The Treasury Department on May 8 issued final regulations (T.D. 9664) on the application of the 2% miscellaneous itemized deduction floor to an estate or trust. The regulations are effective for tax years beginning after May 9, 2014. Because most trusts use a calendar year, this means for most existing trusts the regulations will apply beginning Jan. 1, 2015. However, the regulations will be immediately effective for estates and trusts created after May 9.
Section 67(a) allows the deduction of miscellaneous itemized to the extent that the sum of such deductions exceeds 2% of the taxpayer's adjusted gross income (AGI). Section 67(e) provides a special rule for estates and trusts that allows the full deduction (not subject to the 2% of AGI reduction of administrative costs "which would not have been incurred if the property were not held" in a trust or estate. The application of this special rule has long been the subject of disagreement between taxpayers and the IRS, culminating in the Supreme Court's decision in Knight v. Commissioner, 522 U.S. 181 (2008).
The final regulations closely follow the proposed regulations but make some clarifications. Specifically, costs relating to all estate and generation-skipping transfer tax returns, fiduciary income tax returns and the decedent's final individual income tax returns are not subject to the 2% floor. The costs of preparing all other returns are subject to the 2% floor.
In addition, investment advisory costs are subject to the 2% floor. The regulations do permit the full deduction of additional investment advisory expenses that are incurred only because the assets are held by a trust or estate. For example, if a trust pays $1,000 of investment advisory fees, and if the investment advisor would have charged an individual $800 to manage the same assets, the trust may deduct the $200 excess. The regulations suggest such an excess might be "attributable to an unusual investment objective or the need for a specialized balancing of the interests of various parties (beyond the usual balancing of the varying interests of current beneficiaries and remaindermen)."
Also, bundled fiduciary fees (where a portion of the fee is for services that are, and are not, subject to the 2% floor) must be broken out. If the fiduciary fee is based on the adviser's time, as opposed to a fixed fee, the allocation is based on the time incurred providing each category of service. If the fiduciary fee is not based on hours, only the portion of the fee attributable to investment advisory services is subject to the 2% floor.
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