Deductibility of Fiduciary Expenses

Sullivan & Cromwell LLP - July 27, 2007

On July 26, 2007, the Internal Revenue Service (the “IRS”) issued Proposed Regulation § 1.67-4 governing the income tax deductibility of fiduciary expenses, including fees incurred by a trust for outside investment advice (the “Proposed Regulations”).  The Proposed Regulations provide that expenses  incurred by estates or trusts, other than expenses that are “unique” to an estate or trust, are deductible only to the extent such expenses exceed two percent of the estate or trust’s adjusted gross income (“AGI”). Expenses that are unique to an estate or trust would be deductible without regard to the two percent floor.  An expense is considered unique if “an individual could not have incurred that cost in connection with property not held in an estate or trust.” 

The Proposed Regulations provide that expenses associated with the following non-exhaustive list of services are unique to an estate or trust:  fiduciary accountings, judicial or quasi-judicial filings required as part of the administration of the estate or trust; preparation of fiduciary income tax or estate tax returns; distributions to beneficiaries; trust or will contests or constructions; fiduciary bond premiums; and communications with beneficiaries regarding estate or trust matters.  The Proposed Regulations provide that expenses associated with the following non-exhaustive list of services are not unique to an estate or trust: the custody or management of property; investment advice; preparation of gift tax returns; the defense against claims by creditors of the decedent or grantor; and the purchase, sale, maintenance, repair, insurance or management of property that is not used in a trade or business. 

If an estate or trust pays a single “bundled” fee for services (i.e., for trustee’s fees and the custody and investment of trust assets), the Proposed Regulations require that the taxpayer use a reasonable method to allocate the total fee between the portion that is unique to an estate or trust and, thus, fully deductible, and the portion that is not unique to an estate or trust and is subject to the two percent floor.