Key Takeaways
- New Internal Revenue Code (IRC) Section 68 may limit trust and estate deductions beginning in 2026, reducing the tax benefit of itemized deductions by about 5.4%.
- Joint Committee on Taxation (JCT) guidance suggests beneficiary distribution deductions and other trust deductions may be subject to IRC Section 68 limits.
- Limiting income distribution and charitable deductions could create trust-level taxable income, increase double-taxation risk and affect fiduciary tax planning.
For decades, fiduciaries have relied on a fundamental principle of Subchapter J of the Internal Revenue Code (IRC): income distributed from a trust or estate generally should not be taxed twice. The income distribution deduction has historically allowed trusts and estates to deduct distributed income while beneficiaries report the corresponding taxable amounts on their own returns. Similarly, IRC Section 642(c) has long permitted trusts and estates to claim charitable deductions under rules that are generally more favorable than those applicable to individuals.
Beginning in 2026, however, that longstanding framework may be challenged.
Recent guidance from the Joint Committee on Taxation (JCT) suggests that the new limitation under IRC Section 68 may apply to trusts and estates, raising concerns for fiduciaries, beneficiaries and advisors who routinely rely on income distribution and charitable deductions as part of trust and estate planning and administration.
Background and Tax Law Changes
The One Big Beautiful Bill Act (OBBBA) replaced the former Pease limitation with a new IRC Section 68 limitation on itemized deductions for tax years beginning after December 31, 2025. Under the new rule, taxpayers in the highest marginal tax bracket effectively receive only a 35% tax benefit from affected itemized deductions. Mechanically, the limitation reduces otherwise allowable deductions by 2/37, or approximately 5.4%. For example, $100,000 in deductions could be reduced by as much as $5,405.
Historically, the income distribution deduction under IRC Sections 651 and 661 has served as a mechanism to prevent double taxation by allowing trusts and estates to deduct income distributed, or required to be distributed, to beneficiaries. Similarly, IRC Section 642(c) permits trusts and estates to deduct certain charitable contributions made pursuant to the governing instrument.
Trusts and estates were expressly exempt from the former Pease limitation. As a result, the principal limitation on the income distribution deduction was that it could not exceed distributable net income (DNI), while charitable deductions under Section 642(c) generally were not subject to the percentage limitations applicable to individuals.
Uncertainty has arisen from OBBBA’s removal of the statutory language that previously exempted trusts and estates from Section 68. In footnote 102 of its May 2026 Bluebook, the JCT took the position that trusts and estates are subject to the new limitation and that itemized deductions include the personal exemption under Section 642(b) and the beneficiary distribution deductions under Sections 651 and 661.
Tax Implications to Trusts and Their Advisors
This interpretation is particularly significant because non-grantor trusts reach the highest federal income tax bracket at only $16,000 of taxable income in 2026. Consequently, even a modest limitation on deductions could produce meaningful tax consequences.
Under traditional trust taxation principles, a trust that distributes all of its DNI generally avoids income tax at the trust level because it receives a corresponding distribution deduction, with the beneficiaries reporting the income instead. If income distribution deductions are limited under Section 68, a trust may no longer be able to fully offset distributed income, potentially resulting in trust-level taxable income despite a full distribution to beneficiaries.
For example, if the full 2/37 reduction applies, a trust distributing $1 million of DNI could see its deduction reduced by approximately $54,000 under the JCT’s interpretation. The result would be trust-level taxable income despite a full distribution to beneficiaries, creating a form of economic double taxation that Subchapter J has historically been designed to avoid.
The issue may become even more pronounced in multi-tier trust structures. Where income passes through multiple trusts before reaching the ultimate beneficiary, the application of a separate Section 68 limitation at each level could create a cascading reduction in available deductions. If each trust in the chain is subject to a separate Section 68 limitation, the reduction could compound as income moves through multiple entities.
The JCT’s reasoning may also extend beyond income distribution deductions. Because the Bluebook broadly characterizes trust and estate itemized deductions, practitioners have questioned whether charitable deductions under IRC Section 642(c), as well as deductions for income in respect of a decedent under IRC Section 691(c), could also be subject to the limitation. If so, trusts and estates could lose a portion of deductions that historically have been available to offset taxable income.
Outlook for Technical Correction or Changes
The Bluebook is only an interpretation of OBBBA and is not binding law. There are strong technical arguments that Congress did not intend to limit charitable and other deductions for trusts and estates, and many practitioners expect either IRS guidance or a technical correction to address the issue.
For now, however, the matter remains unresolved and evolving. We will continue to monitor future Treasury guidance, IRS pronouncements and legislative developments that could clarify the application of Section 68 to trusts and estates. Until then, fiduciaries and trusted advisors should closely monitor developments and revisit trust tax projections, charitable planning strategies, and beneficiary distribution assumptions. Trustees and executors should evaluate whether income distribution and charitable deductions could be limited, potentially leaving taxable income in a trust or estate where little or no federal income tax would previously have been due.
We Can Help
Our trust and estate professionals are actively evaluating these developments and their potential impact on existing trust structures, estate administration, charitable planning and beneficiary distribution strategies. Please contact your PKF O’Connor Davies client team to discuss how these developments may affect your trust, estate or family tax planning, or contact:
Bhakti Shah, JD, CPA
Partner
bshah@pkfod.com | 908.956.0464
Laura Rodriguez, JD
Manager
lrodriguez@pkfod.com | 914.341.7025