US Supreme Court Rules Trust Investment Advisory Fees Not Fully Tax Deductible

A trust cannot fully deduct investment advisory fees it incurred from its federal taxable income, ruled the US Supreme Court, but instead is subject to the 2% floor on deductions. In a ruling of intense interest to the investment adviser community, a unanimous Court said that the exemption in the Internal Revenue Code from the 2% floor for costs which are paid in connection with the administration of a trust, and which would not have been incurred if the property were not held in trust, was not available here since individuals as well as trusts commonly incur such investment advisory fees. Knight v. Commissioner of Internal Revenue, No. 06-1286, Jan 16, 2008).

Section 67(a) of the Internal Revenue Code provides that miscellaneous itemized deductions are allowed only to the extent that their aggregate total exceeds 2 percent of adjusted gross income. Investment advisory fees are generally subject to this 2% floor. Section 67(a) is applicable equally to individuals and trusts, except that trust expenses that would not have been incurred if the property were not held in trust are not subject to the 2% floor and thus fully deductible.

In this case, since such investment advisory fees could just as easily have been incurred by an individual, noted the Court, it could not be said that the investment advisory fees would not have been incurred if the property were not held in trust. Thus, the investment advisory fees incurred by the trust were subject to the 2 % floor.

While the Court acknowledged that some trust-related investment advisory fees may be fully deductible if an investment advisor were to impose a special, additional charge applicable only to its fiduciary accounts, there is nothing in the record here to suggest that this particular investment adviser charged the trustee anything extra, or treated the trust any differently than it would have treated an individual with similar objectives.

It is conceivable, moreover, that a trust may have an unusual investment objective, or may require a specialized balancing of the interests of various parties, such that a reasonable comparison with individual investors would be improper. In such a case, conceded the Court, the incremental cost of expert advice beyond what would normally be required for the ordinary taxpayer would not be subject to the 2% floor. Here, however, the trust did not assert that its investment objective or its requisite balancing of competing interests was distinctive.