December 29, 2014
By Andrew J. DeMaio
In 2015, trustees and executors will need to take steps to comply with regulations restricting income tax deductions for administration expenses. The regulations apply to tax years beginning on or after January 1.
Internal Revenue Code section 67 limits the allowance of "miscellaneous itemized deductions". Those deductions are allowable only to the extent they exceed 2 percent of the taxpayer's adjusted gross income. The limitation applies to trusts and estates, but expenses that "would not have been incurred if the property were not held in such trust or estate" are exempt from the limitation. In a 2008 decision, Knight v. Commissioner, the United States Supreme Court provided guidance on how to identify expenses that "would not have been incurred" in the absence of a trust or estate. The new regulations implement that decision.
One nettlesome aspect of the new guidelines is the requirement that compensation paid to a fiduciary be "unbundled" to properly account for investment management fees. According to the regulations, individuals commonly pay for investment advice; therefore the cost of such advice is not unique to trusts and estates, and is generally subject to the 2% limitation. Most executors and trustees, however, do not charge separately for investment management. Their compensation, most often computed based on the value of the trust or estate, covers all of the various services rendered and the responsibilities assumed. The regulation mandates that the fiduciary separate out the portion of the compensation allocable to investment advice, and allows the use of "any reasonable method" to make that allocation.
The new rules affect both individual and corporate fiduciaries. They won't apply to 2014 returns, most of which will be prepared in the next few months. But executors and trustees should be mindful of the new regulations as they administer estates and trusts in 2015.