Any time I review an estate or trust income tax return, Form 1041, I pause on Line 15. That’s the spot where a decision must be made to subject “Other deductions” to the 2% of income floor or to take full advantage of those deductions.
When I arrive at Line 15 I have already fully deducted, legitimately, several items that individuals would not be able to fully deduct on their personal returns. For example, fiduciary fees, attorney fees, accounting fees, and return preparation fees are all fully deductible on Form 1041, but not on Form 1040. On Form 1040, they would be subject to a 2% of adjusted gross income floor.
It is not surprising that I pause on Line 15. This has been an unsettled area of the tax law for the past 28 years. A lot of court cases have looked at the expenses being deducted there and compared them to the expenses incurred by individuals for the same services. The cases have concluded that the fees are fully deductible if they were only incurred because the property is held in a trust or estate. If the fees could have been incurred by individuals owning the same type of property, the expenses are subject to the 2% floor.
This is illogical and inconsistent. Welcome to the world of tax law. It is just like the world of parenting, where we were often told, “You will do it that way because I said so.”
The vast majority of the expenses under scrutiny are normally labeled investment fees. Well, we finally have final regulations about what to do with those fees, effective for tax years beginning on or after May 9, 2014. That would include a decedent whose date of death is on or after that date. On calendar 2015 returns, we will handle the five types of costs discussed in the regulations as follows:
1. Ownership costs. Any costs incurred simply by owning the property will be subject to the 2% floor. For example, these include: condominium fees, insurance premiums, maintenance and lawn service, and miscellaneous itemized deductions from passthrough entities.
2. Tax preparation fees. Continuing to be fully deductible are the preparation of estate and GST tax returns, fiduciary income tax returns (the Form 1041), and the decedent’s final individual income tax return.
Bizarrely omitted from full deductibility is any other type of tax return, including the decedent’s final gift tax returns and final Form 114, Report of Foreign Bank and Financial Accounts. In other words, all other return preparation costs are subject to the 2% floor.
3. Appraisal fees. These are fully deductible by an estate or trust if incurred for determining the value of assets of a decedent’s estate; determining distributions, such as a unitrust payment; or preparing tax returns. All other appraisals are subject to the 2% floor.
4. Fiduciary expenses. These costs to administer an estate, such as probate court costs, surety bond premiums, publishing legal notices, cost of death certificates, etc., are fully deductible.
5. Investment advisory fees. This is usually the largest expense on Form 1041. It is now officially limited by the 2% floor. Banks and trust companies are allowed to break out the portion of their fees that relate to fiduciary, legal, and accounting fees. If broken out for you, you can fully deduct fiduciary, legal, and accounting fees.
In the years leading up the final regulations, we were at various times told we could fully deduct investment fees and could not fully deduct investment fees. As we tend to be consistent from year to year on tax returns, we will have to be vigilant to adopt the final regulations when preparing Form 1041.
The final regulations are fairly consistent with the proposed regulations that were issued for this in 2011. So, for 2013 and 2014 returns and beyond, we should be limiting pure investment fees to the 2% floor.
Karen S. Cohen, CPA
Principal – Packer Thomas
Feel free to contact Karen with your questions: firstname.lastname@example.org