June 16, 2014
Final Regulations on Estate and Trust 2% Expenses
By Cathy Green
On May 8, 2014, the Internal Revenue Service issued final regulations regarding the treatment of administrative costs for non-grantor trusts and estates. These final regulations are similar to the 2011 proposed regulations but provide some clarifications, and are effective for tax years beginning on or after May 9, 2014.
Under Internal Revenue Service Code Section 67 (e)(1), costs paid or incurred in connection with the administration of an estate or trust are deductible in arriving at Adjusted Gross Income ("AGI") if they would not have been incurred if the property was not held in an estate or trust. The fully deductible expenses must be specific to a trust or estate because if they are "customarily" or "commonly" incurred by individuals, the expenses are subject to a 2% AGI floor.
Clarifications made in the final regulations include the following items:
- Bundled fees - There has historically been confusion as to how to correctly deduct bundled fees, which are fees that include both costs that are subject to the 2% AGI limitation and costs that are fully deductible, such as executor's or trustee's commissions. The final regulations provide that bundled fees have to be separated into the two categories by any reasonable method. Factors that determine a reasonable method include, but are not limited to, the percentage of the fiduciary's time spent on investment advice, the percentage of the corpus subject to investment advice, and whether a third party would have charged a similar fee for comparable advice services. Any fiduciary fee not allocated to investment advice and not calculated on an hourly basis may be fully deducted except for (1) payments made to third parties out of the bundled fee that would have been subject to the 2% floor if paid directly by the estate or trust and (2) expenses that are commonly or customarily incurred by an individual.
- Investment advisory fees - Fees for investment services that would be provided to an individual investor are subject to the 2% AGI limitation. However, if the fees exceed the fees generally charged to an individual investor and the excess is due to an "unusual investment objective" of the trust or estate, then that excess is not subject to the 2% AGI floor.
- Ownership costs - Ownership costs are costs that are chargeable to or incurred by an owner of property simply by reason of being the owner of the property. Ownership costs may be miscellaneous itemized deductions subject to the 2% AGI limitation since they would be incurred by an individual owning the property (i.e. partnership costs passed through to and reportable by a partner if the costs are defined as miscellaneous itemized deductions, condominium fees, and insurance premiums) or may be fully deductible under other code sections, such as real estate taxes or royalty expenses.
- Tax preparation fees - Fees incurred for the preparation of estate and generation skipping transfer tax returns, fiduciary income tax returns and a decedent's final individual income tax return are not subject to the 2% AGI limitation, but fees for any other tax preparation services are subject to the 2% AGI limitation since commonly and customarily incurred by individuals (i.e. gift tax returns).
- Appraisal fees - Appraisal fees incurred by an estate or non-grantor trust for determining the fair market value of an asset at the decedent's date of death, for purposes of making distributions or for properly preparing the estate's or trust's tax returns are fully deductible. Appraisals obtained for other purposes such as insurance valuation are subject to the 2% floor.
- Other fiduciary expenses - Expenses that are particular to an estate or trust such as probate court fees and costs, legal publication costs of notices to creditors or heirs, costs of certified copies of death certificates, fiduciary bond premiums, etc. are fully deductible and not subject to the 2% floor.