Under Sec. 67(a), miscellaneous itemized deductions are allowed only to the extent that they exceed 2% of a taxpayer’s adjusted gross income (AGI). The AGI of an estate or trust is computed in the same manner as for an individual for these purposes, except that, under Sec. 67(e)(1), administrative costs that would not have been incurred if the property were not held in an estate or trust are allowed in full as deductions in arriving at AGI (i.e., they are not subject to the 2% floor).
Courts have split over what trust administrative costs fall under this exception. For example, the Sixth Circuit has held that investment advisory fees are not subject to the 2% floor and are fully deductible (O’Neill, 994 F2d 302 (6th Cir. 1993)). In contrast, the Second, Fourth, and Federal Circuits have all held that investment advisory fees are subject to the 2% floor (Rudkin Testamentary Trust, 467 F3d 149 (2d Cir. 2006), cert. granted 6/25/07; Scott, 328 F3d 132 (4th Cir. 2003); Mellon Bank, N.A., 265 F3d 1275 (Fed. Cir. 2001)).
While the Supreme Court has granted certiorari in Rudkin and should settle the split among the circuits, in order to have a uniform standard for identifying types of costs not subject to the 2% floor, the IRS has issued proposed regulations (REG12822406) providing that costs incurred by estates or nongrantor trusts unique to an estate or trust are not subject to the 2% floor. The proposed regulations define a cost as unique to an estate or trust if it could not have been incurred by an individual in connection with property not held in an estate or trust. Costs that do not meet this definition are subject to the 2% floor.
The proposed regulations provide a nonexclusive list of services that either do or do not fit the definition. Seven types of costs are listed as unique to an estate or trust. These are costs incurred for:
- Fiduciary accountings;
- Judicial or quasijudicial filings required as part of the administration of the estate or trust;
- Fiduciary income tax and estate tax returns;
- Division or distribution of income or corpus to or among beneficiaries;
- Trust or will contest or construction;
- Fiduciary bond premiums; and
- Communications with beneficiaries regarding estate or trust matters. Five types of costs are listed as not unique to an estate or trust.
These are costs incurred for:
- Custody or management of property;
- Advice on investing for total return;
- Gift tax returns;
- The defense of claims by creditors of the decedent or grantor; and
- The purchase, sale, maintenance, repair, insurance, or management of nontrade or business property.
The regulations would apply to payments made after the date the final regulations are published in the Federal Register. The Service has requested comments on the proposed regulations, and a public hearing will be held on November 14, 2007.