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Deductibility of investment fees…Trust
(1) the deductions for costs which are paid or incurre d in connection with the adm inistration of the estate
or trust and which would not have been incurred if the property were not held in such trust or estate . . .
shall be treated as allowable in arriving at adjusted gross income.” (emphasis added).
Accordingly, a trust's costs are fully deductible in determining AGI, rather than subject to the two-percent
of AGI floor provided b y Code § 67(a) for miscellaneous item ized deductions, if they satisfy Code §
67(e)(1). A split has developed between the Sixth Circuit on one side and the Second, Fourth, and
Federal Circuits on the other side over whether invest ment advisory fees incurred by a trust satisfy the
requirement that they “would not have been incurred if the property were not held in such trust.”
In O'Neill the Sixth Circ uit ruled that the invest ment advisory fees w ere co sts incurred because the
property was held in trust, thus deductible in full when deter mining adjusted gross inco me. The court
reasoned that because a t rustee has a fiduciary duty to m anage trust assets as a "prudent investor,”
investment advisory fees are "necessary to” the trus t's administration and "caused by ” the fiduciary duty
of the trustee. The court opined that while indi viduals often incur costs for invest ment advice, "they are
not required to consult advisors a nd suffer no penal ties or potent ial liability if they act negligentl y for
themselves.”
In Mellon Bank the Federal Circuit split from the Sixth Circuit and ruled that the investment advisory fees
are a miscellaneous itemized deduction subject to the two-percent of AGI floor opining that only those
trust-related administrative expenses th at are unique to the ad ministration of a trust and not customarily
incurred outs ide of trusts by in dividuals are fully deductible. I n Scott the Fourth Circuit joined t he
Federal Circuit in a sim ilarly reasoned decision holdi ng the invest ment advisory fees do not fall within
Code § 67 (e)(1) as they constitute expenses commonly incurred by individuals as opposed to costs which
“would not have been incurred if the property were not held in such trust.”
In William L. Rudkin Testamentary Trust the Second Circuit recentl y ruled t hat the investment advisor y
fees are a miscellaneous itemized deduction subject to the two-pe rcent of AGI floor reasoning that only
investment fees incurred by a tr ust that could n ot h ave been incurred if the property were held b y an
individual are costs which “would not have been incurred if the property were not held in such trust.”
The Supreme Court i n Knight, Trustee of the William L. Rudkin Testamentary Trust v. Commissioner of
Internal Revenue, 127 S.Ct. 3005 (2007) has granted certiorari and will review the decision of the Second
Circuit’s decision to resolve the split am ong the circ uit courts of appeals over whether investment
advisory fees incurred by a trust should be dedu cted in full to determ ine the trust’s AGI or as a
miscellaneous item ized deduction, wh ich in the aggreg ate are r educed by 2 percent of adjusted gros s
income.
Individuals contemplating forming a trust, whether it be an inter vivos or testamentary trust and trustees
and those with an i nterest in existing trusts should be aware of the im pending Supreme Court decision
with regard to Rudkin as it will have a major impact on the tax liability of the trust and thus the corpus of
the trust. The Court’s decision will impact more than merely the deductibility of investment advisory fees,
but also a my riad of other expenses incurred by a tr ust. If the Court adopts the reasoning of the Sixth
Circuit in O’Neill it would open t he door to the deductibility of almost any expense incurred by a trust
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