Second Circuit holds trust investment advisory fees subject to 2% floor.

• Author: Rudkin, William L.

The issue on this appeal to the Second Circuit is whether investment advice fees inurred by a trust (T) are fully deductible in calculating adjusted gross income (AGI) under Sec. 67(e)(1), or whether they are deductible only to the extent they exceed 2% of the trust's AGI under Sec. 67(a).

Law

Under Sec. 67(e),"the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual," subject to one exception relevant to this appeal. A trust's costs are fully deductible, rather than subject to the 2% floor, if they: (1) are "paid or incurred in connection with the administration of the ... trust"; and (2) "would not have been incurred if the property were not held in such rust"

There is no dispute here that the investment advice fees at issue meet the requirement of the first clause. The issue here, on which some of the circuits have disagreed, is whether such fees also satisfy the requirement of the second clause of Sec. 67(e)(1).

The Sixth Circuit was the first circuit to consider the question presented here, in O'Neill, 994 F2d 302 (1993).That case established the rule that a trust's costs attributable to the trustee's fiduciary duty, and not required outside trust administration, fall within the Sec. 67(e)(1) exception and are fitly deductible. However, the Federal Circuit rejected this reasoning, in Mellon Bank, 265 F3d 1275 (2001). There, the court held that the second clause of Sec. 67(e)(1) "serves as a filter" with respect to the first clause and "treats as fully deductible only those trust-related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of masts" Id. at 1280-81. Because "[i]nvestment advice and management fees are commonly incurred outside of trusts" the court reasoned, "these costs are not exempt under section 67(e)(1) and are required to meet the two percent floor of section 67(a)" Id. at 1281.

The Fourth Circuit subsequently joined the Federal Circuit in holding that investment advice fees incurred by a trust are subject to the 2% floor of Sec. 67(a) in Scott, 328 F3d 132 (2003).The court noted, however, that "[o]ther costs ordinarily incurred by masts, such as fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing fiduciary income tax returns, are not ordinarily incurred by individual taxpayers, and they would be fully deductible under the exception created by...