In January 2008, the Supreme Court ruled in a decision on Michael J. Knight, Trustee of William L. Rudkin Testamentary Trust vs. Commissioner that trusts and investment advisors can deduct investment advisory fees only to the extent that miscellaneous itemized deductions amount to at least 2% of income. The court held that trust and estate investment advisory fees are generally not special estate or trust expenses, because many taxpayers that are not estates or trusts pay similar types of investment advisory fees.
In February 2008, the IRS announced in IRS Notice 2008-32 that it wanted to develop the final regulations taxpayers needed to apply the “commonly or customarily” test from the Knight ruling as quickly as possible. IRS officials said at the time that the final regulations might contain safe harbors for the allocation of fees and expenses between the costs that are subject to the 2% floor and the costs that are not.
Since then, the IRS has issued several batches of interim guidance temporarily freeing estates and trusts from the need to pick the costs affected by the 2% floor out from bundled fiduciary costs while rulemaking is in progress.
Many commenters have asked the IRS to withdraw and redraft the July 2007 proposal to let the public comment on the effects of the Knight decision, officials say.
In the past, some commenters have questioned whether the IRS has the authority to require estates and trusts to unbundle fiduciary commissions, but “the Knight decision posited just such an unbundling in the case of investment advisory costs rendered for certain services, the cost of which exceeds the costs charged to an individual investor,” officials say. “If a fiduciary is performing services that are commonly or customarily performed by an investment advisor retained by an individual investor, then the costs attributable to those services are subject to the 2% floor.”
Other commenters have talked about the cost and administrative difficulty of determining which portions of a single fee are subject to the 2% floor.
“Some commentators anticipated that such a rule would require corporate trustees to invest in expensive software to track and measure the value of the various types of services provided on a trust-by-trust and year-by year basis,” officials say.
IRS officials say the newly proposed regulations:
- Allow the use of any reasonable method to determine which part of a fee is subject to the 2% floor.
- Apply the 2% floor to any portion of a bundled fee atributable to investment advice, “including any related services that would be provided to any individual investor as part of the investment advisory fee.”
- Provide that a fiduciary fee not computed on an hourly basis and not dealing with investment advice is fully deductible, and not subject to the 2% floor. But officials say the 2% floor would still apply to certain types of separately assessed expenses, such as a fee charged by the fiduciary for managing rental real estate owned by the nongrantor trust or estate.
Regulators “are interested in methods for reasonably estimating the portion of a bundled fee that is attributable to investment advice,” officials say.
Regulators have been thinking about adopting numerical or percentage safe harbors, but “commentators noted that, in many cases, fiduciaries could not rely on safe harbors because their fiduciary duties would require them to make a more accurate estimate so as to not harm the trust or their beneficiaries,” officials say. “In addition, safe harbors could increase complexity by requiring complicated anti-abuse rules. Therefore, comments are requested on methods other than numerical or percentage safe harbors.”
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