The U.S. Supreme Court just delivered a knockout punch to administrators of trusts and estates.
Alert: In a new decision, the high court says that investment advisory fees paid by a trust are subject to the “2% floor” for miscellaneous expenses. (Knight, Trustee of William L. Rudkin Testamentary Trust, S. Ct. No. 06-1286, 1/16/08) This can drastically reduce the amount of the available deduction.
Here’s the whole story: As you’re well aware, individuals may deduct miscellaneous expenses only to the extent the annual amount exceeds 2% of their AGI. Generally, the same rule applies to trusts and estates. Key exception: Fees aren’t subject to the 2% floor if they would not have occurred if the assets had not been held in a trust or estate.
The IRS has consistently challenged full deductions for investment advisory fees. In one case, the 6th Circuit Court of Appeals said that fees paid to trustees in discharging fiduciary duties qualified under the tax law exception. (O’Neill, 71 AFTR2d93-2052) On the other hand, several other appeals courts have sided with the IRS.
Latest example: The 2nd Circuit ruled that the 2% floor applied to the investment advisory fees paid by the Rudkin trust. It said that the tax law exception only applies to costs that could not have been incurred by an individual. Because investment advisory fees may be incurred by an individual, the deduction is limited.
Under the 2nd Circuit’s holding, the deduction for the trust’s fees was reduced by almost $18,000.
Final word: The Supreme Court dismissed the trustee’s argument that the case should be decided by a causation test. It determined that the 2% floor should apply to the expenses. But it disagreed with the 2nd Circuit’s interpretation.
The high court ruled that trust fees that avoid the 2% floor are limited to costs that would not commonly or customarily be incurred by individuals. Thus, the court distinguished between fees that “could not” be incurred and those that “would not” be incurred.
Tip: In light of the new decision, the IRS will be revamping proposed regulations it issued in 2007.
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