Are Advisory Fees Tax Deductible for a Trust?
Learn how trusts can handle advisory fee deductions, which expenses qualify, and what documentation is needed to support claims on tax returns.
Trusts often rely on professional advisors for management and compliance, incurring costs. Trustees and beneficiaries frequently ask if these advisory fees can be deducted for tax purposes, as deductions can lower the trust’s tax liability. Recent tax law changes have affected how these deductions are handled. The deductibility of an advisory fee hinges on the service provided and its connection to the trust’s administration.
Which Fees Qualify
The Tax Cuts and Jobs Act of 2017 introduced changes affecting deductions for trusts, primarily through Internal Revenue Code Section 67, which suspended many miscellaneous itemized deductions through 2025.1Legal Information Institute. 26 U.S. Code § 67 – 2-Percent Floor on Miscellaneous Itemized Deductions This initially created uncertainty for trusts, which often calculate income similarly to individuals.
However, the IRS clarified that certain trust expenses remain deductible under a specific exception found in Section 67.2Internal Revenue Service. Notice 18-61: Guidance on Section 67(g) for Trusts and Estates This exception applies to costs paid or incurred for administering an estate or trust that would not have been incurred if the property were not held in that trust or estate. These unique administrative costs are deductible in calculating the trust’s adjusted gross income, not suspended miscellaneous deductions.
Therefore, an advisory fee is deductible only if it represents a cost that arises specifically because the assets are held in a trust. Fees unique to trust administration generally qualify. Examples include:
- Trustee fees
- Fiduciary accounting fees
- Certain legal fees related to trust administration or interpretation
- Probate court costs
- Fiduciary bond premiums
- Costs for preparing fiduciary income tax returns (Form 1041) or estate tax returns
- Appraisal fees needed for distributions or tax filings related to the trust
Conversely, advisory fees commonly incurred by individuals managing similar property are generally not deductible by the trust under this rule. These fall into the category of suspended miscellaneous itemized deductions. Standard investment advisory fees are a primary example, as affirmed by the Supreme Court in Knight v. Commissioner, because individuals commonly pay such fees. Other non-deductible costs typically include:
- Property insurance premiums
- Maintenance costs
- Homeowner association fees
- Fees for preparing gift tax returns
These expenses are generally incurred regardless of whether the property is held in a trust.
If an investment advisor charges a trust a special, higher fee specifically due to its fiduciary nature, or if the fee covers unusual investment needs or complex balancing of beneficiary interests, that incremental portion might be deductible. When a single “bundled” fee covers both deductible (unique trust administration) and non-deductible (standard investment advice) services, the fee must generally be allocated. Only the portion attributable to services unique to the trust’s administration is deductible. Treasury Regulation §1.67-4 offers guidance on differentiating these costs and handling bundled fees.3Federal Register. Effect of Section 67(g) on Trusts and Estates
Determining If an Expense Is Allocable to the Trust
Before considering tax deductibility, an expense must be properly allocable to the trust. This means the cost relates to administering the trust or managing, preserving, or maintaining trust property. The trust document and applicable state law govern this allocation.
State laws, often based on the Uniform Principal and Income Act (UPIA), provide default rules for assigning costs to the trust’s income or principal accounts, aiming for fairness between beneficiaries. For example, many state laws allocate routine trustee compensation and investment advisory fees evenly between income and principal. The trust agreement, however, can specify different allocation methods, which typically override state defaults.
It is also necessary to distinguish between legitimate trust administration expenses and costs that primarily benefit a beneficiary personally. Expenses incurred solely for a beneficiary’s personal needs, even if paid by the trustee, are usually not treated as trust administrative costs but rather as distributions to the beneficiary. Costs directly related to specific trust property, like repairs on a rental home owned by the trust, should be allocated accordingly. General administrative expenses not tied to specific income can often be allocated based on the trustee’s discretion, guided by the trust document and state law.
Properly identifying and allocating expenses according to the trust instrument and state fiduciary law is a basic requirement of trust administration. This ensures costs are correctly charged against income or principal, reflecting the impact on different beneficiaries. Only after confirming an expense is a legitimate and properly allocated trust cost can its tax deductibility be assessed.
Claiming Deductions on Tax Returns
Deductible advisory fees, those unique to trust administration under Section 67, are reported on the trust’s income tax return, IRS Form 1041.4Internal Revenue Service. Form 1041, U.S. Income Tax Return for Estates and Trusts The fiduciary (trustee or personal representative) uses this form to report the trust’s financial activity.
Qualifying administrative costs are reported in the “Deductions” section of Form 1041. Fiduciary fees typically go on Line 12, while attorney, accountant, and return preparer fees are on Line 14. Other qualifying administrative costs fall under Line 15a, “Other deductions.”5Internal Revenue Service. Instructions for Form 1041 and Schedules A, B, G, J, and K-1 These deductions directly reduce the trust’s total income when calculating its adjusted gross income (AGI). Unlike the suspended miscellaneous deductions, these administrative costs are subtracted “above the line.”
Claiming these deductions correctly also affects the calculation of the trust’s Distributable Net Income (DNI), typically determined on Schedule B of Form 1041. DNI generally starts with the trust’s adjusted total income; since administrative deductions reduce AGI, they consequently lower DNI. DNI limits the income distribution deduction the trust can claim for amounts distributed to beneficiaries.
The income distribution deduction, claimed on Line 18 of Form 1041, reflects the income passed through to beneficiaries. It is limited by DNI or the amount distributed, whichever is less. By reducing AGI and DNI, properly claimed advisory fee deductions influence the trust’s final taxable income and the income details reported to beneficiaries on their Schedule K-1s.
Documentation and Supporting Material
Trustees have a fundamental duty to maintain thorough records, especially for tax deductions claimed for advisory fees. Internal Revenue Code Section 6001 requires taxpayers to keep records sufficient to establish their tax liability.6Legal Information Institute. 26 U.S. Code § 6001 – Notice or Regulations Requiring Records, Statements, and Special Returns For trusts, this means documenting all income, expenses, and distributions. This documentation serves as proof if the IRS questions deductions, particularly those claimed as unique trust administration costs.
To substantiate deductible advisory fees, trustees should retain:
- Detailed invoices from advisors describing services, dates, and charges.
- Engagement letters or service agreements outlining duties and fees.
- Proof of payment (canceled checks, bank statements, wire confirmations).
Keeping these records organized is part of the trustee’s fiduciary responsibility.
Detailed invoices are particularly useful when dealing with “bundled fees” covering both deductible and non-deductible services. Treasury Regulation §1.67-4 generally requires allocating these fees. If the advisor’s invoice doesn’t provide a breakdown, the trustee must use a reasonable allocation method and document how it was determined. Supporting documentation might include advisor time records or a written explanation of the allocation methodology.
Trustees must also keep records showing how expenses were allocated between the trust’s income and principal accounts, following the rules set by the trust document or state law. Documentation should also support any allocation of expenses between taxable and tax-exempt income, as this affects the final deductible amount.
The IRS generally recommends keeping records supporting tax return items for three years from the filing date or due date, whichever is later. However, records should be kept longer in certain situations, such as substantial income underreporting (six years) or claims involving worthless securities (seven years). Some records, like those establishing asset basis or the trust instrument itself, may need to be kept for the life of the trust plus a subsequent period. Treasury Regulation §1.6001-1 specifies that records must be retained as long as they might be relevant to tax administration.7Legal Information Institute. 26 CFR § 1.6001-1 – Records These records must be available for IRS inspection upon request.