Trust Advisory Fees Subject to Floor
Supreme Court rules on issue that divided circuits
By Kaye A. Thomas
Posted January 17, 2008
Investment advisory fees of trusts are not fully deductible.
Individual investors who pay investment advisory fees are allowed to claim an itemized deduction for that expense, but only to the extent these fees, together with certain other "miscellaneous itemized deductions," exceed 2% of the individual's adjusted gross income. Many investors lose much or all of this deduction because of the 2% floor.
Example: In a year when your adjusted gross income is $100,000 you pay $1,500 in investment advisory fees and have $700 in other miscellaneous itemized deductions that are subject to the 2% floor. Your expenses in this category add up to $2,200, but you are allowed to deduct only $200, the part that exceeds 2% of your AGI.
With some exceptions, trusts are taxed according to rules similar to the rules that apply to individual taxpayers. The 2% floor generally applies, but not to expenses "paid or incurred in the administration of the trust" if it is a cost "which would not have been incurred if the property had not been held in such trust." Some trusts have taken the position that the 2% floor doesn't apply to their investment advisory fees because trustees must incur such fees to meet their fiduciary duties. The Supreme Court agreed to review this issue because of disagreement in the lower courts.
In a unanimous opinion written by Chief Justice John Roberts, the Court said these fees generally will be subject to the 2% floor. Investment advisory fees are commonly incurred by individuals, so we can't conclude that the fees "would not have been incurred if the property had not been held in such trust." The trustee's fiduciary duty is to manage investments as a prudent investor would. In satisfying that duty the trustee is, by definition, paying expenses a prudent individual would incur.
The opinion holds out the possibility that particular circumstances might lead a trust to incur investment advisory fees that would not be incurred by an individual owner of the same assets, and in this event the 2% floor would not apply. The Court did not find such circumstances in the case it was considering.
Analysis: The decision preserves parity between individuals and trusts in the treatment of these expenses. As a result, wealthy individuals will not achieve a more favorable tax treatment for their investment advisory expenses by transferring assets to a trust.
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