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Saturday, July 28, 2007

ESTATE & TRUST DEDUCTIONS AND THE 2% FLOOR

Under the Internal Revenue Code, miscellaneous itemized deductions are allowed for individuals (which include trusts and estates) only to the extent that the aggregate deductions exceed 2 percent of adjusted gross income. However, certain expenses of an estate or trust are not subject to the 2 percent floor. These expenses are administration expenses which would not have been incurred if the property were not held in the estate or trust (Code Section 67(e)). There has been a significant amount of litigation about what expenses come within this exception – especially as to whether investment advisory fees come within it.

The IRS has now issued proposed regulations on what test should be used to determine whether a deduction comes within the exception. The test employed by the proposed regulations is whether an expense is "unique" to an estate or trust – if it is unique it is not subject to the 2 percent floor. For this purpose, a cost is "unique" if an individual could not have incurred that cost in connection with property not held in an estate or trust.

The proposed regulations indicate that the following expenses are "unique" and thus should not be subject to the 2 percent floor, namely expenses in connection with fiduciary accountings, judicial or quasi-judicial required filings, fiduciary income tax and estate tax returns, the division or distribution or income or corpus to or among beneficiaries, trust or will contests or constructions, fiduciary bond premiums, and communications with beneficiaries regarding estate or trust matters. It also provides a list of items that are NOT unique and thus not subject to the 2% floor, namely relating to the custody or management of property, advice on investing for total return, gift tax returns, defense of claims by creditors of the decedent or grantor, and the purchase, sale, maintenance, repair, insurance or management of non-trade or business property.

The IRS also indicates it will "unbundle" fees for various services, so that each service will need to be addressed on a separate basis.

Of course, these are only proposed regulations, and are not currently applicable, but they are a clear indication of the course the IRS wants to take.

COMMENT: It is interesting that the Code uses the language which "would not have" been incurred if the property was not held in the trust or estate, and the IRS converts this to which "could not have" been incurred in the proposed regulations. It is difficult to determine if this is a meaningful difference, but it seems like it could (or should we say "would") be in some circumstances.

Proposed Regulations Section 1.67-4.

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