Section 67 Limitations on Estates or Trusts, 55322-55325 [2011-22732]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 76, Number 173 (Wednesday, September 7, 2011)]
[Proposed Rules]
[Pages 55322-55325]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-22732]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-128224-06]
RIN 1545-BF80


Section 67 Limitations on Estates or Trusts

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Withdrawal of notice of proposed rulemaking; notice of proposed 
rulemaking and notice of public hearing.

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SUMMARY: This document withdraws the notice of proposed rulemaking that 
was published in the Federal Register on July 27, 2007, providing 
guidance on which costs incurred by estates or trusts other than 
grantor trusts (non-grantor trusts) are subject to the 2-percent floor 
for miscellaneous itemized deductions under section 67(a). This 
document contains proposed regulations that provide guidance on which 
costs incurred by estates or trusts other than grantor trusts (non-
grantor trusts) are subject to the 2-percent floor for miscellaneous 
itemized deductions under section 67(a). The regulations affect estates 
and non-grantor trusts. This document also provides notice of a public 
hearing on these proposed regulations.

DATES: Written and electronic comments must be received by December 6, 
2011. Outlines of topics to be discussed at the public hearing 
scheduled for December 19, 2011 must be received by December 7, 2011.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG-128224-06), Room 5203, 
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-
128224-06), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC, or sent electronically via the Federal 
eRulemaking Portal at https://www.regulations.gov/ (IRS REG-128224-06). 
The public hearing will be held in the IRS Auditorium, Internal Revenue 
Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Jennifer N. Keeney, (202) 622-3060; concerning submissions of comments, 
the hearing, or to be placed on the building access list to attend the 
hearing, Richard A. Hurst, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed regulations amending 26 CFR part 1 
under section 67 of the Internal Revenue Code (Code) by adding Sec.  
1.67-4 regarding which costs incurred by an estate or a non-grantor 
trust are subject to the 2-percent floor for miscellaneous itemized 
deductions under section 67(a).
    Section 67(a) of the Code provides that, for an individual 
taxpayer, miscellaneous itemized deductions are allowed only to the 
extent that the aggregate of those deductions exceeds 2 percent of 
adjusted gross income. Section 67(b) excludes certain itemized 
deductions from the definition of ``miscellaneous itemized 
deductions.'' Section 67(e) provides that, for purposes of section 67, 
the adjusted gross income of an estate or trust shall be computed in 
the same manner as in the case of an individual. However, section 
67(e)(1) provides that the deductions for costs paid or incurred in 
connection with the administration of the estate or trust that would 
not have been incurred if the property were not held in such estate or 
trust shall be treated as allowable in arriving at adjusted gross 
income. Therefore, deductions described in section 67(e)(1) are not 
subject to the 2-percent floor for miscellaneous itemized deductions 
under section 67(a).
    A notice of proposed rulemaking (REG-128224-06, 2007-36 IRB 551) 
was published in the Federal Register (72 FR 41243) on July 27, 2007. 
The proposed regulations provide that a cost is fully deductible to the 
extent that the cost is unique to an estate or trust. If a cost is not 
unique to an estate or trust, such that an individual could have 
incurred the expense, then that cost is subject to the 2-percent floor. 
For this purpose, the proposed regulations clarify that it is the type 
of product or service provided to the estate or trust in exchange for 
the cost, rather than the description of the cost of that product or 
service, that is tested to determine the uniqueness of the cost. The 
proposed regulations also address costs subject to the 2-percent floor 
that are included as part of a comprehensive commission or fee paid to 
the trustee or executor (``Bundled Fiduciary Fee'').
    Written comments were received in response to the notice of 
proposed rulemaking. A public hearing was held on November 14, 2007, at 
which several commentators offered comments on the notice of proposed 
rulemaking.
    On January 16, 2008, the Supreme Court of the United States issued 
its decision in Michael J. Knight, Trustee of the William L. Rudkin 
Testamentary Trust v. Commissioner, 552 U.S. 181, 128 S. Ct. 782 
(2008), holding that fees paid to an investment advisor by a non-
grantor trust or estate generally are subject to the 2-percent floor 
for miscellaneous itemized deductions under section 67(a). The Court 
reached this decision on a reading of section 67(e) that differed from 
that in the proposed regulations. The Court held that the proper 
reading of the language in section 67(e), which asks whether the 
expense ``would not have been incurred if the property were not held in 
such trust or estate,'' requires an inquiry into whether a hypothetical 
individual who held the same property outside of a trust 
``customarily'' or ``commonly'' would incur such expenses. Expenses 
that are ``customarily'' or ``commonly'' incurred by individuals are 
subject to the 2-percent floor.
    Following the Supreme Court's decision in Knight, the Internal 
Revenue Service (IRS) and the Treasury Department issued Notice 2008-32 
(2008-12 IRB 593) (March 24, 2008) to provide interim guidance on the 
treatment of Bundled Fiduciary Fees. The Notice provided that taxpayers 
will not be required to determine the portion of a Bundled Fiduciary 
Fee that is subject to the 2-percent floor under

