beginning after October 19, 2020. Pursuant to section 7805(b)(7), taxpayers may choose to apply the amendments to § 1.67-4 and §§ 1.642(h)-2 and 1.642(h)-5 set forth in this Treasury decision to taxable years beginning after December 31, 2017, and on or before October 19, 2020.

Special Analysis

These regulations are not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations. Therefore, a regulatory impact assessment is not required.

Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that the amount of time necessary to report the required information will be minimal in that it requires fiduciaries of estates and trusts to provide on the Schedule K-1 (Form 1041) issued to beneficiaries information that is already maintained and reported to the IRS on Form 1041. Moreover, it should take an estate or trust no more than 2 hours to satisfy the information requirement in these regulations. Accordingly, the Secretary certifies that the rule will not have a significant economic impact on a substantial number of small entities.

Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking that preceded these regulations was submitted to

the Chief Counsel for the Office of Advocacy of the Small Business Administration for comment on its impact on small businesses, and no comments were received.

Paperwork Reduction Act (PRA)

The collection of information related to these regulations under section 642(h) is reported on Schedule K–1 (Form 1041), Beneficiary’s Share of Income, Deductions, Credits, etc ., and has been reviewed in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) and approved by the Office of Management and Budget under control number 1545–0092. The collection of information in these regulations is in § 1.642(h)–2(b)(1). The IRS requires this information to ensure that excess deductions on an estate’s or trust’s termination that are subject to additional applicable limitations retain their character when taken into account by beneficiaries on their returns. The respondents will be estates, trusts, and their fiduciaries.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget. Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by section 6103.

Drafting Information

The principal author of these regulations is Margaret Burow of the Office of Associate Chief Counsel (Passthroughs and Special Industries). Other personnel from the Treasury Department and the IRS, however, participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1 . The authority citation for part 1 is amended by adding entries for §§ 1.67–4, 1.642(h)–2, and 1.642(h)– 5 in numerical order to read in part as follows:

Authority : 26 U.S.C. 7805 * * * Section 1.67–4 also issued under 26 U.S.C. 67(e).

Section 1.642(h)–2 also issued under 26 U.S.C. 642(h). Section 1.642(h)–5 also issued under 26 U.S.C. 642(h).

Par. 2 . Section 1.67–4 is amended by revising paragraph (a) and the heading of paragraph (d) and adding two sentences to the end of paragraph (d) to read as follows:

§ 1.67–4 Costs paid or incurred by estates or non-grantor trusts.

(a) Deductions— (1) Section 67(e) de- ductions —(i) In general . An estate or trust (including the S portion of an electing small business trust) not described in § 1.67–2T(g) (1)(i) (a non-grantor trust) must compute its adjusted gross income in the same manner as an individual, except that the following deductions (section 67(e) deductions) are allowed in arriving at adjusted gross income:

(A) Costs that are paid or incurred in connection with the administration of the estate or trust that would not have been incurred if the property were not held in such estate or trust; and

(B) Deductions allowable under section 642(b) (relating to the personal exemption) and sections 651 and 661 (relating to distributions).

(ii) Not disallowed under section 67(g) . Section 67(e) deductions are not itemized deductions under section 63(d) and are not miscellaneous itemized deductions under section 67(b). Therefore, section 67(e) deductions are not disallowed under section 67(g). (2) Deductions subject to 2-percent floor . A cost is not a section 67(e) deduction and thus is subject to both the 2-percent floor in section 67(a) and section 67(g) to the extent that it is included in the definition of miscellaneous itemized deductions under section 67(b), is incurred by an estate or non-grantor trust (includ

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ing the S portion of an electing small business trust), and commonly or customarily would be incurred by a hypothetical individual holding the same property.

(d) Applicability date . * * * Paragraph (a) of this section applies to taxable years beginning after October 19, 2020. Taxpayers may choose to apply paragraph (a) of this section to taxable years beginning after December 31, 2017, and on or before October 19, 2020.

Par. 3 . Section 1.642(h)–2 is amended by:

Revising paragraph (a).
Redesignating paragraph (b) as paragraph (d) and adding a heading for newly redesignated paragraph (d).
Redesignating paragraph (c) as paragraph (e) and adding a heading for newly redesignated paragraph (e).
Adding new paragraphs (b) and (c) and paragraph (f).

The revisions and additions read as follows:

§ 1.642(h)–2 Excess deductions on termination of an estate or trust.

