Estate and Trust Costs Subject to 2-Percent Floor

Estate and Trust Costs Subject to 2-Percent Floor

For estates and trusts, IRC Section 67 generally allows "miscellaneous itemized deductions" to be accounted for in computing taxable income only to the extent that in the aggregate these deductions exceed 2 percent of adjusted gross income. IRC 67(e) and 2007 proposed regulations had provided that a cost is fully deductible to the extent it would not have been incurred if the property were not held by an estate or trust.

After much debate as to which expenses were fully deductible and which were subject to the 2-percent floor, the 2008 Supreme Court decision of Knight v. Commissioner, 552 US 181 (2008), held that costs incurred by trusts that escape the 2-percent floor are those that would not "commonly" or "customarily" be incurred by individuals. In light of that decision, the IRS issued interim guidance (Notice 2008-32, Notice 2008-116, Notice 2010-32, Notice 2011-37) on bundled fiduciary fees, and withdrew the 2007 proposed regulations. Proposed regulations where reissued in 2011 to reflect the Knight decision.

The final regulations provide that a cost is subject to the 2-percent floor to the extent that it is included in the definition of miscellaneous itemized deductions under IRC Section 67(b), is incurred by an estate or non-grantor trust, and would commonly or customarily be incurred by a hypothetical individual holding the same property.  Further, costs that do not depend on the identity of the payer are costs that are incurred commonly or customarily by individuals.

The final regulations also provide an exclusive list of tax return preparation costs that are not subject to the 2-percent floor. Any other tax return preparation cost that is included in the definition of miscellaneous itemized deduction under IRC Section 67(b) is subject to the 2 percent floor.  The final regulations specifically provide that some appraisal fees incurred by an estate or non-grantor trust are not subject to the 2-percent floor.
 
The final regulations provide that a bundled fee, for costs subject to the 2-percent floor and costs that are not, must be allocated between those two categories of costs. However, there is an exception to the allocation requirement for a bundled fee that is not computed on an hourly basis.

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