Apr 1, 2007 12:00 PM

, By John M. Janiga, professor, School of Business Administration, Loyola University, Chicago, and Lou

By John M. Janiga, professor, School of Business Administration, Loyola University, Chicago, and Lou

One of the most vexing issues in the federal income taxation of trusts over the last 15 years has been questions about the correct treatment of Internal Revenue Code Section 212 expenses.¹ Are such expenses fully deductible in arriving at a trust's taxable income? Or are they miscellaneous itemized deductions (MIDs) deductible only to the extent that they exceed 2 percent of a trust's adjusted gross income (AGI), often referred to as the “2 percent-of-AGI floor?” Although the answer may have important tax consequences for any Section 212 expense, it's particularly important for investment advisory fees (IAFs) that are often substantial for trusts funded with significant investment assets.

IRC Section 67(a) provides that, in the case of an individual, MIDs are subject to the 2 percent-of-AGI floor. IAFs paid by an individual fall under this provision. Section 67(e), however, provides, in part, that the AGI of a trust is to be computed in the same manner as for an individual, except that certain administrative costs are deductible in arriving at a trust's AGI (referred to as an “above-the-line” deduction) — and, thus are not MIDs — if the costs are “paid or incurred in connection with the … trust and would not have been incurred if the property were not held in such trust.”² Thus, the failure to meet the requirements of Section 67(e) would mean that a trust's administrative costs, including IAFs, are MIDs.