## Facts

- Henry Whittemore created an inter vivos trust (1910) and a testamentary trust (1919) that paid net annual income to his widow and daughters for life.
- After the last surviving daughter died (1958), the trusts and the daughter’s estate terminated, and assets were distributed to descendants in 1959–1960, including Clinton L. Whittemore, Jr.
- At termination, the inter vivos trust held roughly $2.31 million in assets, about 30.5% in municipal bonds; the testamentary trust held roughly $4.27 million, about 39.5% in municipal bonds; and the estate held roughly $1.37 million, about 3.0% in municipal bonds.
- Over prior years, municipal-bond percentages fluctuated materially within the portfolios.
- A corporate fiduciary served as trustee/executor and charged annual and termination fees; total fiduciary fees across the trusts and estate were about $585,730.
- Fiduciary compensation was computed using a base that included interest received from municipal bonds.
- For income tax purposes, municipal bond interest was excluded from gross income, but the taxpayers deducted the full termination fees in the termination years.
- The Internal Revenue Service disallowed deductions for the portion of fiduciary fees attributable to management of municipal bond holdings as allocable to tax-exempt income, generating deficiencies and refund litigation.

## Issues

1. Whether fiduciary fees connected to municipal bond holdings are deductible under 26 U.S.C. § 212 when the bonds generate tax-exempt interest but may also be held to produce taxable income (including capital gains).
2. If fees are partially deductible, what allocation method is reasonable for separating deductible expenses from those allocable to tax-exempt income.

## Decision

- The Eighth Circuit reversed the judgment for the government.
- Fiduciary fees were deductible under § 212 to the extent municipal bond holdings produced taxable income or were held for that purpose.
- The court rejected an all-or-nothing disallowance of fees attributable to municipal bonds.
- The court approved allocating the deductible portion using a reasonable apportionment based on the ratio of taxable to nontaxable income.

## Legal Principles

- Under 26 U.S.C. § 212, individuals may deduct ordinary and necessary expenses for the production or collection of income and for the management, conservation, or maintenance of property held for the production of income.
- When an expense relates to property that yields both taxable and tax-exempt returns, the expense may be apportioned, allowing deduction of the portion reasonably connected to taxable income.
- Municipal bonds may be held for purposes that include taxable returns (e.g., taxable capital gains), so expenses of fiduciary administration tied to such holdings are not automatically nondeductible.
- A reasonable allocation method may use the ratio of taxable to tax-exempt income produced by the relevant property to determine the deductible share of fiduciary fees.

## Conclusion

The court held that fiduciary fees associated with municipal bond holdings are not wholly nondeductible merely because the bonds generate tax-exempt interest; instead, § 212 permits a deduction to the extent the holdings produce or are held to produce taxable income, with the deductible amount determined by a reasonable allocation such as the taxable-to-nontaxable income ratio.


Whittemore v. United States, 383 F.2d 824 (8th Cir. 1967)