2/37 ‘haircut’ pushes advisors to review estate plans

A federal change enacted in July 2025 that limits the value of itemized deductions — known as the 2/37 haircut because it can reduce deductions by 2/37ths — has created uncertainty about how trusts and estates are taxed. The rule was part of the One Big Beautiful Bill Act.

Estate planning specialists who spoke at a June 5 webinar hosted by Shenkman Tietz said the change affects how itemized deductions apply to estate and trust income and that key questions remain unanswered. Officials at the U.S. Department of the Treasury have not yet issued detailed guidance, leaving advisers and fiduciaries to prepare for possible clarifications.

The technical interaction at issue involves the limit on itemized deductions and the distributable net income deduction. That interaction can produce what practitioners refer to as “phantom income” on estate tax returns. Phantom income can shift tax liabilities among beneficiaries and trustees even when cash distributions follow the decedent’s wishes.

Robert Keebler, partner at Keebler & Associates, described a common fact pattern in which a decedent leaves income to a surviving spouse while the estate remainder goes to children from a prior marriage. Under the new rule, income intended for the spouse could result in tax consequences for the remainder beneficiaries. Keebler said representatives for the remainder beneficiaries might need to seek court action to avoid paying tax on income directed to the spouse.

The haircut also affects retirement account planning. Keebler said making an individual retirement account payable to a trust at death may be less attractive because the trust’s tax treatment combined with the new deduction limit can create unexpected liabilities for residual beneficiaries. One possible workaround mentioned at the webinar is naming charities as direct beneficiaries of IRAs to avoid the interaction entirely.

Speakers recommended steps advisers can take now. They advised reviewing beneficiary designations and trust terms, and coordinating with estate attorneys and certified public accountants to determine how tax allocations will be calculated. Keebler suggested beginning the allocation process within six to eight weeks after a death to reduce delay and administrative confusion. Jonathan Blattmachr, principal at Pioneer Wealth Partners, urged advisers to monitor Treasury notices for definitive rules.

Panelists said the issue is most likely to affect high-net-worth estates and trusts where itemized deductions and layered beneficiary arrangements make the math sensitive. Because the change was enacted with little public attention, many existing plans may not reflect the new rule and may require review.

Until regulators issue detailed guidance, advisers are being asked to lead client conversations about potential changes, the webinar participants said. They noted that resolving allocation questions could lengthen probate timelines and increase administrative costs while estates determine who bears taxes tied to distributable income.