[[Page 55323]]

section 67 for any taxable year beginning before January 1, 2008. In 
the Notice, the IRS and the Treasury Department reopened the comment 
period on the proposed regulations with regard to possible factors on 
which to base safe harbors for the allocation of a Bundled Fiduciary 
Fee between costs subject to the 2-percent floor and those exempt from 
the application of that floor. Written comments were received in 
response to the Notice. The IRS and the Treasury Department 
subsequently issued Notice 2008-116 (2008-52 IRB 1372) (December 29, 
2008) extending the interim guidance provided in Notice 2008-32 to 
taxable years that begin before January 1, 2009, Notice 2010-32 (2010-
16 IRB 594) (April 19, 2010) extending the interim guidance provided in 
Notice 2008-116 and Notice 2008-32 to taxable years that begin before 
January 1, 2010, and Notice 2011-37 (2011-20 IRB 785) (May 16, 2011) 
extending the existing interim guidance to taxable years that begin 
before the publication of final regulations in the Federal Register.
    All comments were considered and are available for public 
inspection. Many of the comments recommended that the proposed 
regulations be withdrawn and that new proposed regulations be issued to 
allow the public to comment on the impact of the Knight decision on the 
regulations to be issued under section 67(e). After consideration of 
all of the comments received since the issuance of the proposed 
regulations, the proposed regulations published on July 27, 2007, are 
withdrawn and this document contains new proposed regulations.

Explanation of Provisions

In General

    In Knight, the Supreme Court held that the deductibility of an 
expense under section 67(e)(1) depends upon whether the cost is 
``commonly'' or ``customarily'' incurred when such property is held 
instead by an individual. In other words, section ``67(e)(1) excepts 
from the 2-percent floor only those costs that it would be uncommon (or 
unusual, or unlikely) for such a hypothetical individual'' holding the 
same property to incur (emphasis in original). In applying this 
interpretation of the statute to investment advisory fees incurred by a 
trust, the Court held that such fees generally are not uncommonly 
incurred by individual investors and thus are subject to the 2-percent 
floor. The Court noted, however, that it is conceivable ``that a trust 
may have an unusual investment objective, or may require a specialized 
balancing of the interests of various parties, such that a reasonable 
comparison with individual investors would be improper.'' The Court 
went on to provide that, ``in such a case, the incremental cost of 
expert advice beyond what would normally be required for the ordinary 
taxpayer would not be subject to the 2-percent floor.'' The Court held 
that the investment advisory fees of the trust in Knight properly were 
subject to the 2-percent floor, and that the trustee did not assert any 
such unusual facts that would have brought this cost within the 
exception.
    These proposed regulations reflect the reasoning and holding in 
Knight and provide guidance relating to the limited portion of the cost 
of investment advice that is not subject to the 2-percent floor. To the 
extent that a portion (if any) of an investment advisory fee exceeds 
the fee generally charged to an individual investor, and that excess is 
attributable to an unusual investment objective of the trust or estate 
or to a specialized balancing of the interests of various parties such 
that a reasonable comparison with individual investors would be 
improper, that excess is not subject to the 2-percent floor. Thus, 
where the costs charged to the trust do not exceed the costs charged to 
an individual investor, the cost attributable to taking into account 
the varying interests of current beneficiaries and remaindermen is 
included in the usual investment advisory fees and is not the type of 
cost that is excluded from the 2-percent floor under this narrow 
exception. Individual investors commonly have investment objectives 
that may require a balance between investing for income and investing 
for growth and/or a specialized approach for particular assets. 
Comments are requested on the types of incremental charges, as 
described in this paragraph, that may be incurred by trusts or estates, 
as well as a specific description and rationale for any such charges.
    Many of the comments received in response to Notice 2008-32 
highlighted the legislative intent of the provision imposing the 2-
percent floor for miscellaneous itemized deductions. The commentators 
noted that the intent was to simplify recordkeeping, reduce taxpayer 
errors, ease administrative burdens for the IRS, and reduce taxpayer 
errors in distinguishing between nondeductible personal expenditures 
and deductible miscellaneous itemized deductions. The IRS and the 
Treasury Department recognize the administrative difficulty of 
determining whether every type of cost incurred by a trust or estate is 
the type of cost that would be incurred commonly or customarily by 
individuals owning the same property. Therefore, the proposed 
regulations provide simplified rules for the application of section 
67(e).
    Several commentators questioned the authority of the IRS and the 
Treasury Department to require the unbundling of fiduciary commissions. 
However, the Knight decision posited just such an unbundling in the 
case of investment advisory costs rendered for certain services, the 
cost of which exceeds the costs charged to an individual investor. In 
determining whether a cost is subject to the 2-percent floor, the 
relevant cost at issue under section 67(e)(1) should be defined by 
reference to the products or services that were provided in exchange 
for that cost, rather than the label that is given to the cost. 
Therefore, if a fiduciary is performing services that are commonly or 
customarily performed by an investment advisor retained by an 
individual investor, then the costs attributable to those services are 
subject to the 2-percent floor.
    Many of the comments received in response to Notice 2008-32 
objected to a rule that would require any unbundling of a unitary fee 
due to the cost and administrative difficulty of implementing a process 
to track which portions of a single fee are subject to the 2-percent 
floor. Some commentators anticipated that such a rule would require 
corporate trustees to invest in expensive software to track and measure 
the value of the various types of services provided on a trust-by-trust 
and year-by-year basis.
    These proposed regulations do not require the allocation described 
in the July 2007 proposed regulations. Instead, the proposed 
regulations apply section 67(e) as interpreted by the Supreme Court in 
Knight, while also addressing the Government's and taxpayers' interests 
in reducing the administrative burden of complying with the tax law. 
The proposed regulations limit the costs that are subject to 
allocations pursuant to section 67(e) and allow the use of any 
reasonable method to perform such allocations.
    Specifically, the proposed regulations provide that the portion of 
a bundled fee attributable to investment advice (including any related 
services that would be provided to any individual investor as part of 
the investment advisory fee) will be subject to the 2-percent floor. In 
addition, the proposed regulations provide that, except for the portion 
so allocated to investment advice, a fiduciary fee not computed on an 
hourly basis is fully deductible with certain exceptions. The 
exceptions are

[[Page 55324]]

payments made to third parties out of the bundled fee that would have 
been subject to the 2-percent floor if they had been paid directly by 
the non-grantor trust or estate, and any payments for expenses 
separately assessed (in addition to the usual or basic fiduciary fee or 
commission) by the fiduciary or other service provider that are 
commonly or customarily incurred by an individual owner of such 
property. An example of such a separately assessed expense subject to 
the 2-percent floor might be an additional fee charged by the fiduciary 
for managing rental real estate owned by the non-grantor trust or 
estate.
    The proposed regulations allow the fiduciary and/or return preparer 
to use any reasonable method to make these allocations. However, the 
amount of each payment (if any) out of the fiduciary's fee or 
commission to a third party for expenses subject to the 2-percent 
floor, and of each separately assessed expense that is commonly or 
customarily incurred by an individual owner of such property, is 
readily identifiable without any discretion on the part of the 
fiduciary. Therefore, the reasonable method standard does not apply to 
these amounts that are to be deducted from the portion of the bundled 
fiduciary fee that is not subject to the 2-percent floor.
    Comments are requested on the types of methods for making a 
reasonable allocation, including possible factors on which a reasonable 
allocation is most likely to be based, and on the related 
substantiation that will be needed to satisfy the reasonable method 
standard proposed in these regulations. Specifically, the IRS and the 
Treasury Department are interested in methods for reasonably estimating 
the portion of a bundled fee that is attributable to investment advice. 
For methods based in whole or in part on time devoted to providing 
investment advice, the IRS and Treasury Department ask for suggestions 
for alternatives to contemporaneous time records for specific 
activities that could be used to substantiate the reasonableness of the 
allocation. The IRS and Treasury Department have considered comments 
regarding possible numerical or percentage safe harbors in response to 
Notice 2008-32. Commentators noted that, in many cases, fiduciaries 
could not rely on safe harbors because their fiduciary duties would 
require them to make a more accurate estimate so as to not harm the 
trust or their beneficiaries. In addition, safe harbors could increase 
complexity by requiring complicated anti-abuse rules. Therefore, 
comments are requested on methods other than numerical or percentage 
safe harbors.

