Estates and Trusts


By David Schaengold, CPA, David Tarlow & Co.

An IRS auditor has advised members of the NYSSCPA's Income of Estates and Trusts Committee of its effort to initiate another court proceeding involving trust administration expenses. In 1993, a Tax Court decision in favor of the IRS was overruled by the Sixth Circuit Court of Appeals in William J. O'Neill, Jr. Irrevocable Trust v. Commission [994 F.2d 302 (1993)]. In 1994, the IRS announced that it would not acquiesce to the Appeals Court decision. However, there has been no litigation on the part of the IRS to date that has challenged the Sixth Circuit decision.

The Tax Court's Ruling

The issue is whether an irrevocable trust's expenditures for investment advice are fully deductible from gross income under IRC section 67(e) or are limited by the same two percent rule that limits an individual's deductions under IRC section 67(a). Generally, IRC section 67(a) provides that "miscellaneous itemized deductions for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds two percent of adjusted gross income." However, under IRC section 67(e), if such costs "would not have been incurred if the property were not held in such trust," administrative costs are deductible in full.

In 1992, the Tax Court upheld the IRS position that the investment advisory fees incurred by the trustees of the William J. O'Neill, Jr. Trust were not unique to property held in trust. Accordingly, it is proper that they be subject to the two percent adjusted gross income floor for miscellaneous deductions.

However, the O'Neill trustees appealed to the Sixth Circuit. The trustees argued that a trustee must "meet the prudent investor standard," which imposes on the trustee a duty to diversify--"to distribute the risk of loss within the trust"--and, "where a trustee lacks experience in investment matters, professional assistance may be warranted." The trustees pointed out that because they lacked experience in investing and managing large sums of money, they hired an investment advisor. Without such assistance, they would have placed at risk the assets of the trust. They asked the court to find that "the investment advisory fees were necessary to the continued growth of the trust and were caused by the fiduciary duties of the trustees."

The Sixth Circuit's Ruling

The Sixth Circuit agreed with the O'Neill trustees and reversed the Tax Court decision. In its opinion, the Appeals Court reasoned that the fees are fully deductible because "fiduciaries uniquely occupy a position of trust for others and have an obligation to exercise proper skill and care with the assets of the trust."

The Income of Estates and Trusts Committee learned that the IRS has begun a search for returns where the two percent limitation would be an issue. The effort is supported by the IRS's National Office, with a plan to move the issue to litigation in the Second District. Practitioners and taxpayers outside of the Sixth Circuit, and especially those in the Second District (which includes New York), may want to reexamine the issue and consider the risks involved if the IRS is successful in its search for a case to litigate. *

Lawrence M. Lipoff, CPA
Rogoff & Company, P.C.

Alan D. Kahn, CPA
The AJK Financial Group

Contributing Editors:
Barry C. Picker, CPA

Richard H. Sonet, JD, CPA
Marks Shron & Company LLP

Peter Brizard, CPA

Ellen G. Gordon, CPA
M.R. Weiser & Co., LLP

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