## Facts

- A testamentary trust held investment assets and filed fiduciary income tax returns.
- The trustee hired an investment advisory firm to advise on the trust’s investments.
- The trust deducted the investment advisory fees in full, asserting the fees qualified for the exception in 26 U.S.C. § 67(e)(1).
- The IRS determined the fees were miscellaneous itemized deductions subject to the 2% floor in § 67(a) and allowed only the amount exceeding 2% of adjusted gross income.
- The Tax Court ruled for the IRS; the Second Circuit affirmed.

## Issues

1. Whether investment advisory fees paid by a trust are deductible without regard to the § 67(a) 2% floor under § 67(e)(1) as costs that “would not have been incurred if the property were not held in such trust.”
2. What standard governs the § 67(e)(1) inquiry: whether an individual could incur the cost, or whether the cost is uncommon for an individual owner of the same property.

## Decision

- The Supreme Court unanimously affirmed.
- The Court held that investment advisory fees generally are subject to the § 67(a) 2% floor when incurred by a trust.
- The Court rejected the Second Circuit’s “could be incurred” formulation and adopted a “common or customary” standard.
- The Court noted, without resolving, that any incremental portion of a fee attributable solely to a trustee’s special fiduciary duties might raise a different question.

## Legal Principles

- Under § 67(e)(1), a trust escapes the § 67(a) 2% floor only for costs that would be uncommon (unusual or unlikely) for an individual to incur if the same property were held individually.
- The statutory phrase “would not have been incurred” calls for a counterfactual prediction grounded in what customarily or commonly occurs, not a mere possibility test.
- Because individuals commonly pay investment advisory fees, such fees ordinarily do not qualify for the § 67(e)(1) exception and remain subject to the 2% floor.
- Section 67(e)(1) functions as a narrow exception preserving general parity between trusts and individuals for expenses that are routinely incurred by individual investors.

## Conclusion

The Court ruled that a trust may deduct expenses without the § 67(a) 2% floor only when those expenses are uncommon for individuals holding the same property, and it held that investment advisory fees generally fail that test and therefore are subject to the 2% limitation.


Knight v. Comm’r, 552 U.S. 181 (2008)