Deduction of Investment Advisory Expenses for Estates and Trusts

Deduction of Investment Advisory Expenses for Estates and Trusts

Editor's Note: This article is excerpted from Matthew Bender's How to Save Time and Money Preparing Fiduciary Income Tax Returns.*

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Trusts and estates may deduct ordinary and necessary administration or nonbusiness expenses paid or incurred during the tax year in the same manner as individuals deduct nonbusiness expenses. [IRC §§ 212, 641; Treas Reg §§ 1.212-1(i), 1.641(b)-1.] Estates and trusts are allowed miscellaneous itemized deductions to the extent that those expenses exceed 2 percent of adjusted gross income. [IRC § 67.] In Knight v. Commissioner, the Supreme Court held that the deduction of costs for outside investment advice paid by a trust is subject to the 2-percent floor. Under this ruling, the deduction escapes application of the 2-percent floor only if the costs are not of a type that would "commonly" or "customarily" be incurred by individuals. [Knight v. Comm'r, 552 U.S. 181 (U.S. 2008), affg, 467 F.3d 149 (2d Cir. 2006).] The decision resolved a conflict among the United States Circuit Courts of Appeal, and the Service has issued proposed regulations consistent with the decision in Knight v. Commissioner. [76 FR 55322.]

ANALYSIS:

Deductibility of an Estate or Trust's Administration Expenses. ... In order to be deductible, the expenses must be ordinary and necessary in administering the trust or estate and be paid or incurred during the tax year. [IRC § 212, Treas Reg §§ 1.212-1(a).] In addition, the expenses must be:

  1. for the production or collection of income;
  2. for the management, conservation or maintenance of property held for the production of income; or
  3. in connection with the determination, collection or refund of any tax. [IRC § 212.]

Expenses attributable to tax-exempt income are not deductible. [IRC § 265.]

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Expenses incurred in connection with the termination of a trust or estate and the distribution of its assets are fully deductible as administration expenses, even though their connection with the production of income may be remote. [Trust of Bingham v. Commissioner, 325 U.S. 365 (U.S. 1945), Commissioner v. Goldberger's Estate, 213 F.2d 78 (3d Cir. 1954); New York Trust Co. v. United States, 115 F. Supp. 661 (S.D.N.Y. 1953)Treas Reg § 1.212-1(b).] These expenses may include any necessary court and legal fees, accounting fees or fees for transfer of title.

No deduction is allowed for expenses incurred for maintenance of nonincome producing property such as a family residence, even though the terms of the will or trust may require the fiduciary to make these expenditures. [
Alfred I. Du Pont Testamentary Trust v. Commissioner, 514 F.2d 917 (5th Cir. 1975); Fuller v. Commissioner, 9 T.C. 1069 (T.C. 1947), aff'd per curiam, 171 F.2d 704 (3d Cir. 1948).] However, these expenses may be deductible on the estate tax return. [Treas Reg § 20.2053-3(d)(1). See Clark, How to Save Time & Taxes Handling Estates (Matthew Bender).]

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Miscellaneous Itemized Deductions. ... Miscellaneous itemized deductions do not include costs paid or incurred in connection with the administration of the estate or trust if these costs would not have been incurred were the property not held in trust or as part of an estate. [IRC § 67(e).] ...

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Proposed Regulations. The Service has issued proposed regulations and plans to issue final regulations consistent with the Supreme Court's holding in Knight v. Commissioner. In addition, the final regulations will address the issue raised when a nongrantor trust or estate pays a "Bundled Fiduciary Fee" for costs incurred in-house by the fiduciary, some of which are subject to the 2-percent floor and some of which are fully deductible without regard to the 2-percent floor. The Service has provided interim guidance that provides a safe harbor for the treatment of a Bundled Fiduciary Fee until regulations are finalized. [Notice 2011-37, 2011-20 IRB 785, modifying and superseding, Notice 2010-32, 2010-16 IRB 594.]

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The proposed regulations, issued September 7, 2011, reflect the reasoning and holding in Knight and provide guidance relating to the limited portion of the cost of investment advice that is not subject to the 2-percent floor. To the extent that a portion (if any) of an investment advisory fee exceeds the fee generally charged to an individual investor, and that excess is attributable to an unusual investment objective of the trust or estate or to a specialized balancing of the interests of various parties such that a reasonable comparison with individual investors would be improper, that excess is not subject to the 2-percent floor...

* Copyright 2013, Matthew Bender & Company, Inc., a member of the LexisNexis Group.

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