Final rules on fiduciary fees keep "unbundling" requirement: controversial rules prompted by the Knight decision parse certain income tax deductions of estates and trusts.

Author:Schreiber, Sally P.
 
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The IRS issued final regulations on the controversial question of which costs incurred by trusts and estates are subject to the 2% floor on miscellaneous itemized deductions under Sec. 67(a). The regulations apply to tax years beginning on or after May 9, 2014. They retain from the proposed rules a requirement that certain "bundled" fees be unbundled.

The regulations finalize proposed rules issued in September 2011 (REG-12822406) in response to the U.S. Supreme Court's decision in Knight, 552 U.S. 181 (2008), on the deductibility by estates and nongrantor trusts of investment advisory and other fees. Under Knight, fees paid to an investment adviser by a nongrantor trust or estate are generally miscellaneous itemized deductions subject to a floor of 2% of adjusted gross income (AGI), rather than fully deductible as an expense of administering an estate or trust under Sec. 67(e)(1). The Supreme Court held that the latter provision is limited to expenses that would not "commonly" or "customarily" be incurred if the property were held by an individual.

The regulations implement the Court's "commonly or customarily incurred" requirement for investment advisory fees by stating that a fee is not subject to the 2%-of-AGI floor to the extent it exceeds the fee generally charged to an individual investor, where the additional charge is added solely because the investment advice is rendered to a trust or estate rather than to an individual or is attributable "to an unusual investment objective" of the trust or estate or to "the need for a specialized balancing of the interests of various parties ... such that a reasonable comparison with individual investors would be improper" (Regs. Sec. 1.67-4(b)(4)).

The final rules adopt the proposed regulations with a few modifications in response to comments. The proposed regulations provided that costs that do not depend on whether the payer is an individual or an estate or trust count as costs that are commonly or customarily incurred by an individual. One commentator said that this treatment was overly broad and was a disguised attempt to reassert the IRS's effort, rejected in Knight, to subject any costs that could be incurred by an individual to the 2% floor. The IRS agreed and removed the reference to costs that do not depend on the payer's identity.

Another change was the removal of real estate taxes as an example of an ownership cost because they are not miscellaneous itemized deductions but are fully...

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