Effective/Applicability Dates

    Notice 2011-37 provides that taxpayers will not be required to 
determine the portion of a Bundled Fiduciary Fee that is subject to the 
2-percent floor under section 67 for taxable years beginning before the 
date that these regulations are published as final regulations in the 
Federal Register.

Availability of IRS Documents

    The IRS notices cited in the preamble are published in the 
Cumulative Bulletin and are available at https://www.irs.gov.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f), the notice of proposed rulemaking 
preceding these regulations was submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on its impact 
on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and the Treasury Department also request comments on the 
clarity of the proposed rules and how they can be made easier to 
understand. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for December 19, 2011, 
beginning at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 
1111 Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the Internal Revenue Building lobby more than 30 minutes before 
the hearing starts. For information about having your name placed on 
the building access list to attend the hearing, see the FOR FURTHER 
INFORMATION CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who 
wish to present oral comments at the hearing must submit written or 
electronic comments by December 6, 2011 and submit an outline of the 
topics to be discussed and the time to be devoted to each topic (signed 
original and eight (8) copies) by December 7, 2011. A period of 10 
minutes will be allotted to each person for making comments. An agenda 
showing the schedule of speakers will be prepared after the deadline 
for receiving outlines has passed. Copies of the agenda will be 
available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Jennifer N. Keeney, 
Office of the Associate Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Withdrawal of Notice of Proposed Rulemaking

    Accordingly, under the authority of 26 U.S.C. 7805, the notice of 
proposed rulemaking amending 26 CFR parts 1 and 301 that was published 
in the Federal Register on July 27, 2007, 72 FR 41243 (REG-128224-06), 
is withdrawn.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.67-4 is added to read as follows:


Sec.  1.67-4  Costs paid or incurred by estates or non-grantor trusts.

    (a) In general. Section 67(e) provides an exception to the 2-
percent floor on miscellaneous itemized deductions for costs that are 
paid or incurred in connection with the administration of an estate or 
a trust not described in Sec.  1.67-2T(g)(1)(i) (a non-grantor trust) 
and which would not have been incurred if the property were not held in 
such estate or trust. A cost is subject to the 2-percent floor to the 
extent that it is included in the definition of

[[Page 55325]]