(a) Excess deductions —(1) In general . If, on the termination of an estate or trust, the estate or trust has for its last taxable year deductions (other than the deductions allowed under section 642(b) (relating to the personal exemption) or section 642(c) (relating to charitable contributions)) in excess of gross income, the excess deductions as determined under paragraph (b) of this section are allowed under section 642(h)(2) as items of deduction to the beneficiaries succeeding to the property of the estate or trust.

(2) Treatment by beneficiary . A beneficiary may claim all or part of the amount of the deductions provided for in paragraph (a) of this section, as determined after application of paragraph (b) of this section, before, after, or together with the same character of deductions separately allowable to the beneficiary under the Internal Revenue Code for the beneficiary’s taxable year during

which the estate or trust terminated as provided in paragraph (c) of this section.

(b) Character and amount of excess deductions —(1) Character . The character and amount of the excess deductions on termination of an estate or trust will be determined as provided in this paragraph (b). Each deduction comprising the excess deductions under section 642(h)(2) retains, in the hands of the beneficiary, its character (specifically, as allowable in arriving at adjusted gross income, as a non-miscellaneous itemized deduction, or as a miscellaneous itemized deduction) while in the estate or trust. An item of deduction succeeded to by a beneficiary remains subject to any additional applicable limitation under the Internal Revenue Code and must be separately stated if it could be so limited, as provided in the instructions to Form 1041, U.S. Income Tax Return for Estates and Trusts, and the Schedule K–1 (Form 1041), Beneficiary’s Share of Income, De- ductions, Credit, etc ., or successor forms.

(2) Amount . The amount of the excess deductions in the final year is determined as follows:

(i) Each deduction directly attributable to a class of income is allocated in accordance with the provisions in § 1.652(b)–3(a);

(ii) To the extent of any remaining income after application of paragraph (b)(2) (i) of this section, deductions are allocated in accordance with the provisions in § 1.652(b)–3(b) and (d); and (iii) Deductions remaining after the application of paragraph (b)(2)(i) and (ii) of this section comprise the excess deductions on termination of the estate or trust. These deductions are allocated to the beneficiaries succeeding to the property of the estate or trust in accordance with § 1.642(h)–4.

(c) Year of termination —(1) In general . The deductions provided for in paragraph (a) of this section are allowable only in the taxable year of the beneficiary in which or with which the estate or trust terminates, whether the year of termination of the estate or trust is of normal duration or is a short taxable year.

(2) Example . Assume that a trust distributes all its assets to B and terminates on December 31, Year X. As of that date, it has excess deductions of $18,000, all characterized as allowable in arriving at adjusted gross income under section 67(e). B, who reports on the calendar year basis, could claim the $18,000 as a deduction allowable in arriving at B’s adjusted gross income for Year X. However, if the deduction (when added to other allowable deductions that B claims for the year) exceeds B’s gross income, the excess may not be carried over to any year subsequent to Year X.

(d) Net operating loss carryovers . * * * (e) Items included in net operating loss or capital loss carryovers . * * *

(f) Applicability date . Paragraphs (a) through (c) of this section apply to taxable years beginning after October 19, 2020. The rules applicable to taxable years beginning on or before October 19, 2020, are contained in § 1.642(h)-2 as in effect prior to October 19, 2020 (see 26 CFR part 1 revised as of April 1, 2020). Taxpayers may choose to apply paragraphs (a) through (c) of this section to taxable years beginning after December 31, 2017, and on or before October 19, 2020. Par. 4 . Section 1.642(h)–5 is revised to read as follows:

§ 1.642(h)–5 Examples.

Paragraphs (a) and (b) of this section ( Examples 1 and 2 ) illustrate the application of section 642(h).

(a) Example 1: Computations under section 642(h) when an estate has a net operating loss —(1) Facts . On January 31, 2020, A dies leaving a will that provides for the distribution of all of A’s estate equally to B and an existing trust for C. The period of administration of the estate terminates on December 31, 2020, at which time all the property of the estate is distributed to B and the trust. For tax purposes, B and the trust report income on a calendar year basis. During the period of administration, the estate has the following items of income and deductions:

Table 1 to Paragraph (a)(1)

Income Taxable interest ……………………………………………………………………………… $2,500 Business income ……………………………………………………………………………… 3,000

Total income ……………………………………………………………………………………………………… 5,500

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Table 2 to Paragraph (a)(1)

Deductions Business expenses (including administrative expense allocable to business income) ……………… 5,000 Administrative expenses not allocable to business income that would not have been incurred if property had not been held in a trust or estate (section 67(e) deductions) …………………………………… 9,800

Total deductions ………………………………………………………………………………………………….…. 14,800

(2) Computation of net operating loss . (i) The amount of the net operating loss carryover is computed as follows:

Table 3 to Paragraph (a)(2)(i)

Gross income ………………………………………………………………………….......... $5,500 Total deductions ……………………………………………..………… 14,800 Less adjustment under section 172(d)(4) (allowable non-business expenses ($9,800) limited to non-business income ($2,500)) ……………………… 7,300

Deductions as adjusted ……………………………………………………………………..… 7,500

Net operating loss ……………………………………………………………………………………………......…... 2,000

(ii) Under section 642(h)(1), B and the trust are each allocated $1,000 of the $2,000 unused net operating loss carryover of the terminated estate in 2020, with the allowance of any net operating loss carryover to B and the trust determined under section 172. Neither B nor the trust can carry back any of the net operating loss of A’s estate made available to them under section 642(h)(1). See § 1.642(h)1(b). (3) Section 642(h)(2) excess deduc- tions . The $7,300 of non-business deduc

tions not taken into account in determining the net operating loss of the estate are excess deductions on termination of the estate under section 642(h)(2). Under § 1.642(h)–2(b)(1), such deductions retain their character as section 67(e) deductions. Under § 1.642(h)–4, B and the trust each are allocated $3,650 of excess deductions based on B’s and the trust’s respective shares of the burden of each cost.

(4) Consequences for C . The net operating loss carryover and excess deductions

are not allowable directly to C, the trust beneficiary. To the extent the distributable net income of the trust is reduced by the net operating loss carryover and excess deductions, however, C may receive an indirect benefit from the carryover and excess deductions.

(b) Example 2: Computations under section 642(h)(2) —(1) Facts . D dies in 2019 leaving an estate of which the residuary legatees are E (75%) and F (25%). The estate’s income and deductions in its final year are as follows:

Table 4 to Paragraph (b)(1)

Income Dividends ………………………………………………………………………………... $3,000 Taxable Interest ……………………………………………………………………………... 500 Rent ……………………………………………………………………………………….. 2,000 Capital Gain ………………………………………………………………………………. 1,000

Total Income …………………………………………………….………………………………………. 6,500

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Table 5 to Paragraph (b)(1)

Deductions Section 62(a)(4) deductions: Rental real estate expenses ……………………………………………………… 2,000

Section 67(e) deductions: Probate fees ………………………………………………………… 1,500 Estate tax preparation fees ………………………….……………… 8,000 Legal fees ……………………………………..……………………. 2,500 Total Section 67(e) deductions …………………………………….………12,000 Non-miscellaneous itemized deductions: Personal property taxes ………………………………………………………….. 3,500 Total deductions ………………………….………………………………… ~~………~~ …… 17,500

(2) Determination of character . Pursuant to § 1.642(h)–2(b)(2), the character and amount of the excess deductions is determined by allocating the deductions among the estate’s items of income as provided under § 1.652(b)–3. Under § 1.652(b)–3(a), the $2,000 of rental real estate expenses is allocated to the $2,000 of rental income. In the exercise of the executor’s discretion pursuant to § 1.652(b)–3(b), D’s executor allocates $3,500 of personal property taxes and $1,000 of section 67(e) deductions to the remaining income. As a result, the excess deductions on termination of the estate are $11,000, all consisting of section 67(e) deductions. (3) Allocations among beneficiaries . Pursuant to § 1.642(h)–4, the excess deductions are allocated in accordance

with E’s (75 percent) and F’s (25 percent) interests in the residuary estate. E’s share of the excess deductions is $8,250, all consisting of section 67(e) deductions. F’s share of the excess deductions is $2,750, also all consisting of section 67(e) deductions. (4) Separate statement . If the executor instead allocated $4,500 of section 67(e) deductions to the remaining income of the estate, the excess deductions on termination of the estate would be $11,000, consisting of $7,500 of section 67(e) deductions and $3,500 of personal property taxes. The non-miscellaneous itemized deduction for personal property taxes may be subject to limitation on the returns of both B and C’s trust under section 164(b) (6)(B) and would have to be separately stated as provided in § 1.642(h)–2(b)(1).

(c) Applicability date . This section is applicable to taxable years beginning after October 19, 2020. Taxpayers may choose to apply this section to taxable years beginning after December 31, 2017, and on or before October 19, 2020.

Sunita Lough, Deputy Commissioner for Services

and Enforcement.

Approved: September 16, 2020.

David J. Kautter, Assistant Secretary of the Treasury

(Tax Policy).

(Filed by the Office of the Federal Register on October 16, 2020, 8:45 a.m., and published in the issue of the Federal Register for October 19, 2020, 85 F.R. 66219)

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