Trust and Estate Expenses: Deductibility Under Final Treasury Regulations
Jean McDevitt, Tax Principal
This year the IRS issued final regulations under IRC Section 67 addressing the application of the 2% floor on miscellaneous itemized deductions to estates and non-grantor trusts. The final regulations were issued originally as effective for tax years beginning or after May 9, 2014. The regulations were subsequently amended, however, to be effective for tax years beginning on or after January 1, 2015.
The IRS issued the regulations as clarification following the U.S. Supreme Court’s decision in Knight v. Commissioner, 552 U.S. 181 (2008), in which the Court held that fees paid to an investment advisor by an estate or trust are generally subject to the 2% floor. The Court ruled that the 2% floor limitation as applied to expenses of an estate or trust depends on whether a hypothetical individual who held the same asset would customarily or commonly incur the expense.
Following the hypothetical individual analysis discussed in the Knight decision, the final regulations address the tax treatment of a variety of administrative expenses typically incurred by estates and trusts. A discussion of specific expenses follows.
Ownership costs incurred in the ownership of non-income producing property are subject to the 2% floor, including expenses such as insurance premiums, maintenance expenses, and investment custody fees.
Tax return preparation fees may be subject to the 2% floor depending upon the return type. The cost of preparing estate and GST tax returns, fiduciary income tax returns, and the decedent’s final individual income tax return are not subject to the 2% floor. Fees for the preparation of all other tax returns, including gift tax returns, are subject to the 2% floor.
Appraisal fees paid to determine the value of assets for estate and GST tax returns and for purposes of making distributions from a trust or estate are not subject to the 2% floor. Appraisal fees incurred for other purposes, such as gift tax returns, are subject to the 2% floor.
Litigation expenses incurred in defending the existence, validity, or administration of a trust or an estate are administration expenses that are not subject to the 2% floor. Costs of litigation falling outside that scope are subject to the 2% floor.
Other fiduciary expenses, including probate court fees and costs, fiduciary bond premiums, costs of legal publication notices to creditors and heirs, the cost to obtain certified copies of a decedent’s death certificate, and costs related to fiduciary accounts are not subject to the 2% floor.
Investment advisory fees are generally subject to the 2% floor under the final regulations. However, costs of investment advice in excess of that normally charged to an individual are not subject to the 2% floor. The cost of specialized advice due to an estate or trust’s unusual investment objective or the need for a specialized balancing of various parties’ interests are likewise fully deductible.
The regulations require that a “bundled fee” – a single fee charged for a combination of services – be unbundled and allocated between costs subject to the 2% floor (e.g., investment fees) and costs not subject to the floor (e.g., fiduciary fees). If bundled fees are not computed on an hourly basis, only the portion attributable to non-specialized investment advice is subject to the 2% floor. The regulations allow for bundled fees to be allocated by any reasonable manner.
A reasonable method could be based on: (1) the percentage of the value of the corpus subject to investment advice; (2) whether a third party advisor would have charged a comparable fee for similar advisory services; and (3) the amount of the fiduciary’s attention to the trust or estate that is devoted to investment advice as compared to dealings with beneficiaries, distribution decisions and other fiduciary functions. The unbundling requirement is applicable to all professional fees – not just fiduciary and investment fees – including attorneys’ and accountants’ fees.
If you have questions about these final regulations and their impact on fiduciary income taxes, please contact us.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.