Trust investment advisory fees and the 2%-of-AGI limit.

• Author: Nager, Ross W.
• Position: Adjusted gross income

On June 2, 1993, the Sixth Circuit reversed the Tax Court and held that investment advisory fees incurred by a trust are not subject to Sec. 67(a), which limits certain itemized deductions by 2% of adjusted gross income (AGI). Although the Service may pursue this issue in other circuits, the decision in O'Neill, 994 F2d 302 (6th Cir. 1993), represents a significant taxpayer victory.

O'Neill involved a trust with substantial assets and co-trustees with little investment experience. Applicable state law required trustees to invest and manage trust assets as "prudent investors," but also provided a list of preapproved investments.

Although Sec. 67(a) limits certain itemized deductions by 2% of AGI, Sec. 67(e)(1) contains a special exception for trusts and estates. An "above-the-line" (i.e., no limitation) deduction is allowed for costs "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 ...... The Tax Court interpreted this exception to apply only to costs "unique" to trusts and estates. Since individuals frequently hire investment advisers, the Tax Court deemed that such fees were not unique.

Citing Stevens v. National City Bank, 544 N.E.2d 612 (Ohio 1989), the Sixth Circuit noted that the mere selection of approved investments did not automatically meet the prudent investor standard. The trustee had the duty to diversify the investment of trust assets, and to distribute the risk of loss within the trust. The Sixth Circuit stated:

Where a trustee lacks experience in investment matters, professional assistance may be warranted. The trustees here lacked experience in investing and managing large sums of money and, therefore, sought the assistance of an investment advisor. Without [the manager], the co-trustees would have put at risk the assets of the Trust. Thus, the investment advisory fees were necessary to the continued growth of the Trust and were caused by the fiduciary duties of the...