Knight v. Commissioner: Calculating Estate Costs and Itemized Deductions

Knight v. Commissioner: Calculating Estate Costs and Itemized Deductions

Phillip R. Fink, J.D., Professor of Accounting at the University of Toledo and noted author, provides an analysis of the landmark Supreme Court case of Knight v. Comm'r, 552 U.S. 181 (U.S. 2008), interpreting IRC Section 67(e)(1) regarding the deduction of costs for the administration of an estate or trust in computing the adjusted gross income for estates and trusts in the context of the 2-percent floor on miscellaneous itemized deductions. 

Professor Fink writes: This landmark Supreme Court case attempts to resolve a conflict among the Circuit Courts of Appeal on the interpretation of IRC Section 67(e)(1). It is hoped that the ruling in this case will provide a uniform standard for determining when investment advisory fees are subject to the 2% rule of IRC Section 67(e)(1). Knight v. Comm'r, 552 U.S. 181 (U.S. 2008).

In general, the tax laws state that the taxable income for an estate or trust will be computed in the same manner as for an individual unless otherwise stated. However, IRC Section 67(e)(1) differentiates the tax treatment for miscellaneous expenses of individuals on the one hand, and estates and trusts on the other. Miscellaneous itemized deductions are generally allowed only to the extent that they exceed 2% of adjusted gross income. IRC Section 67(e)(1) allows a full deduction for estates and trusts if two requirements are met. First, expenses must be paid or incurred in connection with the administration of an estate or trust. Second, such costs would not have been incurred if the property were not held in an estate or trust. In other words, the expense in question would not have been incurred had the property been owned outright by an individual.
 
*                              *                              *
 
The court ruled that in order for an expense not to be subject to the 2% rule, it must be an expense that is unique to the administration of an estate or trust. In other words, an expense incurred by an estate or trust is not subject to the 2% rule if it would not be “commonly” or “customarily” incurred by individuals. Thus, in asking whether a particular type of cost “would not have been incurred” if the property were held by an individual, IRC Section 67(e)(1) excepts from the 2% rule only those costs that would be uncommon (or unusual, or unlikely) for such a hypothetical individual to incur. Since many individuals do incur the expense of an investment adviser, this type of an expense is not unique to a trust; and therefore, is subject to the 2% rule.

Comments

Philip R. Fink, J.D.
  • 07-02-2008

The devil's in the details as to whether costs incurred in estate or trust administration would or would not be uncommonly, unusually or unlikely incurred by individuals.  The fact-driven nature of the principle is prone to ongoing challenges.