Knight v. CIR
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Authorship: This page is maintained by Molly Cutler, a 3L at Stanford Law School.
Contents |
[edit] Briefs and Documents
Docket: 06-1286
AFFIRMED in an opinion by Chief Justice Roberts
Merits briefs
- Brief for Petitioner Michael J. Knight, Trustee of the William L. Rudkin Testamentary Trust
- Brief for Respondent Commissioner of Internal Revenue
- Reply Brief for Petitioner Michael J. Knight, Trustee of the William L. Rudkin Testamentary Trust
Certiorari filings
[edit] Pre-Argument Articles
[edit] Argument Preview
On November 27, 2007, the Supreme Court will hear Knight v. CIR. The case asks whether investment-advice fees incurred by a trust are deductible from adjusted gross income to the same extent as an individual’s investment-advice fees or are instead fully deductible under Section 67(e) of Revenue Code, which allows a trust to deduct in full “costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in such trust or estate.”
[edit] Background
Petitioner Michael Knight is the trustee of the William L. Rudkin Testamentary Trust, a family trust funded with proceeds from the sale of Pepperidge Farm to the Campbell Soup Company. Knight says that he lacks the skills and training necessary to make investment decisions required by his fiduciary obligations and thus sought investment advice at an annual fee of 0.8% of the trust’s assets. He deducted those fees in full on the trust’s income tax return.
The IRS disallowed the full deduction. Instead, it permitted the trust to deduct the fees only to the extent that an individual would be able to do so – i.e., only the portion that exceeded 2% of the trust’s income. Knight petitioned the Tax Court, which sustained the Commissioner’s position. Consistent with decisions of the Fourth and Federal Circuits, the Tax Court held that only costs which are not “customarily” or “commonly” incurred by individuals are fully deductible by trusts and estates. Knight then appealed to the Second Circuit, which affirmed with a rule even more unfavorable to taxpayer trusts. The court of appeals held that costs that could be incurred if the property were held individually rather than in trust were not deductible under Section 67(e). The Supreme Court granted certiorari to determine whether the investment-advice fees, which are one of the major expenses of trusts, are costs “which would not have been incurred if the property were not held in such trust” within the meaning of Section 67(e).
After the Court granted certiorari, the Commissioner issued a proposed regulation interpreting Section 67(e) that essentially adopts the Second Circuit’s position. It says that only costs which are “unique” to trusts and estates are fully deductible, and it defines a cost as “unique” to a trust “if an individual could not have incurred that cost” in connection with property not held in trust.
[edit] Merits Briefing
The petitioner trustee argues that Section 67(e) imposes a straightforward causation test: the costs of a trust are fully deductible if they “would not have been incurred if the property were not held in such trust or estate.” He argues that investment advice fees are incurred to fulfill trustees’ fiduciary obligations, which prevent them from investing trust assets as an individual would, and are tailored to those unique obligations. According to the petitioner, such advice is different in kind from the investment advice sought by individuals and is therefore fully deductible. The petitioner argues that this approach is consistent with the plain meaning, broad policy concerns, and legislative history of the statute, which was intended to subject expenses with a personal or voluntary aspect to the 2% floor. Investment advice sought by a trustee, he argues, is not subject to those concerns.
On behalf of the Commissioner, the United States argues that Section 67(e) is an exception to the general rule of taxability and therefore must be narrowly construed. It argues that there are two linguistically permissible, workable interpretations of the phrase “costs . . . which would not have been incurred if the property were not held in such trust.” First, consistent with the position of the Second Circuit, it could mean only those costs that individuals do not incur absent a trust. Second, consistent with the Fourth and Federal Circuits, it could mean those costs that individuals do not customarily or commonly incur. The United States argues that investment advice fees are not covered under either of these possible definitions because they can be – and commonly are – incurred by individuals, but also that the Second Circuit’s interpretation is more administrable and therefore preferable. The United States adds that if the proposed Treasury regulation adopting the position of the Second Circuit is adopted as a final regulation, that interpretation would be upheld under the deferential Chevron review afforded to administrative interpretations of the Internal Revenue Code.
[edit] Oral Argument Recap
At oral argument on Tuesday, members of the Court suggested that Section 67(e) permits a trust to deduct fees for investment advice that is related to trust status, but does not allow the trust to deduct fees for advice that is indistinguishable from advice sought by individuals.
Peter Rubin argued on behalf of petitioner that Section 67(e) imposes a categorical rule that permits a trust to deduct all investment advice sought by a trustee. Chief Justice Roberts was the first to express skepticism of petitioner’s position, which rests on the premise that trust investment fees are incurred because of the trustee’s fiduciary duty and are thus always distinctive. He asked why advice that is otherwise unrelated to trust status and is usually sought by individual investors should be excluded from the 2% floor. Justice Scalia added that petitioner’s argument about fiduciary duty would apply, apparently implausibly, to preservation of all trust property, including fixing the roofs of any buildings owned by the trust. And in Justice Stevens’s view, the “most normal reading of the language” at issue would require one to distinguish between advice that is related to trust status and advice that is normally incurred by individuals; Justice Breyer agreed that “special expenses” of a trust are those that are not incurred by a reasonable person who was not holding those assets in trust. Justice Ginsberg also commented that some investment advice – but not all fees – might be related to trust status, and pushed Rubin towards a concession that he refused to make. Instead, Rubin kept presenting his fiduciary duty argument, even as it seemed to find little traction with members of the Court—it is only coincidence, Rubin argued, if the investment advice for a trust is identical to advice given to an individual about how to maximize returns. Instead, he argued, what matters is the “decisional process [of the trustee] leading to obtaining the advice.” Justice Kennedy thought that the last point, if true, would just invite avoidance.
On behalf of the Commissioner, Eric Miller argued that that the word “would” in Section 67(e) means “could,” meeting some resistance from Justices Scalia and Ginsberg. Miller quickly took Chief Justice Roberts’ suggestion, however, that “now might be a good time to fall back” on the position that “would not have been incurred” means customarily or ordinarily would not have been incurred by individuals. Members of the Court then worked on where to draw the line. Justice Kennedy asked whether the appropriate test is if the trust is attempting to achieve an objective that a non-trust business would also want to achieve. Looking for a bright-line rule, Justice Scalia stated that it might be plausible to distinguish advice sought by a trustee as to how to fulfill his responsibilities under the trust. Miller responded that the substance of the interaction with the investment advisor would be the same, but Justice Scalia remained skeptical that investment advisors or the courts could distinguish the parts of advice that were related to trust status from those that were general. Justices Alito and Souter didn’t understand how the government could say that investment advice in general is subject to the 2% floor but the cost of preparing and filing a fiduciary tax return is not—either it always matters who is filing the return or seeking the advice, or it doesn’t, they seemed to suggest. Chief Justice Roberts asked directly how the “customarily or ordinarily” test would work and why it isn’t just a vague line. Justice Scalia added that wherever the line is drawn, trusts would contort themselves to fall beneath it.
All of these concerns about administrability provoked Miller to turn again to the categorical approach that is preferred by the government, but also to suggest the Service regulations like the one currently proposed could lend clarity.
[edit] Opinion Analysis
[edit] Links and further information
[edit] Press
- Can Trusts Deduct Fees for Investment Advice? (Nov. 28, 2007)
[edit] From the Blogosphere
- TaxProf Blog: Oral Argument in Knight v. Commissioner (Nov. 28, 2007)
