RESPONDENT:Commissioner of Internal Revenue
DOCKET NO.: 06-1286
DECIDED BY: Roberts Court (2006-2009)
LOWER COURT: United States Court of Appeals for the Second Circuit
CITATION: 552 US 181 (2008)
GRANTED: Jun 25, 2007
ARGUED: Nov 27, 2007
DECIDED: Jan 16, 2008
Eric D. Miller – on behalf of the Respondent
Peter J. Rubin – on behalf of the Petitioner
Facts of the case
Trustee Michael J. Knight hired a firm to provide investment-management advice to the William L. Rudkin Testamentary Trust. The Trust deducted all of the fees paid for the investment-advice service from its tax return, but the IRS rejected the deduction. A provision in 26 U.S.C. 67(e) allows trusts to fully deduct certain administrative costs, but the IRS maintained that fees for investment-advice services fall outside the statute’s scope. The tax court agreed with the IRS and ruled the fees nondeductible. Federal Courts of Appeals had come to opposite conclusions on the question.
On appeal, the U.S. Court of Appeals for the Second Circuit affirmed the tax court. The court cited Section 67(e)’s requirement that a trust’s fees are only fully deductible when they “would not have been incurred if the property were not held in such trust.” The provision was meant to exempt special administrative expenses that are incurred by trusts. Therefore, the court ruled, costs that could possibly be incurred by individual taxpayers as well as trusts were never deductible in full. Since an individual could pay for investment-advice services, and since the individual’s payment would not be fully deductable, Section 67(e) did not exempt a trust’s payment for the same services.
Does 26 U.S.C. 67(e) allow trusts and estates to fully deduct the cost of investment management and advisory services on their income tax returns?
Media for Knight v. Commissioner of Internal Revenue
Audio Transcription for Opinion Announcement – January 16, 2008 in Knight v. Commissioner of Internal Revenue
John G. Roberts, Jr.:
I have our opinion today in case 06-1286, Knight versus Commissioner of Internal Revenue.
The petitioner in this case is the trustee of a trust holding the proceeds of the sale of the Pepperidge Farm Company to Campbell Soup.
The trustee had hired an investment advisor to manage the trust assets.
On its tax return for the year 2000, the trust claimed a full deduction for the fees it paid the investment advisor.
Now, under the tax code, individuals may claim deductions for certain items, including investment advisory fees on their tax returns, but only to the extent those deductions exceed 2% of their adjusted gross income.
Tax lawyers call this the 2% floor.
The code generally treats deductions claimed by trust the same way it treats those claimed by individuals as subject to this 2% floor, but there is an exception and it is that exception that gives rise to this case.
If a cost incurred by a trust “would not have been incurred if the property were held by an individual” rather than in trust, the expense is not subject to the 2% floor, but is fully deductible.
The Court of Appeals for the Second Circuit decided in this case that investment advisory fees incurred by a trust are subject to the 2% floor because the only costs that are fully deductible are those that could not be incurred by individuals.
This reading of the statute is wrong.
The statute asks whether the cost would have been incurred, not whether they could have been.
If Congress had intended the Court of Appeals’ reading, it easily could have replaced would with could and presumably would have.
The trustee argues that the exception to the 2% floor applies whenever a trust incurs an expense because the property is subject — because – because the subject property is held in trust.
But on this view, every trust expense would be fully deductible allowing the exception to swallow the rule.
More to the point, the statute does not ask whether a particular cost is incurred because property is held in trust, rather, it asks what would happen if the property were not held in trust.
Other lower courts have held — have read the statute to ask whether a particular cost would commonly be incurred if the trust property were held by an individual rather than by a trust.
Now while we found the Second Circuit’s approach too restrictive and petitioner’s approach too broad, we find this approach to be just right.
In asking whether a particular cost would have been incurred if the property were held by an individual, the statute asks us to make a prediction about what would happen if a fact were changed.
When you make a prediction in such a case, you try to figure out what would commonly or usually happen.
It is certainly common for individuals to incur investment advisory fees and so the similar fees incurred by the trust are subject to the 2% floor.
Now, we recognize that our test may not be the easiest to apply in other cases, but it is the test that the statute requires.
And we have no authority to amend statutes simply because we might find an alternative, easier – easier to apply.
We affirm the judgment of the Court of Appeals, but for reasons different from those given by that Court.
Our opinion is unanimous.