The Internal Revenue Service has released a final rule under Internal Revenue Code Section 67(e) that requires certain fiduciary fees to be “unbundled” for tax purposes.
The following explanation of the rule is provided by the American Bankers Association:
Background: Generally when computing a taxpayer’s taxable income, miscellaneous itemized deductions are allowed only to the extent they exceed two percent of the taxpayer’s adjusted gross income (i.e., the 2-percent floor). However, Section 67(e) of the Code makes an exception for costs that are incurred in connection with the administration of an estate or trust, which would not have been incurred if the property were not held in such estate or trust. Under this exception, these deductible costs are not subject to the 2-percent floor for miscellaneous itemized deductions – instead they are fully deductible from the income of the trust or estate. The IRS issued the final rule to provide guidance on which costs incurred by a trust or estate are subject to the 2-percent floor, and how to address “bundled” fiduciary fees that cover costs that are subject to the 2-percent floor and those that are not.
Unbundling Requirement in Final Rule: Under the final rule, fiduciaries must “unbundle” their trustee and executor fees into two buckets: (1) costs subject to the 2-percent floor and (2) costs that are not. To determine whether the cost is subject to the 2-percent floor, the trustee must consider whether it is one that an individual would “commonly” or “customarily” incur. If the individual would commonly or customarily incur such a cost, it is subject to the 2-percent floor and is not fully deductible from income. The final rule lists, by example, the following costs as subject to the 2-percent floor:
- Ownership costs (such as condo fees, insurance costs, maintenance and lawn services
- Certain tax preparation fees
- Certain appraisal fees, and
- Investment advisory fees.
The final rule also mentions certain costs that are not subject to the 2-percent floor (the list is not exhaustive):
- Real estate taxes,
- Costs associated with rental property,
- Probate court fees and costs,
- Fiduciary bond premiums,
- Legal publication costs of notices to creditors and heirs,
- Cost of certified copies of decedent’s death certificate,
- Costs related to fiduciary accounts, and
- Certain incremental costs of investment advice beyond the amount that normally would be charged to an individual investor.
Exception for “Bundled” Fees Not Computed on an Hourly Basis: If a “bundled” fiduciary fee is not computed on an hourly basis, the current proposal requires that the portion of that fee that is attributable to investment advice is subject to the 2-percent floor, while the remaining portion of that fiduciary fee is fully deductible. In other words, only the portion of the fiduciary fee attributable to investment advice needs to be unbundled and subject to the 2-percent floor. Notwithstanding this exception, in an effort to prevent evasion of the rule, any payments made to third-parties out of the bundled fee for services rendered to the estate or non-grantor trust must also be subject to the 2-percent floor.
“Reasonable Method” of Allocating Fees: Under the rule, a fiduciary may use any “reasonable method” to allocate bundled fees including allocating a portion of the bundled fee to investment advice. Such standard does not apply however to payments made to third parties because those payments are readily identifiable.
Effective Date: The rule applies to taxable years beginning on or after January 1, 2015.