“Bundled” Fiduciary Fees Fully Deductible for 2009

The IRS in Notice 2010-32 extended to tax years beginning in 2009 its interim guidance on deductibility of a “bundled” investment advisory commission or fee paid to a trustee or executor on behalf of a nongrantor trust or estate.

The interim guidance was issued in February 2008 in Notice 2008-32 for tax years beginning before 2008 and extended to tax years beginning in 2008 by Notice 2008-116. It addresses the treatment of deductions claimed by a nongrantor trust or estate arising from payments of fiduciary commissions and fees that combine costs that are fully deductible and those that as miscellaneous itemized deductions are subject to the 2% of adjusted gross income floor under IRC § 67(a). Generally, the guidance provides that such “bundled” fees may be fully deducted while the IRS develops final regulations in light of proposed regulations and the U.S. Supreme Court’s decision in Knight v. Commissioner (552 U.S. 181 (2008)).

In that case, the Supreme Court held that investment advisory fees and commissions incurred by a nongrantor trust or estate generally are only deductible under section 67(a) as miscellaneous itemized deductions and are not, as the taxpayer had argued, covered by the exception under section 67(e)(1) for expenses “paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate.” This exception, the court held, applies only to costs of a trust or estate that an individual would not commonly incur. The expenses at issue in Knight were expenses that individuals would commonly incur and therefore were not eligible for the section 67(e)(1) exception, the court said.

Before the Supreme Court issued its opinion, the IRS issued Prop. Treas. Reg. § 1.67-4 (REG-128224-06, 72 F.R. 144, July 27, 2007) with its own distinction for expenses eligible for the exception: those that are “unique” to trusts and estates. The regulations also proposed (section 1.67-4(c)) that, where trustees bundle together in their fees both deductible and nondeductible expenses, taxpayers must “unbundle” those fees fully deductible under section 67(e) from those subject to the 2% floor.

The Supreme Court in Knight did not address bundling. The IRS has said it expects that final regulations will include a safe harbor for allocating fees and expenses between IRC § 67(a) and § 67(e)—including where those fees and expenses are bundled—but the regulations will not be issued in time to apply to tax years beginning in 2009.