Trust post-termination legal fees

[joshuabarksatlcs]

A year after selling an inherited rental from husband's living trust, the widow/trustee is sued by his son (not a beneficiary).   The trust assets (cash from the sale) had been distributed, final return was filed for 2021 (the year the rental was sold.)  NOL and Excess  Deductions on Termination were passed through on the 2021 K-1's and written off by the beneficiaries.

Are the legal fees paid in 2023 a misc deduction subject to 2% (that simply got swept under the tax carpet under TCJA 2018), or are they deductible in another way without reviving the Trust?

[BobKamman]

Not sure it makes any difference, but is she being sued in her individual capacity, or as trustee, or both?  

Courts have been known to award attorney fees to the prevailing party in such cases.  

[sjrcpa]

And what was the nature of the suit? Something to do with the rental?

Or wicked stepmom stole my inheritance?

[joshuabarksatlcs]

Yep.  Wicked stepmom stole my inheritance.  Boo hoo.

I think any reimbursement of legal fees down the road will be reported under the tax benefit rule in the year of receipt.  In the meantime, I wonder if the fees paid in 2023 and 2024 could be in the nature of other than Sch A 2% misc.

[BobKamman]

One person's opinion:

Litigation-Related Expenses

Administration expenses are those that are actually and necessarily incurred in the administration of the decedent’s estate; for example, for the collection of assets, payment of debts, and distribution of property. These may include legal fees incurred by the fiduciary, which are usually deductible for estate tax purposes. However, expenditures that are not essential to the settlement of the estate, but that are incurred for the individual benefit of the decedent’s heirs, may not be taken as deductions. For the expenditure to be allowable as an administration expense, it must have benefited the estate as a whole, as contrasted with the personal benefit of a beneficiary. This distinction is often difficult to make.

https://www.nyestatelitigationblog.com/2013/12/articles/probate/tax-considerations-in-will-contests/

[joshuabarksatlcs]

Let's say the legal expenses (or a determined portion) benefited the trust.  The issue here is that the trust has been terminated.  EDOT of Section 67(e)  expenses is allowed only in the final year.   So, it seems, even if the fees are related to the trust, they would be misc. deduction subject to 2%, which isn't deductible for federal tax purposes.  I just wondered if there's another way to deduct such a post-termination portion other than Sch A misc deduction subject to 2%.

[BobKamman]

The trust is dead; long live the beneficiary, but it's her problem now.  Seems to me it was a tactical move for the stepson to wait until the trust was terminated.  How is claiming its expenses on a 1041, any different from claiming them on the deceased grantor's 1040?  (Don't answer that, just thinking out loud.)  I'm not even sure the deduction would be allowed if we could still put miscellaneous deductions on Schedule A.  It has nothing to do with the production of income, unless perhaps an IRA distribution is involved.  

[joshuabarksatlcs]

Perhaps I didn't make it clear in my initial posting that it was a rental property.

Say you owned an office building (Sch E) in your living trust.  Someone sued you, saying he owned a portion of the property.  Wouldn't the legal fee be ordinary and necessary for defending the title of the property, which produced income for you?  I would say you'd make a good case deducting the expenses on Sch E, instead of on Sch A.  At the minimum, it would add to the basis, as it was an action for the title.

[BobKamman]

If I still owned the building, the legal fees could probably be claimed on Schedule E.  But if I never owned or rented the building myself -- it was sold by an irrevocable trust, of which I was the beneficiary -- then two years later I would be looking at strictly personal expenses.  The mistake was distributing the funds when the trust still had exposure to claims.  Bad advice then does not lead to a deduction for good advice needed now.  

[joshuabarksatlcs]

Points are well taken.

Yet, If you never owned the building, but after two years of the trust termination, the rental had a windfall, like an unexpected payment of back rent, wouldn't you have to pay tax on it?  Heads you lose, tails government wins?  

[BobKamman]

Best just to add this to your collection of "lies that the people who market living trusts tell."  

Avoid probate!  Well, OK, but you can still end up in court, with the same evidence needed and law followed in a will contest.  At least in my state, the venue is Probate Court (technically, the Probate Division of the Superior Court).  

[joshuabarksatlcs]

Well, I may be stepping right into the arena of PLWL (Practicing Law without a License" ... but it seems the "Avoide Probate" part still holds, while any boosting of "Avoid Will Protest" doesn't.