Second Circuit Addresses Circuit Split Re: Deductibility of Investment-Advice Fees Under 26 U.S.C. § 67(e)(1); Joins 4th & Fed Circuits

Per William L. Rudkin Testamentary Trust v. Comm'r, ---F.3d----, 2006 WL 2972609 (2d Cir. Oct. 18, 2006):

The question presented on this appeal is whether investment-advice fees incurred by a trust are fully deductible in calculating adjusted gross income for purposes of the Internal Revenue Code ("IRC") under 26 U.S.C. § 67(e)(1) (2000), or whether these fees are deductible only to the extent that they exceed two percent of the trust's adjusted gross income under § 67(a). We affirm the decision of the tax court and hold that a trust's investment-advice fees are subject to the two-percent floor of § 67(a) and therefore not fully deductible in arriving at adjusted gross income.

The Sixth Circuit was the first federal court of appeals to consider the question presented here. It held that "the investment advisor fees paid by the Trust were costs incurred because the property was held in trust, thereby making them eligible for the § 67(e) exception and not subject to the base of two percent of adjusted gross income." O'Neill v. Comm'r, 994 F.2d 302, 304 (6th Cir.1993). . . . In short, O'Neill established the rule that a trust's costs attributable to the trustee's fiduciary duty, and not required outside the administration of trusts, fall within the § 67(e)(1) exception and are therefore fully deductible.

The Federal Circuit rejected this reasoning in Mellon Bank, N.A. v. United States, 265 F.3d 1275 (Fed.Cir.2001). In Mellon Bank, the court held that the second clause of § 67(e)(1) "serves as a filter" with respect to the first clause and "treats as fully deductible only those trust-related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of trusts." Id. at 1280-81. . . .

The Fourth Circuit subsequently joined the Federal Circuit in holding that investment-advice fees incurred by a trust are subject to the two-percent floor of § 67(a). Scott v. United States, 328 F.3d 132, 140 (4th Cir.2003). . . . Stating a rationale similar to the Federal Circuit's in Mellon Bank, the court said that to find a trust's investment-advice fees to be fully deductible would lead to the conclusion that "[a]ll trust-related administrative expenses could be attributed to a trustee's fiduciary duties," rendering the second clause of § 67(e)(1) meaningless. Id.


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