Final Regulations: Miscellaneous Itemized Deductions for Estates and Non-Grantor Trusts – July 15, 2014 by Andy Whitehair

Back in 2008, the U.S. Supreme Court issued its ruling in Knight v. Commissioner, holding that fees paid to an investment advisor by an estate or non-grantor trust generally are subject to the 2% floor on miscellaneous deductions. The 2% floor only allows miscellaneous deductions in excess of 2% of a taxpayer's adjusted gross income (AGI). This decision differed from proposed regulations issued in 2007, hence a long process culminating in the final regulations, issued on May 9, 2014, which attempt to clarify what is and is not subject to the floor.

General Rules

Section 67(a) of the Internal Revenue Code (IRC) provides individuals the ability to deduct miscellaneous deductions in excess of 2% of AGI.For expenses incurred by estates and non-grantor trusts, expenses subject to the floor include costs classified as miscellaneous itemized deductions that would be commonly or customarily be incurred by a hypothetical individual holding the same property. Sections 67(b) and 67(e) exclude certain costs from treatment as miscellaneous itemized deductions, such as costs incurred by an estate or non-grantor trust for administrative purposes.

Common and Customarily Incurred Costs
Some miscellaneous itemized deductions subject to the floor include ownership costs, tax preparation fees, investment advisory fees, appraisal fees and certain other fiduciary expenses. However, the new regulations clarify that several exceptions to the floor apply to additional costs, including:

  • Ownership costs, which are typically subject to the floor unless fully deductible under another section of the IRC.
  • Tax preparation fees relating to all estate and generation skipping transfer tax returns, fiduciary income tax returns, and decedent’s final individual income tax return.
  • Investment advisory fees beyond the amount that normally would be charged to an individual investor
  • Appraisal fees incurred to determine the Fair Market Value (FMV) of the assets at the date of the decedent’s date of death, to determine the value for purposes of making distributions, or fees required to properly prepare estate or trust returns.
  • Certain fiduciary expenses including probate court fees, fiduciary bond premiums, and legal publication costs of notices to creditors or heirs.

Bundled Fees

Estates or non-grantor trusts that incur “bundled fees,” i.e. fees that are partially subject to the floor and partially exempt), must allocate the fees between those subject to the floor and those that are not. However, only the portions of bundled fees not calculated on an hourly basis and related to investment advice are subject to the floor; certain non-allocable expenses, including out-of-pocket expenses billed to the estate or non-grantor trust, payments made from bundled fees to third parties subject to the floor, and fees or expenses for services commonly or customarily incurred by an individual must be subjected to the floor even if part of a bundled fee. The new regulations provide that in the absence of specific tracing of investment expenses any reasonable method may be used to allocate bundled fees.

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