The IRS has reissued proposed regulations that clarify when a nongrantor trust’s (NGT) or estate’s investment advisory services are fully deductible for income tax purposes. Most advisory expenses are subject to what can be a severe restriction that greatly reduces their deductibility.
Individuals are permitted to deduct “miscellaneous itemized deductions” only to the extent the deductions exceed 2% of the individual’s adjusted gross income [referred to as the 2% floor]. For example, if an individual taxpayer has an adjusted gross income of $1MM and $30k in miscellaneous itemized deductions, only $10k of the expenses is deductible [2% of $1MM is $20k and $30k-$20k =$10k].
Miscellaneous itemized deductions include investment advisory fees.
Until the Supreme Court case of Knight v. Commissioner was decided, executors and trustee were uncertain how the floor applied to estates and NGTs. Knight clarified which of an estate’s or NGT’s expenses are subject to the 2% floor for itemized deductions. Expenses that are “customarily” or “commonly” incurred when property is held by an individual are subject to the 2% floor when they are incurred by an estate or nongrantor trust. Expenses that are unique to estates and NGTs are not subject to the floor.
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What Knight didn’t do was enunciate specific rules; it didn’t precisely define what are “common” and “customary” expenses. It left the Treasury and IRS to define the contours of the rule. And the IRS did just that. After Knight, the IRS issued a series of Notices that curtailed the deductibility of investment adviser’s fees for estates and nongrantor trusts.
On Sept. 6 the IRS and Treasury reissued proposed regulations defining which expenses of a nongrantor trust or estate are subject to the 2% floor. The regulations define which of an estate’s or trust’s expenses are commonly or customarily incurred when individual taxpayers hold the property.