Circuit Rules on Deductibility of Investment Advisor Fees Incurred
- The U.S. Court of Appeals for the Second Circuit, in William
L. Rudkin Testamentary Trust v. Comm’r [467 F.3d 149
(2006)], recently ruled that investment advisory fees incurred by
a trust are not fully deductible, but rather are subject to the
2% floor. This question has caused a split among the federal appellate
courts. The Sixth Circuit Court of Appeals had previously held that
investment advisory fees are fully deductible. The Second Circuit
has joined the Fourth Circuit and the Federal Circuit in holding
that investment advisor fees incurred by trusts are subject to the
Tax Court decision in Rudkin allowed as a deduction only
that portion of investment advice fees that exceeded 2% of the
trust’s adjusted gross income (AGI), and the trust appealed.
Because the parties to the case were able to stipulate to the
facts, the Second Circuit’s task was to interpret the statute,
namely IRC section 67(e). The Code states that “costs which
are paid or incurred in connection with the administration of
the estate or trust and which would not have been incurred if
the property were not held in such estate or trust” are
allowable in arriving at adjusted gross income.
in Rudkin argued that the Second Circuit should follow
the Sixth Circuit, which held that investment advisor fees paid
by a trust are incurred because the property is held in trust
and, therefore, such costs should be fully deductible under IRC
section 67(e). The Sixth Circuit reasoned that, because a trustee
has a fiduciary duty to manage trust assets as a prudent investor
(and can be personally surcharged or held liable for failure to
do so), investment advisory fees are necessary expenses incurred
in the proper administration of a trust, and thus should be fully
deductible. Although the Sixth Circuit acknowledged that individuals
often incur fees for investment advice, individuals are not required
to consult advisors and suffer no penalty or liability for failure
to consult an investment advisor. (Obviously, individuals are
free to invest their own money as they see fit, and, unlike a
trustee, individual investors have only themselves to answer to.)
Circuit rejected this reasoning, and held that the statute requires
an “objective determination of whether the particular cost
is one that is unique to trusts and one that individuals are incapable
of incurring.” Because individuals commonly pay fees to
investment advisors, the Second Circuit ruled, such fees are not
unique to trusts and are therefore not fully deductible but rather
subject to the 2% floor. The court noted that only costs that
individuals are incapable of incurring, such as trustee fees and
commissions, expenses associated with judicial accountings, and
the costs of preparing fiduciary income tax returns, would be
fully deductible for a trust.
the Supreme Court
Supreme Court granted the trust’s petition for certiorari
on June 25, 2007, meaning it will hear the appeal of the case.
Presumably, the Court will use Rudkin to resolve the
conflicting circuit court decisions. The full text of Rudkin,
posted by the court on October 18, 2006, can be found at www.ca2.uscourts.gov.
S. Kulakoff, CPA, is with Siegel & Kulakoff, CPAs,
Massapequa Park, N.Y.
CPA Journal is broadly recognized as an outstanding, technical-refereed
publication aimed at public practitioners, management, educators,
and other accounting professionals. It is edited by CPAs for CPAs.
Our goal is to provide CPAs and other accounting professionals
with the information and news to enable them to be successful
accountants, managers, and executives in today's practice environments.
The New York State Society of CPAs. Legal