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George F. Bearup, J.D. Senior Legal Trust Advisor

7-May-18

Tax Impact of Investment Advisory Fees

Take-Away: The deductibility of an  investment advisory fee is impacted by the 2017 Tax Cut Act, not in a good way.

Background: As a gross generalization, investment advisory expenses, along with tax preparation and other professional fees are/were treated as miscellaneous itemized deductions. Prior to 2018 a taxpayer’s miscellaneous itemized deductions were allowed but only to the extent that their aggregate value exceeded 2% of a taxpayer’s adjusted gross income. [IRC 62(a).] These were called below the-line-deductions.  Restated, these deductions were added together and then reduced, but not below zero, by 2% of the taxpayer’s adjusted gross income, aka the 2% floor. Some common itemized deductions were the following:

  • Costs to defend a claim against the estate, the decedent, or claims unrelated to the existence, validity or administration of the estate or trust;
  • Ownership-costs;
  • Tax preparation fees;
  • Appraisal fees; and
  • Investment advisory fees.

With the 2017 Tax Cut Act the 2% floor was lost, and those itemized deductions cannot be carried forward to future tax years. [New IRC 67(g) provides: ‘no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017 and before January 1, 2026.’]

Exception: However,  IRC 67(e) directs that certain deductions of a trust or estate that would otherwise be miscellaneous itemized deductions will be treated as above-the-line deductions, which are preserved under the Tax Cut Act. Specifically, these refer to costs that are paid or incurred in connection with the administration of a trust or estate which would not have been incurred if the property were not held in such a trust or estate. [Treas. Reg. 1.67-4(a)-(b)(1).] Accordingly,  these deductions which are unique to trusts and estates are not subject to the 2% floor, and they continue to be available to taxpayers. Based on the plain language the Tax Code, expenses associated with a trust or estate under IRC 67(e) are not are not itemized deductions and thus are preserved and still available to trusts and estates.

Examples: Examples of expenses that are unique to an estate or trust, and thus are an above-the-line deductions, include: probate court fees and costs, fiduciary bond premiums, legal publication notices to creditors or heirs, costs of certified copies of the decedent’s death certificates, and costs related to fiduciary accountings.  [Treas. Reg. 1.67-4(b)(6).]

Investment Advisory Fees: In 2008 a trust or estate’s investment advisory costs were held by the Supreme Court to be miscellaneous itemized deductions because it is common for individuals to hire investment advisors, notwithstanding that an individual, acting in his individual capacity, would not have the fiduciary duty of a trustee and could not incur trust investment advisory fees. See Knight v Commissioner, 552 US 181 (2008) pages 187-188. As a terse summary of that court decision, the standard shifted from whether expenses that were unique to a trust or estate to whether the costs incurred was commonly and customarily incurred by individuals. The upshot of that court decision was that a fixed fee for trust services had to be unbundled, to remove the investment advisory fees component, which was then subject to the 2% itemized deduction floor.

Unbundled and Bundled Fees:  Subsequent Treasury Regulations require that if an estate or trust pays a single fee, commission, or other expense for both types of costs [the above-the-line and below-the-line expenses] the taxpayer must allocate the payment using any reasonable method between the costs that are subject to the 2% floor and those that are not. [Treas. Reg. 1.67-4(c)(1).] Therefore, if a bundled fee is not computed on an hourly basis, only the portion of that fee that is attributable to investment advice that was previously subject to the 2% floor is no longer is available as a tax deduction.

Allocating Bundled Fees: In determining how the allocation of the bundled fee is allocated, the Regulations provide limited guidance as to what is taken into account in that allocation:

  • The percentage of the value of the trust corpus that is subject to the investment advice;
  • Whether a third party advisor would have charged a comparable fee for similar advisory services; and
  • The amount of the fiduciary’s attention to the trust or estate that is devoted to investment advice as compared to dealing with beneficiaries and distribution decisions and other fiduciary functions. [ Treas. Reg. 1.67-4(c)(4).]

Bottom line: Investment advisory fees are no longer deductible, whether incurred individually with an advisor, or those which are ‘buried’ in an unbundled fee charged by a trustee, as they were eliminated as itemized deductions under the 2017 Tax Cut Act.