Volume IV, Issue II (April 2006) - Columbus School of Law

THE DIFFERING TAX TREATMENT OF INVESTMENT ADVISORY FEES AND BROKERAGEFEES; A GENERAL ANALYSIS AND AN ANALYSIS IN THE CONTEXT OF CHARITABLEINVESTMENTSBARRY RICKERT 396I.IntroductionInvesting in securities has inherent risks. The specific securities in an investor’s portfolio mayplummet overnight, the market could crash, or an investment professional could engage infraudulent activity, leading to an investor loss. A 2002 poll concluded that forty percent ofAmericans had at least $10,000 invested in the stock market at that time. 397 Considering the largepercentage of Americans investing in securities, it would seem rational to expect that tax lawswould be written in a way that encourages taxpayers to seek investment professionals who areheld to high standards of conduct. However, the tax laws not only fail to provide incentives fortaxpayers to seek the advisors with the highest degree of fiduciary duties, but they actually favorthe use of investment professionals with the least accountability. The message being sent toindividual investors is clear: “the lower the fiduciary duty, the better the tax consequences.” Thisarticle will explore the current tax laws, analyze the policy considerations and proposealternatives to the current system, especially as regards individual taxpayers.The fiduciary duty implications discussed in this paper are mainly addressed in the context oftaxable persons (individual taxpayers); however, the differing duties are also applicable to theinvestment advisors and brokers hired by charitable organizations. Trustees of charitable trusts,in making investment decisions, are “under a duty similar to that of the trustee of a privatetrust.” 398 The Introduction of the Restatement (Third) of Trusts summarized principles ofprudence designed to instruct trustees. 399 One of those principles is that “trustees have a duty toavoid fees and other costs that are not justified by the needs and realistic objectives of the trust’sinvestment program.” 400 Because trustees of charitable trusts have a duty to avoid unjustified feesand costs, an analysis of the fiduciary consequences of hiring an investment advisor or a broker isrelevant to the management of such trusts.Generally speaking, investment advisory fees may be deducted under Internal Revenue Code(“IRC”) § 212(2) 401 if: (1) an individual taxpayer elects to itemize his 402 deductions, pursuant to396 Juris Doctor Candidate, Pace University School of Law (May 2006); Student Attorney in Pace Law’sSecurities Arbitration Clinic; B.A., Villanova University. Many thanks to Professor Bridget J. Crawford,Associate Professor of Law, Pace University School of Law, for her invaluable consultation and assistancewith this article. Thanks also to Ian Yankwitt, a registered investment advisor, who provided valuableinsight on many of the topics presented.397 See J. Brent Wilkins, Comment, The Sarbanes-Oxley Act of 2002: The Ripple Effects of RestoringShareholder Confidence, 29 S. Ill. U. L. J. 339 (2005).398 Marion Fremont-Smith, GOVERNING NONPROFIT ORGANIZATIONS (Belknap, Harvard 2004) at 190-191(citing Restatement (Second) of Trusts, §389 (revised)).399 Fremont-Smith at 191 (citing Restatement (Third) of Trusts: Prudent Investor Rule, Introductory Note).400 Id.401 Unless otherwise provided all citations to the IRC are to the Internal Revenue Code of 1986, asamended.71