Tax Law Changes in OBBBA May Require New Planning Strategies for Non-Grantor Trusts, Estates and Their Beneficiaries By Patricia Giarratano, CPA
Included in the Joint Committee on Taxation’s (JCT’s) recently released Blue Book report, lawmakers clarify a provision in the One Big Beautiful Bill Act (OBBBA) that introduces new limits on itemized deductions claimed by taxpayers in the top tax bracket and extends them to non-grantor trusts and estates for the first time. The result could have a meaningful impact on a significant number of trusts and their beneficiaries, including risks of double taxation and potential increases to both taxable income and the amount of taxes due.
Background
Before 2018, tax law required high-net-worth taxpayers in the top tax bracket with adjusted gross income (AGI) exceeding specified thresholds to reduce certain miscellaneous itemized deductions by 3 percent, up to a maximum of 80 percent of all allowable itemized deductions. A provision in the law specifically excluded trusts and estates from this deduction cap, known as the Pease limitations.
The Tax Cuts and Jobs Act (TCJA) subsequently suspended these limits for tax years beginning after Dec. 31, 2018, and through Dec. 31, 2025, enabling wealthy taxpayers previously subject to the Pease limitation to fully deduct their allowable itemized expenses during those periods. However, rather than allowing the Pease limitations to return in 2026, the OBBBA permanently suspended them, effective July 4, 2025, along with the exclusion for trusts and estates.
In its place, the OBBBA introduced a new cap on itemized deductions for taxpayers in the top tax brackets equal to 2/37, or approximately 5.4 percent, of the lesser of:
- their total itemized deductions otherwise allowed for the year, or
- the amount of annual taxable income that exceeds the dollar amount at which the 37 percent tax bracket begins.
The Challenges for Trusts
For individuals, the top income tax bracket of 37 percent applies in 2026 when income exceeds $640,600, or $768,700 for married couples filing jointly. This means that the 2/37 reduction on itemized deductions applies solely to a small pool of very top earners.
By contrast, the 37 percent tax bracket for trusts applies in 2026 when trust income exceeds $16,000, a low threshold that many trusts will surpass. Pending additional guidance, it appears that many trusts will be limited in their ability to fully claim deductions for charitable contributions, even when those donations are authorized by the trust’s governing documents and made from trust income, rather than principal. The same 2/37th haircut also applies to deductions for legal, accounting and executor fees associated with the administration of a trust or estate. Even more troubling is the effect the OBBBA will have on the deduction trusts and estates have long enjoyed on their distributive net income (DNI).
DNI is a tax concept that refers to the maximum amount a trust or estate can distribute to its beneficiaries, either at the trustee’s discretion or as mandated by the trust’s terms. Generally, a trust receives a tax deduction for certain distributions to beneficiaries, who, in turn, report those amounts as taxable income on their individual tax returns. In this sense, the DNI deduction prevents the risk of double taxation, reducing the trust’s taxable income and shifting the tax burden to the individual beneficiaries who are likely in a lower tax bracket than the trust. According to the JCT Blue Book, this is not necessarily the case when considering the OBBBA’s new limits on itemized deductions and their application to trusts beginning in 2026.
Essentially, the Blue Book highlights a critical structural flaw: the IRC Section 68 limitation on itemized deductions can be applied twice to the same pool of income, affecting the trust’s distributive net income deduction and inflating beneficiaries’ individual tax liabilities.
As an example, consider an irrevocable non-grantor trust with $116,000 of ordinary income in 2026 that distributes 100 percent of its income to a high-earning beneficiary. The trust’s excess income (above the $16,000 threshold for the 37 percent tax bracket) is $100,000. That amount is reduced by 2/37 under the OBBBA, resulting in a $5,405.41 reduction to the trust’s allowable deduction. Therefore, even though the trust distributed all its cash to the beneficiary, its allowable deduction drops from $116,000 to $110,594.59, leaving it subject to a 37 percent tax on the remaining $5,405.41 of phantom income.
The new law can be equally distressing for the beneficiary in the top 37 percent tax. Ultimately, the same DNI could cause the taxpayer to face the itemized deduction haircut as well as the trust.
With this in mind, grantors, trustees and beneficiaries should work with their trusted advisors to assess how the OBBBA may affect their tax efficiency and consider implementing strategies to minimize its impact. This may include leveraging the tax code’s 65-day rule, which gives trustees additional time after the close of a calendar year to shift income subject to tax at the highest individual rates to beneficiaries who are often in lower tax brackets, thereby reducing the tax burdens of both the trust and its beneficiaries. Alternatively, consideration may be given to designing a beneficiary defective grantor trust (BDGT) in which the primary beneficiary is treated as the grantor for income tax purposes.
About the Author: Patricia Giarratano, CPA, is a managing director of Tax and Wealth with Baker Tilly x Berkowitz Pollack Brant, where she works with high-net-worth clients and business owners to develop comprehensive, tax-efficient estate, trust, gift tax and income plans. She can be reached at the CPA firm’s West Palm Beach, Fla., office at (561) 361-2050 or info@bpbcpa.com.
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