Prop. regs. clarify treatment of trust administrative expenses.

• Author: Nevius, Alistair M.

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 sprit 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 (REG-128224-06) 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...