Supreme Court Limits Deductibility of Trust Investment Advisory Fees
Trustees and trust advisors should be aware that on January 16th, 2008, the United States Supreme Court reached a unanimous decision that trusts and estates incurring investment advisory fees could deduct those fees only to the extent they exceed 2% of the adjusted gross income. The case, Knight v. Commissioner, No., 06-1286, conclusively resolved the conflict existing among the circuit courts as to whether such fees were fully deductible. In Knight, the Supreme Court essentially found that because expenditures for investment advisory fees were not unique to trust administration, trusts and estates should be subject to the same 2% floor limitation as individuals. The Court did leave open the possibility that such fees could be fully deductible in the rare situation where the trust or estate has an unusual investment objective.
In anticipation of the decision in Knight, the IRS issued proposed treasury regulations mirroring the Court’s conclusion that investment advisory fees will be subject to the 2% floor limitation. The proposed regulations also detail the extent to which co-called “bundled fees” will be affected. “Bundled fees” are those flat fees charged by advisors for a variety of services including legal, accounting, investment advisory, and appraisal services. The proposed regulations provide that trust advisors will have to unravel their bundled fees in order to reveal which part of the fees are attributable to services that are now subject to the 2% floor limitation. It is expected that the IRS will fast-track the final version of these proposed regulations. However, in a recent notice, the IRS stated the unbundling rules of the proposed regulations will only apply to trusts and estates with tax years beginning January 1, 2008 and later. For trusts and estates with taxable years beginning before January 1, 2008, the full amount of the bundled fees, including investment advisory fees, may be deducted without regard to the 2% floor.