On May 8, 2014, the IRS issued final regulations with respect to Code § 67(a). Treas. Reg. § 1.67-4 specifically address costs incurred by non-grantor trusts and estates. These final regulations clarify whether investment advisory fees are fully deductible by the trust or subject to the 2% floor.
In January 2008, the Supreme Court held in “Knight v Commissioner,” 522 US 181, 2008, that only costs and expenses that are not customarily or commonly incurred by an individual are fully deductible, any other costs and expenses are subject to a 2% floor, and treated as miscellaneous deductions.
The main issue of the Knight ruling was the deduction of investment advisory fees. The Supreme Court ruled that they were subject to the 2% floor unless there were specific circumstances, such as a unique investment objective making it different from the investments of an individual. The determination that investment advisory fees were subject to the 2% floor created an issue for many trusts with an institutional trustee, as they bundled their fees. Bundled fees are a set fee (usually a percentage) for serving as trustee and for investment advisory services. To address this, the IRS issued interim guidance in a series of notices, the most recent being Notice 2011-37, which provided that until final regulations were issued, bundled fees paid by a trust were fully deductible.
On May 8, the final regulations were issued taking effect for tax years beginning on or after May 9, 2014. Therefore, calendar year trusts may want to pay their fees on or before December 31, 2014 so they may be fully deductible one final year.
Treas. Reg. § 1.67-4 states that bundled fees must be allocated between fees eligible for the full deduction and those subject to the 2% floor. This can be done by any reasonable method used for allocating between the types of costs. Consequently, the trustees will need to determine whether it makes sense to continue to bundle their fees and determine an allocation between full deductible expenses and those subject to the 2% floor, or whether it makes sense to unbundle their fees and attribute the fees separately.
The final regulations also clarify that court costs and appraisal fees, such as those for determining the value of property on a decedent’s death, are fully deducted.
Treas. Reg. § 1.67-4 allows a full deduction for the tax preparation fees of fiduciary income tax returns and estate and generation-skipping transfer tax returns, as well as the decedent’s final income tax return, rather than being subject to the 2% floor.
Since the final regulations have been issued, it is important to review them and ensure that appropriate deductions are taken either as full deductions or subject to the 2% floor.