Trust deductions: Knight, prop. regs. still govern.

• Author: Anderson, Kevin D.

In September 2011, the IRS issued Prop. Regs. Sec. 1.67-4 (REG-128224-06) that superseded proposed regulations from 2007 regarding the treatment of certain trust deductions. The new proposed regulations provide that a cost incurred by a trust that is "commonly or customarily" incurred by a hypothetical individual holding the same property is subject to the 2% floor on miscellaneous itemized deductions as applied under Sec. 67(e). The proposed regulations also state that, if a trust pays a single fee or other expense for both costs that are subject to the 2% floor and costs that are not subject to it (a "bundled fee"), then the amount "must be allocated ... between the costs subject to the 2% floor and those that are not."

The IRS issued Notice 2011-37, however, to provide that the requirement of unbundling fees will not apply to tax years that begin before final regulations are issued. As of February 2012, the IRS had not released final regulations. Thus, preparers of fiduciary tax returns for tax years 2011 and 2012 will not be required to unbundle fiduciary fees, but they still must treat payments readily identifiable as subject to the 2% floor separately from a bundled fiduciary fee.

Background

Under Sec. 67(a), for an individual, miscellaneous deductions "shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income." According to Sec. 641(b), the taxable income of an estate or trust is computed in the same manner as for an individual, with certain exceptions not relevant to this discussion. Sec. 67(e) makes an exception to the general rule of Sec. 67 for trusts and estates, stating that "the deductions for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate ... shall be treated as allowable in arriving at adjusted gross income."

In William L. Rudkin Testamentary Trust, 467 F.3d 149 (2d Cir. 2006), the court held that investment advisory fees of a trust were subject to the 2% floor, as they were similar to costs incurred by individuals that are subject to the 2% floor. Only trust expenses that individuals are incapable of incurring are not subject to the 2% floor, the court held. Examples of such costs discussed in the decision include "fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing...