Rev. Rul. 61-86

Advice has been requested regarding the deductibility of State income taxes paid by a fiduciary of an estate or trust which receives taxable income, tax-exempt interest income, and other exempt income.

Section 641(b) of the Internal Revenue Code of 1954 provides that the taxable income of an estate or trust shall be computed in the same manner as in the case of an individual, with certain exceptions not here material.

Section 164 of the Code provides, in part, as follows:

(A) GENERAL RULE.--Except as otherwise provided in this section, there shall be allowed as a deduction taxes paid or accrued within the taxable year.

Section 212 of the Code provides, in part, that in the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income.

State income tax imposed upon net income of estates and trusts is deductible from income under the provisions of section 164 of the Code in the same manner as in the case of an individual. Since State income tax is not an expense relating to the production of income, its deductibility by an estate or trust is not controlled by section 212 of the Code.

Section 265 of the Code provides, in part, as follows:

No deduction shall be allowed for--

(1) EXPENSES.--Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this subtitle, or any amount otherwise allowable under section 212 (relating to expenses for production of income) which is allocable to interest (whether or not any amount of such interest is received or accrued) wholly exempt from the taxes imposed by this subtitle.

From the foregoing, it is evident that section 265 of the Code prohibits the deduction of an item otherwise allowable as a deduction, which is attributable to tax-exempt interest income only if such item is deductible under section 212 of the Code as an expense related to the production of income. State income tax is not considered an expense for the production of income, deductible under section 212 of the Code. However, the portion of such tax allocable to exempt interest income is deductible under section 164 of the Code. State income tax attributable to the income of an estate or trust which is subject to the Federal income tax is also deductible under that section. However, any State income tax allocable to exempt income, other than exempt interest income, is nondeductible under section 265 of the Code.

Accordingly, it is held that in the case of an estate or trust only that portion of its State income taxes which is allocable to exempt income, other than exempt interest income, is nondeductible under section 265 of the Code. That portion of such taxes attributable to exempt interest income and to income subject to the Federal income tax is deductible under section 164 of the Code.