Court Opinion

ID: 4631724
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:10:14.575811+00
Date Added: 2024-06-11T07:59:21.141776
License: Public Domain

WILLIAM L. RUDKIN TESTAMENTARY TRUST U/W/O HENRY A. RUDKIN, MICHAEL J. KNIGHT, TRUSTEE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilliam L. Rudkin Testamentary Trust v. Comm'rNo. 3297-04 United States Tax Court124 T.C. 304; 2005 U.S. Tax Ct. LEXIS 20; 124 T.C. No. 19; June 27, 2005, Filed 2005 U.S. Tax Ct. LEXIS 20">*20 T is a trust established in 1967. The trustee engaged an outsidefirm to provide investment management advice for T, and the firmwas paid $ 22,241.31 for such services during the 2000 taxableyear. On its Federal income tax return, T deducted these fees(rounded) in full.Held: The investment advisory fees paid by T are notfully deductible under the exception provided in sec. 67(e)(1),I.R.C., and are deductible only to the extent that they exceed 2percent of the T's adjusted gross income pursuant to sec. 67(a),I.R.C.  Michael J. Knight (specially recognized), for petitioner.Frank W. Louis, for respondent.  Wherry, Robert A., Jr.  ROBERT A. WHERRY, JR.  124 T.C. 304">*305 WHERRY, Judge: Respondent determined a Federal income tax deficiency in the amount of $ 4,448 with respect to the 2000 taxable year of the William L. Rudkin Testamentary Trust (the trust). The sole issue for decision is whether investment advisory fees paid by the trust are fully deductible under the exception provided in section 67(e)(1) or whether the fees are deductible only to the extent that they exceed 2 percent of the trust's adjusted2005 U.S. Tax Ct. LEXIS 20">*21  gross income pursuant to section 67(a). 1FINDINGS OF FACTThe majority of the facts have been stipulated and are so found. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. Michael J. Knight serves as trustee of the trust and provided an address in Fairfield, Connecticut, at the time the petition in this case was filed.The trust was established under the will of Henry A. Rudkin on April 14, 1967. 2 Henry A. Rudkin's family was involved in the founding of Pepperidge Farm, a food products company. Pepperidge Farm was sold to Campbell Soup Company in the 1960s, and the trust was initially funded primarily with proceeds from that sale.2005 U.S. Tax Ct. LEXIS 20">*22  The will of Henry A. Rudkin referenced above sets forth the governing provisions of the trust. In general, income and principal of the trust were to be applied for the benefit of Henry A. Rudkin's son, William L. Rudkin, and the son's spouse, descendants, and spouses of descendants. Principal distributions were also subject to a special power of appointment held by William L. Rudkin. The trustee and other fiduciaries of Henry A. Rudkin's estate were provided with broad authority in the management of property, including the authority "to invest and reinvest the funds of my estate or of any trust created hereunder in such manner as they may deem advisable without being restricted to investments of 124 T.C. 304">*306  the character authorized by law for the investment of estate or trust funds" and "to employ such agents, experts and counsel as they may deem advisable in connection with the administration and management of my estate and of any trust created hereunder, and to delegate discretionary powers to or rely upon information or advice furnished by such agents, experts and counsel".The trustee engaged Warfield Associates, Inc., to provide investment management advice for the trust. During the taxable2005 U.S. Tax Ct. LEXIS 20">*23  year 2000, Warfield Associates, Inc., was paid $ 22,241.31 for its services.A Form 1041, U.S. Income Tax Return for Estates and Trusts, for the 2000 year was timely filed on behalf of the trust. Thereon the trust reported total income of $ 624,816. The Form 1041 also reflected, among other things, a deduction of $ 22,241 on line 15a for "Other deductions not subject to the 2% floor", further described on an attached statement as "INVESTMENT MANAGEMENT FEES". No deduction was claimed on line 15b for "Allowable miscellaneous itemized deductions subject to the 2% floor".On December 5, 2003, respondent issued to the trust a statutory notice of deficiency determining the aforementioned $ 4,448 deficiency for the taxable year 2000. Respondent disallowed full deduction of the $ 22,241 in investment fees and instead permitted a deduction of $ 9,780, the amount by which $ 22,241 exceeded 2 percent of adjusted gross income of $ 623,050 (i.e., $ 12,461).The trustee filed the underlying petition in this case disputing respondent's determination on grounds that the investment advisory fees should not be subject to the 2-percent limitation. During trial preparations, the parties became aware2005 U.S. Tax Ct. LEXIS 20">*24  that the notice of deficiency contained an error in its computation of adjusted gross income. The parties have now stipulated that the correct adjusted gross income figure is $ 613,263, for a corresponding deduction under respondent's position of $ 9,976. However, on account of the alternative minimum tax, the parties are in further agreement that the resultant deficiency if respondent's position is sustained remains unchanged at $ 4,448.124 T.C. 304">*307  OPINIONI. General RulesAs a general rule, the Internal Revenue Code imposes a Federal tax on the taxable income of every individual and trust. Sec. 1. Taxable income is defined as gross income less allowable deductions. Sec. 63(a). Gross income broadly comprises "all income from whatever source derived," sec. 61(a), and allowable deductions are calculated through application of a multi-tiered process. First, certain enumerated deductions may be subtracted from gross income to arrive at adjusted gross income. Sec. 62(a). Itemized deductions may then be subtracted from adjusted gross income in arriving at taxable income. Sec. 63(d).Itemized deductions, however, are further segregated into two categories that impact on their deductibility. Section2005 U.S. Tax Ct. LEXIS 20">*25  67(b) sets forth a list of itemized deductions allowed without further limitation to the extent permitted under the appropriate statutory section authorizing the deduction. For individual taxpayers, the remaining itemized deductions are characterized as "miscellaneous itemized deductions" and are allowed under section 67(a) only to the extent that they exceed 2 percent of adjusted gross income. For estates and trusts, section 67(e) mandates application of the rule of section 67(a), with specified modifications. Specifically, section 67 provides as follows in relevant part:SEC. 67. 2-PERCENT FLOOR ON MISCELLANEOUS ITEMIZED DEDUCTIONS.(a) General Rule. -- In the case of an individual, themiscellaneous itemized deductions for any taxable year shall beallowed only to the extent that the aggregate of such deductionsexceeds 2 percent of adjusted gross income.*   *   *   *   *   *   *(e) Determination of Adjusted Gross Income in Case of Estatesand Trusts. -- For purposes of this section, the adjusted grossincome of an estate or trust shall be computed in the same2005 U.S. Tax Ct. LEXIS 20">*26     manner as in the case of an individual, except that --(1) the deductions for costs which are paid or incurred inconnection with the administration of the estate or trustand which would not have been incurred if the property werenot held in such trust or estate * * **   *   *   *   *   *   *shall be treated as allowable in arriving at adjusted grossincome. * * *124 T.C. 304">*308  Hence, the statutory text of section 67(e)(1) creates an exception allowing for deduction of trust expenditures without regard to the 2-percent floor where two requirements are satisfied: (1) The costs are paid or incurred in connection with administration of the trust, and (2) the costs would not have been incurred if the property were not held in trust. Otherwise, deductibility is limited to the extent it would be for individual taxpayers.In that vein, regulations promulgated under section 67 list examples of expenses that, in the context of individuals, are subject to the 2-percent floor. Sec. 1.67-1T(a)(1),Temporary Income Tax Regs., Temporary Income Tax Regs., 53 Fed. Reg. 98752005 U.S. Tax Ct. LEXIS 20">*27  (Mar. 28, 1988). 3 Included are expenses incurred "for the production or collection of income for which a deduction is otherwise allowable under section 212(1) and (2), such as investment advisory fees, subscriptions to investment advisory publications, certain attorneys' fees, and the cost of safe deposit boxes". Sec. 1.67-1T(a)(1)(ii),Temporary Income Tax Regs.,  supra (emphasis added).II. Contentions of the PartiesAgainst this backdrop, the trustee contends that the investment management fees in dispute here are properly deductible under the exception set forth in section 67(e)(1). The trustee maintains that the fees were paid in connection with administration of the trust and would not have been incurred if the property were not held in trust. In reaching2005 