Yesterday morning, the Supreme Court heard arguments in Knight v. Commissioner, No. 06-1286. At stake: whether a trust’s investment fees are subject to the 2% floor under Section 67. In general, trusts, like individuals, may deduct only those miscellaneous itemized deductions in excess of 2% of their adjusted gross income. However, the petitioner argued, investment fees incurred by a trustee on behalf of a trust are expenses that “would not have been incurred if the property were not held in such trust or estate” and thus, under Section 67(e)(1), are not subject to Section 67’s 2% floor.
Unfortunately, no tax lawyers were gathered with signs in front of the Supreme Court, and nobody had pitched tents overnight in order to ensure a seat at the argument, but at 7 a.m., in front of the Supreme Court, a CPA assured the six people gathered that the line would be around the corner by 8 a.m. At 8 a.m., the line barely reached the stairs leading from the Court’s plaza to the sidewalk, but it was a raucous and dedicated gathering nonetheless.
How will the case turn out? This much seems clear: the Court will not adopt the Second Circuit’s reasoning that to ask whether trust costs would have been incurred had the property not been held in trust is to ask whether the trust costs could have been incurred outside a trust. Indeed, the government’s lawyer led with this position, but just a few minutes into his argument Justice Roberts asked, to general laughter, “You didn’t think much of this argument before the Second Circuit adopted it, did you? You didn’t argue this before the Court of Appeals?” The government's lawyer acknowledged that Justice Roberts was correct.
“So you have a fallback argument,” Justice Roberts said.
“Well, that—that’s right.”
“Well, now might be a good time to fall back,” Justice Roberts suggested. The balance of the government’s argument was devoted to explaining what trust expenses should be considered customarily or ordinarily not incurred by individuals, the test applied by the Fourth Circuit and Federal Circuit.
Interestingly, Justice Scalia asked about the legislative history of the section. He claimed, “I don’t care about legislative history, but some of my colleagues do,” and proceeded to ask several questions on just that subject. He also stated that the legislative history showed that “the dog didn’t bark”—as if the absence of discussion in the legislative history gave some assistance in interpreting the statute. One wonders how using legislative history to persuade others, even if one remains unpersuaded, fits with believing that legislative history should not be a factor in Court decisions.
A few statements raised eyebrows for tax professors and students in attendance (for example, that Section 162 expenses are not subject to the Section 67 floor, because they are “not miscellaneous itemized deductions”). Nonetheless, we can all look forward to the resolution of a much-contested circuit split and hope for a narrow ruling that does not upset existing tax law.