National Association of Estate Planners and Councils

January, 2009 Newsletter
Provided by Leimberg Information Services

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Trustees Freed From Bondage One More Year

Long a thorn in the side of CPAs and attorneys, the issue in Knight v. CIR captured the attention of Wall Street when trustees and brokers fought an intensive battle on whether their fees for investment advice to trustees are fully deductible or subject to the 2-percent floor on miscellaneous itemized deductions under IRC § 67(e).

On January 16, 2008 the U.S. Supreme Court rendered its unanimous decision in Knight v. CIR (formerly Rudkin Testamentary Trust v. Commissioner), holding that

 "There is nothing in the record to suggest that Warfield charged the Trustee anything extra, or treated the Trust any differently than it would have treated an individual with similar objectives, because of the Trustee's fiduciary obligations. … Accordingly, we conclude that the investment advisory fees incurred by the [Knight] Trust are subject to the 2% floor."(Opinion p. 13)

In reaching this conclusion, the Supreme Court rejected the positions advanced by both parties and adopted instead the "commonly" test of the 4th and Federal Circuits. What's more, it left both the IRS and the taxpayer the impossible task of predicting what ordinary people would "commonly" do with the property.

No one knows this case and the issues it presents better than Carol A. Cantrell of Briggs & Veselka Co. in Bellaire, Texas, co-counsel for the Rudkin Trust  (Knight v. Commissioner of Internal Revenue). Carol brings LISI members this exclusive on the latest development!


Like a wet firecracker, on December 11, 2008 the IRS issued the long-awaited Notice 2008-116, which announced that trustees and executors are free from unbundling the investment portion of their fiduciary fees for one more year. Thus, for 2008 and prior tax returns, trustee fees and executor commissions are fully deductible under IRC § 67(e). The Notice was necessary because regulations under § 1.67-4 will not be issued in time for fiduciaries to prepare their 2008 tax returns, let alone back-track how they should have been allocating trustees' fees all year long.


In a less than 400 words,  IRS Notice 2008-116 extends for one more year the provisions of Notice 2008-32, issued last February, which waived the unbundling requirement for "investment advisory costs and other costs subject to the 2-percent floor under § 67(a) that are integrated as part of one commission or fee paid to the trustee or executor ("Bundled Fiduciary Fee") and are incurred by a trust other than a grantor trust (nongrantor trust) or an estate."


NOTE:   Payments by a fiduciary to third parties for expenses that are readily identifiable and subject to the 2-percent floor must be treated separately from the otherwise Bundled Fiduciary Fee.


The Notice also reiterates the Service's intention to issue regulations under § 1.67-4 "consistent with the Supreme Court's holding in Knight." The 2009 Semiannual Regulatory Agenda indicates a June 2009 target date for final regulations under Section 67(e) and no further public hearing scheduled past the one last November 14, 2007. Based on this timetable, there will need to be another Notice waiving the unbundling requirement for 2009 tax returns.



It is hard to see how the Service can issue regulations that are "consistent with the Supreme Court's holding in Knight" and yet require trustees to unbundle their fees.  Why?  Because Knight did not address or even mention trustee fees. In fact, dozens of commentators told the IRS they believe it is reasonable to infer from Knight that trustee fees are fully deductible because the Supreme Court adopted the Mellon approach, which allowed a full deduction for trustee fees on the basis that individuals do not commonly incur them.



 It is also worth noting that Knight dealt with "investment advisory fees" only.  But no portion of a trustee fee constitutes an investment advisory fee.

The Securities and Exchange Commission defines an "investment adviser" as "any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities."

Simply put, trustees are not investment advisers because they are not engaged in the business of advising others. Rather, they act as principal, holding legal title to the trust property, and directly managing and investing it.  Unlike investment advisers, trustees advise no one.

Moreover, the Securities and Exchange Commission (SEC) specifically excludes banks from the definition of investment adviser under the Investment Advisers Act of 1940. Presumably this is because they are subject to their own regulatory scheme.

Individual trustees are also excluded from the definition of investment advisers where they are not compensated or engaged in the business of advising others or where they are acting as principal rather than advising the trust corpus.[1]



Therefore, it will be interesting to see how the final regulations fit the square peg of "investment advisory fees" into the round hole of "trustee fees." But even if they do, many corporate trustees assert that their entire fee is attributable to assuming the responsibilities and liability as a trustee and their investment costs are a "sunk cost." That is, they would maintain the investment department for their non-trust customers anyway. Therefore, there is little or no additional cost associated with investing the trust corpus.



But this may all become a moot point if Congress enacts the legislative solution supported by the AICPA, the American Bankers Association, and others, which will allow a full deduction for all fiduciary administrative costs. Ironically, a legislative solution would be as much a blessing for Treasury as it would be for trustees.

But the million dollar question is how much it will cost Treasury to give up the 2-percent floor for estates and trusts. No one knows because there's no "tracking" going on. Trustees do not track the investment portion of their trustee fees and the IRS does not track the current level of compliance with the 2-percent floor by estates and trusts.




Carol Cantrell



LISI Estate Planning Newsletter # 1383 (December 15, 2008) at  Copyright 2008 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to ANY Person Prohibited – Without Express Permission.



Notice 2008-116, 2008-52 I.R.B. ____ (Dec. 11, 2008); Notice 2008-32, 2008-11 I.R.B. 593 (Feb. 16, 2008); Knight v. CIR, 128 S. Ct. 782 (2008); oral argument transcript available at; Prop. Reg. § 1.67-4, Fed. Reg. Doc. E7-14489 (REG-128224-06); Dept. of the Treasury Semiannual Agenda and Fiscal Year 2009 Regulatory Plan (Nov. 24, 2008), available at; William L. Rudkin Testamentary Trust v. Commissioner, 124 T.C. 304 (2005), aff'd 467 F.3d 149 (2nd Cir. 2006), cert. granted sub nom. Knight v. CIR (S. Ct. Doc. No. 06-1286); Mellon Bank, N.A. v. United States, 265 F.3d 1275 (Fed. Cir. 2001); Scott v. United v. United States, 328 F.3d 132 (4th Cir. 2003); O'Neill v. Comm'r, 994 F.2d 302 (6th Cir. 1993); IRC Section 67; Investment Advisers Act of 1940 § 202(a)(11), 15 U.S.C. § 80b-2(a)(20).

[1] See Selzer v. Bank of Bermuda Ltd., 385 F. Supp. 415, 420 (S.D.N.Y. 1974) (finding the Advisers Act inapplicable because "the trustee does not advise the trust corpus, which then takes action pursuant to its advice, rather the trustee acts himself as principal"); but see Joseph J. Nameth,  SEC No Action Letter, 1983 WL 30256 (Jan. 31, 1983) ("We believe that a person who, for compensation, engages in the business of investment management with discretionary power to buy and sell securities is an investment adviser even if such business is operated through the medium of trusts.")

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