U.S. Tax Ct. LEXIS 20">*28  this conclusion, the trustee relies largely on the fiduciary duties imposed on trustees. According to the trustee, while an individual may make a voluntary and personal choice to seek investment advice, fiduciary duties render such professional advice a necessary and "involuntary" component of trust administration.In contrast, it is respondent's position that the section 67(e)(1) exception does not apply to the expenses at issue. Respondent does not dispute the expenditures were made in connection with the administration of the trust. However, respondent alleges that because investment advisory fees are commonly incurred by individual investors outside the context124 T.C. 304">*309  of trust administration, the fees fail to satisfy the requirement that they would not have been incurred if the assets were not held in trust. It is also respondent's view that neither State law nor the governing trust instrument imposed a legal obligation on the fiduciary to obtain professional investment management services.III. AnalysisThe deductibility of investment advisory fees by a trust under section 67(e)(1) is not a matter of first impression. This Court and three Courts of Appeals have ruled on the question. 2005 U.S. Tax Ct. LEXIS 20">*29 Scott v. United States, 328 F.3d 132">328 F.3d 132 (4th Cir. 2003); Mellon Bank, N.A. v. United States, 265 F.3d 1275">265 F.3d 1275 (Fed. Cir. 2001); O'Neill v. Commissioner, 994 F.2d 302">994 F.2d 302 (6th Cir. 1993), revg. 98 T.C. 227">98 T.C. 227 (1992). The result has been a split in authority on the issue.This Court in O'Neill v. Commissioner, 98 T.C. 227">98 T.C. 230- 231, held that investment advice costs were not deductible under section 67(e), reasoning as follows:We believe that the thrust of the language of section 67(e) isthat only those costs which are unique to theadministration of an estate or trust are to be deducted fromgross income without being subject to the 2-percent floor onitemized deductions set forth at section 67(a). Examples ofitems unique to the administration of a trust or estate would bethe fees paid to a trustee and trust accounting fees mandated bylaw or the trust agreement. Individual investors routinely incurcosts for investment advice as an integral part of theirinvestment activities. Consequently, it cannot be argued thatsuch costs are somehow2005 U.S. Tax Ct. LEXIS 20">*30 unique to the administration of an estateor trust simply because a fiduciary might feel compelled toincur such expenses in order to meet the prudent personstandards imposed by State law.The Court of Appeals for the Sixth Circuit reversed in O'Neill v. Commissioner, 994 F.2d 302">994 F.2d at 304-305. Although the Court of Appeals concurred that "certain expenditures unique to trust administration are excepted from the two percent floor", the Court disagreed with our analysis as to why the costs in dispute were not unique. 994 F.2d 302">Id. at 303-304. Noting our statement that individual investors routinely incur costs for investment advice, the Court of Appeals opined: "Nevertheless, they are not required to consult advisors and suffer no penalties or potential liability if they act negligently for themselves. Therefore, fiduciaries uniquely occupy a position of trust for 124 T.C. 304">*310  others and have an obligation to the beneficiaries to exercise proper skill and care with the assets of the trust." 994 F.2d 302">Id. at 304.Subsequently, the Courts of Appeals for the Federal and Fourth Circuits in 265 F.3d 1275">Mellon Bank, N.A. v. United States, supra, and 328 F.3d 132">Scott v. United States, supra,2005 U.S. Tax Ct. LEXIS 20">*31  respectively, diverged from the position taken by the Court of Appeals for the Sixth Circuit. These latter rulings were consistent in their rationale and result, summarized as follows by the Court of Appeals for the Fourth Circuit:the second requirement of section 67(e)(1) does not ask whethercosts are commonly incurred in the administration of trusts.Instead, it asks whether costs are commonly incurredoutside the administration of trusts. As the FederalCircuit decided in Mellon Bank, investment-advice feesare commonly incurred outside the administration of trusts, andthey are therefore subject to the 2% floor established by section 67(a). * * * [328 F.3d 132">Scott v. United States, supra at 140.]See also 265 F.3d 1275">Mellon Bank, N.A. v. United States, supra at 1281 ("the second requirement treats as fully deductible only those trust- related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of trusts").In construing section 67(e)(1), the Courts of Appeals for both the Federal and Fourth Circuits emphasized the importance of not interpreting2005 U.S. Tax Ct. LEXIS 20">*32  the statute so as to render superfluous any portion thereof. 