Knight v Commissioner: A Supreme Court Error in Determining Deductibility of Miscellaneous Expenses?

Knight v Commissioner: A Supreme Court Error in Determining Deductibility of Miscellaneous Expenses?

In Knight v Commissioner, 128 S. Ct. 782 (2008), the Supreme Court put an end to the oft-debated issue of the deductibility of third-party investment advisor fees paid by a trust or estate. The Court determined that such fees are subject to the "two percent floor" for miscellaneous itemized deductions under IRC Section 67(a) rather than fully deductible under IRC Section 67(e). The Court dismissed the Trustee’s argument that he was obligated to obtain investment advice to satisfy his fiduciary duty and that therefore the fees paid to the investment advisor are fully deductible under IRC Section 67(e). Rather, the Court determined that an estate or trust’s miscellaneous expense is subject to the "two percent floor" if the cost would have been incurred if the property were held by an individual rather than an estate or trust.  
 
In making the test a comparison of property held by a trust or estate vis a vis property held by an individual, the Supreme Court completely dismissed the statutorily created fiduciary duty to which executors and trustees are held on the premise that to allow consideration of the fiduciary duty would permit all trust expenses to be fully deductible. However, as the Sixth Circuit explains, an individual investor is not required to consult an advisor, and suffers no penalties or liability if she acts negligently, whereas "fiduciaries uniquely occupy a position of trust for others and have an obligation to the beneficiaries to exercise proper skill and care with the assets of the trust." O’Neil v Commissioner, 994 F.2d 302, 304 (1993).  
 
It is true that individuals commonly employ investment advisors and thus investment fees can be incurred, whether the property is held in a trust or by an individual. The individual has a choice, however, whether to employ an investment advisor or to make investment decisions on his own. Given the fact that fiduciaries have little or no choice as to whether or not an investment advisor will be employed, the Supreme Court erred in using the oversimplified test of comparing property held by an individual to property held by a trust.