Estate and trust investment advisory fees: 2% limit applies.

• Author: Barton, Peter C.

In William L. Rudkin Testamentary Trust, 124 TC No. 19 (2005), the Tax Court ruled (in a reviewed opinion, 18-0) that investment advisory fees incurred or paid by an estate or trust were deductible only to the extent they exceeded 2% of adjusted gross income (AGI). Of the three circuit courts that have ruled on this issue (discussed below), two agreed with the Tax Court, but one allowed a flail deduction for such fees. Rudkin has been appealed to the Second Circuit, which has not yet weighed in on the issue.

Background

Sec. 67(a) allows individuals to deduct miscellaneous itemized deductions only to the extent that they exceed 2% of AGI. Temp. Regs. Sec. 1.67-1T(a)(1)(ii) includes Sec. 212 investment advisory fees under this rule. According to Sec. 67(e), the AGI of estates and trusts is calculated in the same manner as for individuals; however, expenses paid or incurred in estate or trust administration, "which would not have been incurred if the property were not held in such trust or estate," are fully deductible in calculating AGI.

Cases

In O'Neill Trust, 98TC 227 (1992), rev'd, 994 F2d 302 (6th Cir. 1993), the Tax Court ruled that only expenses unique to estate or trust administration qualify for the Sec. 67(e)(1) exception to the 2% rule, such as trustee or estate fiduciary fees and accounting fees required by state law or the governing trust or estate instrument. The Tax Court concluded that investment advisory fees are not unique, because they are routinely incurred by individual investors. Further, the fact that a trustee or estate fiduciary might feel compelled to hire investment advisers to satisfy prudent person standards imposed by state law, does not make investment advisory fees unique to estate or trust administration.

In reversing, the Sixth Circuit emphasized that individual investors are neither required to consult investment advisers, nor do they incur penalties or potential liability if they act negligently for themselves. However, trustees and estate fiduciaries uniquely occupy positions of trust and can incur penalties or potential liability for acting negligently in managing assets on beneficiaries' behalf. Thus, the court concluded that an estate or trust must incur investment advisory fees that would not be incurred if the assets were not held in the estate or trust, to permit a flail deduction.

Two circuits have rejected the Sixth Circuit's reasoning and adopted the Tax Court's position; see Mellon Bank, N.A., 265...