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Second Circuit holds trust investment advisory fees subject to 2% floor.

The issue on this appeal to the Second Circuit is whether investment advice fees inurred by a trust (T) are fully deductible in calculating adjusted gross income (AGI) under Sec. 67(e)(1), or whether they are deductible only to the extent they exceed 2% of the trust's AGI under Sec. 67(a).


Under Sec. 67(e),"the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual," subject to one exception relevant to this appeal. A trust's costs are fully deductible, rather than subject to the 2% floor, if they: (1) are "paid or incurred in connection with the administration of the ... trust"; and (2) "would not have been incurred if the property were not held in such rust"

There is no dispute here that the investment advice fees at issue meet the requirement of the first clause. The issue here, on which some of the circuits have disagreed, is whether such fees also satisfy the requirement of the second clause of Sec. 67(e)(1).

The Sixth Circuit was the first circuit to consider the question presented here, in O'Neill, 994 F2d 302 (1993).That case established the rule that a trust's costs attributable to the trustee's fiduciary duty, and not required outside trust administration, fall within the Sec. 67(e)(1) exception and are fitly deductible. However, the Federal Circuit rejected this reasoning, in Mellon Bank, 265 F3d 1275 (2001). There, the court held that the second clause of Sec. 67(e)(1) "serves as a filter" with respect to the first clause and "treats as fully deductible only those trust-related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of masts" Id. at 1280-81. Because "[i]nvestment advice and management fees are commonly incurred outside of trusts" the court reasoned, "these costs are not exempt under section 67(e)(1) and are required to meet the two percent floor of section 67(a)" Id. at 1281.

The Fourth Circuit subsequently joined the Federal Circuit in holding that investment advice fees incurred by a trust are subject to the 2% floor of Sec. 67(a) in Scott, 328 F3d 132 (2003).The court noted, however, that "[o]ther costs ordinarily incurred by masts, such as fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing fiduciary income tax returns, are not ordinarily incurred by individual taxpayers, and they would be fully deductible under the exception created by [section] 67(e)" Id. at 140. These costs, the court explained, are "solely attributable to a trustee's fiduciary duties, and as such are fully deductible under [section] 67(e)"

(O'Neill, Mellon Bank and Scott are discussed in Satchit, "Trusts, Investment Advisory Fees and the 2% Floor," TTA, February 2004, p. 87.)


T argues that the statute sets forth a "but for" causal test: if the cost would not have been incurred without the trustee, then it is attributable to the trustee's performance of its fiduciary duty and is thus fully deductible under Sec. 67(e)(1).Thus, according to T, the second prong of Sec. 67(e)(1) requires no consideration of whether a generic individual owner of the same assets may have incurred the cost at issue.

Had Congress intended to create a causation test, which disregards what an individual asset owner may have done if the assets were not held in trust, it could have done so in language clearly expressing that intent. Such a "but for" causation test, however, is not apparent from the text's "ordinary, common meaning" The statute demands not a subjective and hypothetical inquiry but, rather, an objective determination of whether the particular cost is one peculiar to trusts and that individuals are incapable of incurring. Investment advice fees are subject to the 2% floor under regulations applicable to individual taxpayers; thus, the fees are a cost that individual taxpayers are capable of incurring. By contrast, costs that individuals are incapable of incurring, like "fees paid to trustees, expenses associated with judicial accountings, and the costs of preparing and filing fiduciary income tax returns," are fully deductible (Scott, 328 F3d at 140).

This court joins the Federal and Fourth Circuits in holding that Sec. 67(e)(1) does not exempt investment advice fees incurred by trusts from the 2% floor. However, it disagrees with their statement that costs "not customarily incurred outside of trusts" are the ones not subject to the floor. The plain text of Sec. 67(e) requires that we determine with certainty that costs could not have been incurred if the property were held by an individual. Thus, the plain meaning of the statute permits a trust to take a full deduction only for those costs that could not have been incurred by an individual property owner.

Legislative History

T contends that the drafting history indicates that Congress added the second clause of Sec. 67(e)(1) to restrict a trust's use of passthrough entities to avoid the 2% floor of Sec. 67(a) and not to limit the deductibility of any other trust administrative costs. Because the statute's text is "clear and unambiguous" we need not address the legislative history arguments; see Scott, 328 F3d at 139. However, if Congress's only purpose had been to restrict the ability of trusts as ultimate taxpayers to deduct fully their share of the administrative costs of passthrough entities in which they had invested, it could have drafted the second clause of Sec. 67(e)(1) more narrowly. It could have, for example, permitted full deductibility for those administrative costs "which are not pass through costs restricted under Sec. 67(c)." Instead, Congress chose the broader language of Sec. 67(e)(1). Nothing in the legislative history suggests a clearly expressed Congressional intent contrary to the plain meaning of the statute itself.


A trust's investment advice fees are deductible only to the extent that they exceed 2% of the trust's AGI, because Sec. 67(e)(1) unambiguously exempts only those costs incurred by a trust that could not have been incurred if the property were held by an individual. Individual property owners obviously can incur investment advice fees and the regulation explicitly includes such fees. The Tax Court's judgment is affirmed.

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Title Annotation:ESTATES, TRUSTS & GIFTS
Author:Rudkin, William L.
Publication:The Tax Adviser
Date:Dec 1, 2006
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