Unique costs: judicial & administrative actions affect estate & trust deductions.

• Author: Josephs, Stuart R.
• Position: Federal tax

Under IRC Sec. 67(a), individuals' miscellaneous itemized deductions are allowed only to the extent they exceed 2 percent of adjusted gross income (AGI), i.e., the "floor." Sec. 67(e) states that, for this purpose, an estate's or trust's AGI should be computed as for an individual.

However, under Sec. 67(e)(1), deductions for costs paid or incurred in administering the estate or trust, which would not have been incurred if the property were not held in such estate or trust shall be treated as allowable in arriving at AGI. Therefore, deductions described in Sec. 67(e)(1) are not subject to this floor.

Appeals Courts Split

Several appeals courts have interpreted Sec. 67(e)(1) differently. The issue in each case was whether the trust's investment advisory fees "would not have been incurred if the property were not held in such trust or estate."

In William J. O'Neill, Jr., Irrevocable Trust v. Commissioner (994 F. 2d 302, 6th Cir. 1993) the court decided that these fees were fully deductible where the trustees lacked experience in managing large sums of money. The court found that, under state law, the trustee was required to engage an investment advisor to meet its fiduciary obligations and to incur fees that the trust would not have incurred if the property were not held in trust. The court held that estate or trust expenditures that are necessary to meet specific fiduciary obligations under state law are not subject to the floor.

In contrast, in Mellon Bank, N.A. v. United States (265 F. 3d 1275, Fed. Cir. 2001), J.H. Scott v. United States (328 F. 3d 132, 4th Cir. 2003) and William L. Rudkin Testamentary Trust v. Commissioner (467 F. 3d 149, 2d Cir. 2006) the courts held that these fees are subject to this floor.

Specifically, the Mellon Bank and Scott courts concluded that a trust expense is subject to the floor if it is an expense "commonly" or "customarily" incurred by individuals. The Rudkin court looked to whether such an expense was "peculiar to trusts" and "could not" be incurred by individuals.

Supreme Court Review

The Supreme Court granted certiorari on June 25, 2007 in an appeal by Rudkin, now called Knight (a trustee). Possibly, arguments may be heard in December and a decision may be rendered by June 2008.

Proposed Regulations

Proposed regulations were published July 27, 2007 and would apply to payments made after the date final regulations are published in the Federal Register. Under these proposals, costs incurred by estates...