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TAX COURT: TRUST INVESTMENT FEES GET 2% HAIRCUT

June 28, 2005

The tax law disallows deductions for "miscellaneous itemized deductions," except to the extent they exceed 2% of adjusted gross income. These expenses include tax preparation fees and investment expenses. In some ways this has been a blessing for practitioners, who no longer have to explain to clients that their Maxim subscriptions don't qualify as investment expenses, because they fall victim to the haircut anyway. It also gives us the opportunity to pitch a "2% of AGI return preparation fee system" (no takers, alas). The blessing is well-disguised, though, because clients are happier with deductions than without.

Optimistic practitioners have grasped onto a part of the tax law that eliminates the 2% haircut for trusts, at least for expenses "which would not have been incurred if the property were not held in such trust or estate." The argument is that all investment expenses by a trust "would not have been incurred" absent the trust.

The Tax Court yesterday reaffirmed its disapproval of this argument. The Sixth Circuit has disagreed with the Tax Court's position, but the Tax Court will continue to require the 2% haircut in cases that can be appealed to other circuits. The Tax Court reasons:

We believe that the thrust of the language of section
67(e) is that only those costs which are unique to the
administration of an estate or trust are to be deducted
from gross income without being subject to the 2-
percent floor on itemized deductions set forth at
section 67(a). Examples of items unique to the
administration of a trust or estate would be the fees
paid to a trustee and trust accounting fees mandated by
law or the trust agreement. Individual investors
routinely incur costs for investment advice as an
integral part of their investment activities.
Consequently, it cannot be argued that such costs are
somehow unique to the administration of an estate or
trust simply because a fiduciary might feel compelled
to incur such expenses in order to meet the prudent
person standards imposed by State law.

The Eighth Circuit, which covers Iowa, has yet to rule on the issue. Iowans' who ignore the 2% haircut for trust investment expenses will find a trip to Tax Court is a waste of time, and will probably instead choose to litigate this one in district court.

Cite: Willim L. Rudkin Testamentary Trust v. Commissioner, 124 T.C. No. 19.

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