Treasury Department Issues Final Regulations Concerning Treatment of Trust or Estate Expenses for Purposes of the 2 Percent Floor

July 23, 2014 | Roger A. McEowen

Tax law provides that if an expense was "paid or incurred in connection with the administration of thest estate or trust...which would not have been incurred if the property were not held in such estate or trust" the expense deduction is not subject to the 2 percent floor. In 2008, the United States Supreme Court set forth a fairly broad test for determining which expenses should qualify for this exception. In response to this decision, the IRS issued temporary guidance, which was extended for several years. In late summer of 2011, the Treasury issued proposed regulations concerning how, for income tax purposes, expenses that a trust or an estate incurred would be treated for purposes of the 2 percent floor on miscellaneous itemized deductions and whether such expenses would be deductible in computing AGI for a trust.

Now,beginning on or after May 9, 2014, the Treasury Department has issued Final Regulations on the matter.[1]  Under the general rule,[2] a cost incurred in defending a claim against a trust or an estate is commonly and ordinarily incurred by an individual, but not if the claim challenges the trust’s validity, administration or existence. 

The Final Regulations detail five specific areas of costs:

  • Ownership costs that a trust or an estate incurs because of its ownership of property are deemed to be expenses that an individual owner would incur.[3]
  • Certain tax preparation fees will not be subject to the 2 percent floor.  Those fees include preparation fees for estate tax returns, GSTT returns, fiduciary income tax returns and a decedent’s final individual income tax return.[4]  But, the cost of preparing all other types of returns is subject to the 2 percent floor. 
  • Investment advisory fees are generally subject to the 2 percent floor, but in certain situations the excess portion of the fee will not be subject to the 2 percent floor.[5]  Those situations include incremental costs of investment advice that goes beyond what a normal investor would be charged.  The regulation explains this as advice that is rendered to an estate or a trust caused by an unusual investment objective or a need for balancing of the interests of the parties that makes a reasonable comparison with individual investors improper.[6]  In this situation, it is the excess portion of the fee (i.e., the amount that normally wouldn’t be charged) that is not subject to the two percent floor.
  • Certain types of appraisal fees are not subject to the 2 percent floor.  These include FMV appraisals at date of death or at the alternate valuation date (six months after death); appraisals to peg value when making trust distributions; and appraisals required for return preparation (estate, trust or GSTT).[7]  All other appraisal fees are deemed to be those that an individual would incur, including insurance-based appraisals.[8] 
  • Certain fiduciary expenses are specifically listed as not subject to the 2 percent limitation include (1) probate court fees and costs; (2) fiduciary bond premiums; (3) costs of providing notice to creditors and/or heirs; (4) costs of providing certified copies of the decedent’s death certificate; and (5) costs of maintaining fiduciary accounts.[9]

 

As for bundled fees, the Final Regulations deal specifically with fees that could end up with “mixed” treatment.If a single fee is paid that covers costs that are not subject to the 2 percent floor and others that are, the fee must be allocated between the two types of costs.[10]For fees that are not charged on an hourly basis, just the portion of the expense that relates to investment advice is subject to the 2 percent limitation.[11]The Final Regulations also state that any payments made to third parties out of a bundled fee that would have been subject to the 2 percent limitation if paid directly by an estate or trust are not subject to allocation.[12] Similarly, no allocation is necessary for expenses assessed by a payee of the bundled fee for services that are commonly or customarily incurred by an individual.[13]

 

The Final Regulations specify that any reasonable method can be used to allocate fees between those subject to the 2 percent floor and those that are not.[14]But, certain factors are listed that can aid in making the allocation.

 

[1] TD 9664.  79 Fed. Reg. 26626-26620 (May 9, 2014). These regulations would have applied beginning January 1, 2015, to a trust created or an estate of a decedent dying after May 8, 2014. However, IRS later postponed the effective date such that the rules apply to taxpayers whose tax years begin on or after January 1, 2015. TD 9664 79 Fed. Reg. 41636 (Jul. 17, 2014).

[2] Treas. Reg. §1.67-4(b)(1).

[3] Treas. Reg. §1.67-4(b)(2).

[4] Treas. Reg. §1.67-4(b)(3).

[5] Treas. Reg. §1.67-4(b)(4).

[6] Id.

[7] Treas. Reg. §1.67-4(b)(5).

[8] Id.

[9] Treas. Reg. §1.67-4(b)(6).

[10] Treas. Reg. 1.67-4(c)(1).  The regulation points out that fiduciary fees, attorney fees and accountant fees may be subject to “mixed” treatment. 

[11] Treas. Reg. §1.67-4(c)(2).Apparently, a detailed parsing of the fee is necessary for a fee that is charged on an hourly basis.

[12] Treas. Reg. §1.67-4(c)(3).

[13] Id.

[14] Treas. Reg. §1.67-4(c)(4).