miscellaneous itemized deductions under section 67(b), is incurred by 
an estate or non-grantor trust, and commonly or customarily would be 
incurred by a hypothetical individual holding the same property.
    (b) ``Commonly'' or ``Customarily'' Incurred--(1) In general. In 
analyzing a cost to determine whether it commonly or customarily would 
be incurred by a hypothetical individual owning the same property, it 
is the type of product or service rendered to the estate or non-grantor 
trust in exchange for the cost, rather than the description of the cost 
of that product or service, that is determinative. In addition to the 
types of costs described in paragraphs (b)(2), (3) and (4) of this 
section, costs that are incurred commonly or customarily by individuals 
also include expenses that do not depend upon the identity of the payor 
(in particular, whether the payor is an individual or instead is an 
estate or trust). Such commonly or customarily incurred costs include, 
but are not limited to, costs incurred in defense of a claim against 
the estate, the decedent, or the non-grantor trust that are unrelated 
to the existence, validity, or administration of the estate or trust.
    (2) Ownership costs. Ownership costs are costs that are chargeable 
to or incurred by an owner of property simply by reason of being the 
owner of the property, such as condominium fees, real estate taxes, 
insurance premiums, maintenance and lawn services, automobile 
registration and insurance costs, and partnership costs deemed to be 
passed through to and reportable by a partner. For purposes of section 
67(e), ownership costs are commonly or customarily incurred by a 
hypothetical individual owner of such property.
    (3) Tax preparation fees. The application of the 2-percent floor to 
the cost of preparing tax returns on behalf of the estate, decedent, or 
non-grantor trust will depend upon the particular tax return. All 
estate and generation-skipping transfer tax returns, fiduciary income 
tax returns, and the decedent's final individual income tax returns are 
not subject to the 2-percent floor. The costs of preparing other 
individual income tax returns, gift tax returns, and tax returns for a 
sole proprietorship or a retirement plan, for example, are costs 
commonly and customarily incurred by individuals and thus are subject 
to the 2-percent floor.
    (4) Investment advisory fees. Fees for investment advice (including 
any related services that would be provided to any individual investor 
as part of an investment advisory fee) are incurred commonly or 
customarily by a hypothetical individual investor and therefore are 
subject to the 2-percent floor. However, certain incremental costs of 
investment advice beyond the amount that normally would be charged to 
an individual investor are not subject to the 2-percent floor. For this 
purpose, such an incremental cost is a special, additional charge added 
solely because the investment advice is rendered to a trust or estate 
instead of to an individual, that is attributable to an unusual 
investment objective or the need for a specialized balancing of the 
interests of various parties (beyond the usual balancing of the varying 
interests of current beneficiaries and remaindermen), in each case such 
that a reasonable comparison with individual investors would be 
improper.
    (c) Bundled fees--(1) In general. If an estate or a non-grantor 
trust pays a single fee, commission, or other expense (such as a 
fiduciary's commission, attorney's fee, or accountant's fee) for both 
costs that are subject to the 2-percent floor and costs (in more than a 
de minimus amount) that are not, then the single fee, commission, or 
other expense (bundled fee) must be allocated, for purposes of 
computing the adjusted gross income of the trust or estate in 
compliance with section 67(e), between the costs subject to the 2-
percent floor and those that are not. Out-of-pocket expenses billed to 
the trust or estate are treated as separate from the bundled fee.
    (2) Exception. If a bundled fee is not computed on an hourly basis, 
only the portion of that fee that is attributable to investment advice 
is subject to the 2-percent floor; the remaining portion is not subject 
to that floor. In addition, payments made from the bundled fee to third 
parties that would have been subject to the 2-percent floor if they had 
been paid directly by the non-grantor trust or estate are subject to 
the 2-percent floor, as are any fees or expenses separately assessed by 
the fiduciary or other payee of the bundled fee (in addition to the 
usual or basic bundled fee) for services rendered to the trust or 
estate that are commonly or customarily incurred by an individual.

    Example. A corporate trustee charges a percentage of the value 
of the trust income and corpus as its annual commission. In 
addition, the trustee bills a separate amount to the trust each year 
as compensation for leasing and managing the trust's rental real 
estate. The separate real estate management fee is subject to the 2-
percent floor because it is a fee commonly or customarily incurred 
by an individual owner of rental real estate.

    (3) Reasonable Method. Any reasonable method may be used to 
allocate a bundled fee between those costs that are subject to the 2-
percent floor and those costs that are not, including without 
limitation the allocation of a portion of a fiduciary commission that 
is a bundled fee to investment advice. The reasonable method standard 
does not apply to determine the portion of the bundled fee attributable 
to payments made to third parties for expenses subject to the 2-percent 
floor or to any other separately assessed expense commonly or 
customarily incurred by an individual, because those payments and 
expenses are readily identifiable without any discretion on the part of 
the fiduciary or return preparer.
    (d) Effective/applicability date. These regulations apply to 
taxable years beginning on or after the date that these regulations are 
published as final regulations in the Federal Register.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2011-22732 Filed 9-6-11; 8:45 am]
BILLING CODE 4830-01-P