328 F.3d 132">Scott v. United States, supra at 140; 265 F.3d 1275">Mellon Bank, N.A. v. United States, supra at 1280. Moreover, both courts explicitly rejected the taxpayers' arguments premised on fiduciary duties as running afoul of this principle of construction. 328 F.3d 132">Scott v. United States, supra at 140; 265 F.3d 1275">Mellon Bank, N.A. v. United States, supra at 1280-1281. In the words of the Court of Appeals for the Fourth Circuit:we would, by holding that a trust's investment-advice fees werefully deductible, render meaningless the second requirement ofsection 67(e)(1). All trust-related administrative expenses couldbe attributed to a trustee's fiduciary duties, and the broadreading of section 67(e)(1) urged by the taxpayers would treat asfully deductible any costs associated with a trust. But thesecond clause of section 67(e)(1) specifically limits theapplicability of section 67(e) to certain types of trust-relatedadministrative expenses. To give effect to this limitation, wemust hold that the investment-advice fees incurred2005 U.S. Tax Ct. LEXIS 20">*33  by the Trustdo not qualify for the exception created by section 67(e). Rather,they are subject to the 2% floor established by section 67(a).[328 F.3d 132">Scott v. United States, supra at 140.]The Court of Appeals for the Fourth Circuit characterized the contrary analysis in this regard of the Court of Appeals for the Sixth Circuit in O'Neill v. Commissioner, 994 F.2d 302">994 F.2d at 304, as containing "a fatal flaw". 328 F.3d 132">Scott v. United States, supra at 140. The Court of Appeals for the Federal Circuit similarly branded the taxpayer's attempts to bolster its interpretation through legislative history as "unpersuasive." 265 F.3d 1275">Mellon Bank, N.A. v. United States, supra at 1281. To wit, the Court of Appeals for the Federal Circuit, tracing the genesis of section 67(e), noted that to premise full deduction of all trust expenses on fiduciary duties would run counter tolegislative intent to equate the taxation of trusts with thetaxation of individuals, limit the ability of sophisticatedtaxpayers to use trusts or other complex arrangements to lowertheir tax burden compared to similarly situated individuals, 2005 U.S. Tax Ct. LEXIS 20">*34  andto minimize the impact of the tax code on economic decisionmaking. [Id.]Having reviewed our initial construction of section 67(e) and the ensuing judicial developments detailed above, this Court concludes that the interpretation set forth in O'Neill v. Commissioner, 98 T.C. 227">98 T.C. 230-231, and expressed by the Courts of Appeals in Scott v. United States, 328 F.3d 132">328 F.3d at 139-140, and Mellon Bank, N.A. v. United States, 265 F.3d 1275">265 F.3d at 1280-1281, remains sound. The trustee here, in support of full deductibility, relies on concepts rejected in the foregoing decisions. Appeal in the instant case, barring stipulation to the contrary, would be to the Court of Appeals for the Second Circuit, which has not ruled on the issue. See Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 54 T.C. 742">757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). The Court therefore holds that the investment the exception provided in section 67(e)(1) and are deductible only to the extent that they exceed 2 percent of the trust's adjusted gross income pursuant to section 67(a).To reflect the foregoing,Decision will be entered for respondent.Reviewed by the2005 U.S. Tax Ct. LEXIS 20">*35  Court.GERBER, COHEN, SWIFT, WELLS, COLVIN, HALPERN, CHIECHI, LARO, FOLEY, VASQUEZ, GALE, THORNTON, MARVEL, HAINES, GOEKE, KROUPA, and HOLMES, JJ., agree with this opinion.  Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the year in issue, and Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The will refers to the trust as the "William L. Rudkin Family Testamentary Trust", but all other documents contained in the record omit "Family" from the name. The difference is not material.↩3. Temporary regulations are entitled to the same weight and binding effect as final regulations. Peterson Marital Trust v. Commissioner, 102 T.C. 790">102 T.C. 790, 102 T.C. 790">797 (1994), affd. 78 F.3d 795">78 F.3d 795↩ (2d Cir. 1996).