The One Big Beautiful Bill Act (OBBBA) introduced a new limitation on itemized deductions under IRC §68 that could have significant implications for Distributable Net Income (DNI) planning, trust distribution deductions and fiduciary income tax planning. Although the provision is new, its potential application to trusts and estates raises questions regarding how certain distribution deductions may be treated for tax year 2026.
Most practitioners initially assumed that the new IRC §68 limitation would affect only traditional itemized deductions. Trust and estate distribution deductions under IRC §§651 and 661 were expected to remain fully deductible because IRC §67(e) historically treats those deductions as allowable in arriving at adjusted gross income. However, a footnote in the Joint Committee on Taxation’s technical explanation appears to reject that interpretation and instead concludes that distribution deductions under §§651 and 661 are itemized deductions for purposes of the new limitation.
The Joint Committee’s position has the potential to alter one of the fundamental principles of fiduciary income taxation. Historically, the distribution deduction under IRC §§651 and 661 has ensured that income distributed by a trust is taxed only once — typically to the beneficiary rather than the trust. If the new IRC §68 limitation applies to those deductions, as suggested by the Joint Committee’s footnote, that result may no longer hold true. A trust could distribute all of its DNI and yet be denied a portion of the corresponding deduction, leaving residual taxable income subject to tax at the trust level.
Given the compressed income tax brackets applicable to trusts, many non-grantor trusts could encounter this issue even at relatively modest levels of income. The following is an example of the 2/37 impact on DNI:
IRC Sec. 68(a) reduces itemized deductions for trusts and estates by 2/37 of the lesser of itemized deductions or taxable income in excess of where the 37% bracket begins effective January 1, 2026.
| Pre-2026 | 2026 | |
|---|---|---|
| Trust Income | $1,000,000 | $1,000,000 |
| Distributions | ($1,000,000) | ($1,000,000) |
| 2% Cut-Back Applied | – | $53,189 |
| Income Distribution Deduction | ($1,000,000) | ($946,811) |
| Taxable Income | – | $53,189 |
| Tax Due | – | $17,611 |
| 2% Cut-Back Computation | ||
| Itemized Deductions (A) | $1,000,000 | |
| Taxable Income Above 37% Bracket (B) | $984,000* | |
| Lesser of (A) or (B) Above | $984,000 | |
| 2/37 Limitation | $53,189 |
Whether the Treasury Department and the IRS ultimately adopt the Joint Committee’s interpretation remains to be seen. Nevertheless, the footnote raises a significant question regarding the continued treatment of distribution deductions under IRC §§651 and 661 and the potential impact on longstanding DNI planning strategies for trusts and estates.
Fiduciaries and advisors should closely monitor future guidance and evaluate whether projected trust distributions could result in unexpected trust-level income tax exposure beginning in tax year 2026.
For more information on this topic, please contact a member of our Private Client Services Team.
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