Supreme Court holds investment advisory fees are subject to 2% floor.

• 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 mast are allowed in full as deductions in arriving at AGI (i.e., they are not subject to the 2% floor).

Courts have sprit 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), aff'd sub nom. Knight, S. Ct. Dkt. 06-1286 (U.S. 1/16/08); Scott, 328 F3d 132 (4th Cir. 2003); Mellon Bank, N.A., 265 F3d 1275 (Fed. Cir. 2001)).

In October 2006, in Rudkin, the Second Circuit held that "would not" means "could not" in Sec. 67(e). The court held that Sec. 67(e) grants an estate or trust an exception from the 2% floor for itemized deductions only for "costs of a type" that "individuals are incapable of incurring."

By contrast, the Fourth and Federal Circuits, while still subjecting trust investment advisory fees to the 2% floor, held that trust administrative costs of a type that would not "commonly" or "customarily" be incurred by individuals are not subject m the 2% floor.

The Supreme Court granted certiorari in the Rudkin case in June 2007 and has now issued a decision (Knight, S. Ct. Dkt. 06-1286 (U.S. 1/16/08)). The Court held that investment advisory fees are generally subject to the 2% floor (overruling O'Neill) but refused to go as far as the Second Circuit in saying that the exclusivity test requires that the fees could not have been incurred by an individual. Chief Justice Roberts, writing for a unanimous...