Are a trust's advisory fees subject to the 2%-of-AGI deduction floor?

• Author: Lerman, Jerry L.
• Position: Itemized deductions; adjusted gross income

The Federal Circuit affirmed the Court of Federal Claims in Mellon Bank, NA, 9/7/01, holding that a trust's deduction of fees paid for outside investment advice and other services were subject to the 2% floor on miscellaneous itemized deductions. This decision creates a split with the Sixth Circuit, which held in William O'Neill, 994 F2d 302 (1993), that such expenses were deductible without regard to the 2% floor.

Under Sec. 67(a), individuals can deduct miscellaneous itemized deductions only to the extent the aggregate amount of the deductions exceeds 2% of the taxpayer's adjusted gross income (AGI). Sec. 67(e) addresses the application of the 2%-of-AGI rule to estates and trusts. Sec. 67(e)(1) provides an exception from the 2% rule for costs paid or incurred for administration of an estate or a trust, and which the taxpayer would not have incurred if the property were not held in such estate or trust.

In Mellon Bank, the trustees took a broad approach. They contended that their fees (which were acknowledged as fully deductible) were merely a label for all services for which they were responsible under state fiduciary law. They argued that services delegated by the trustee for investment strategy advice, accounting and tax preparation and management should be fully deductible, because they were within the range of the bank's fiduciary duties.

In O'Neill, the trustees took a focused approach. They contended that the investment advisory fees paid by the trust were unique to trust administration and excepted from the 2% floor. The trustees had no expert knowledge in the investment of large sums of money. In fact, none of the individuals agreed to serve as trustee until an investment adviser was hired to manage and invest the trust's assets.

In Mellon Bank, the trustees wanted all...