Supreme Court Upholds Trust Expense Floor

The Supreme Court ruled in a unanimous opinion that administrative expenses of nongrantor trusts or estates generally are subject to the 2% of adjusted gross income floor as miscellaneous itemized expenses, resolving a split among circuit courts on the issue. The case, Knight v. Commissioner (101 AFTR2d 2008-380), was styled as Rudkin Testamentary Trust v. Commissioner in lower court proceedings. At issue was the exemption under IRC § 67(e) from the floor for expenses that “would not have been incurred if the property were not held in such trust or estate.” While agreeing with the Second Circuit’s result (98 AFTR2d 2006-7368), the Supreme Court criticized its analysis. Rather than asking, as the Second Circuit held, whether a trust expense could have been incurred by an individual, the statute requires asking whether it would customarily be incurred by an individual, the Supreme Court said. To determine that, the court said, the trustee must predict what would happen if the property were held in the hands of an individual. Moreover, if the trustee can show that he incurred some extra, incremental cost that an ordinary individual investor would not have incurred, it would be fully deductible. The opinion addressed only investment adviser fees and did not discuss trustee fees, tax preparation fees or other costs.

On similar facts and arguments, the Sixth Circuit in 1993 allowed exemption from the floor for investment advisory fees a trustee paid to meet fiduciary requirements under state law (William O’Neill Jr. Irrevocable Trust v. Commissioner, 71 AFTR2d 93-2052).