William L. Rudkin Testamentary Trust v. C.I.R.

• Decision Date: 18 October 2006
• Docket Number: Docket No. 05-5151-AG.
• Parties: WILLIAM L. RUDKIN TESTAMENTARY TRUST, u/w/o Henry A. Rudkin, Michael J. Knight, Trustee, Petitioner-Appellant, v. COMMISSIONER of INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Second Circuit

467 F.3d 149

WILLIAM L. RUDKIN TESTAMENTARY TRUST, u/w/o Henry A. Rudkin, Michael J. Knight, Trustee, Petitioner-Appellant, v. COMMISSIONER of INTERNAL REVENUE, Respondent-Appellee.

Docket No. 05-5151-AG.

United States Court of Appeals, Second Circuit.

Argued: May 10, 2006.

Decided: October 18, 2006.

Carol. A. Cantrell, Briggs & Veselka Co., Bellaire, TX, for Petitioner-Appellant.

Gilbert S. Rothenberg, Attorney, Tax Division, United States Dept. of Justice (Eileen J. O'Connor, Assistant Attorney General; Anthony T. Sheehan, Attorney, Tax Division, United States Dept. of Justice, on the brief), Washington, D.C., for Respondent-Appellee.

Gregory F. Taylor, Lisa Bleier, American Bankers Association, Washington, D.C., for Amici Curiae, American Bankers Association and New York, Bankers Association.

Before: SOTOMAYOR and HALL, Circuit Judges.^*

SOTOMAYOR, Circuit Judge.

The question presented on this appeal is whether investment-advice fees incurred by a trust are fully deductible in calculating adjusted gross income for purposes of the Internal Revenue Code ("IRC") under 26 U.S.C. § 67(e)(1) (2000), or whether these fees are deductible only to the extent that they exceed two percent of the trust's adjusted gross income under § 67(a). Petitioner-appellant Michael J. Knight, trustee of the William L. Rudkin Testamentary Trust ("the Trust"), appeals from a decision of the United States Tax Court (Robert A. Wherry, Jr., J.). We affirm the decision of the tax court and hold that a trust's investment-advice fees are subject to the two-percent floor of § 67(a) and therefore not fully deductible in arriving at adjusted gross income.

BACKGROUND

The parties in this case stipulated to the following facts. Henry A. Rudkin established the William L. Rudkin Testamentary Trust in Connecticut on April 14, 1967, for the benefit of his son William, William's wife and William's descendants and their spouses. The Trust was originally funded with proceeds from the sale of Pepperidge Farm, a food products company, to Campbell Soup Company. In 2000, Michael J. Knight, the trustee, engaged Warfield Associates, Inc. ("Warfield") to provide investment-management advice to the Trust. In its 2000 tax return, the Trust reported total income of $624,816 and claimed a deduction in the amount of $22,241 for investment-management fees paid to Warfield. The Trust claimed this deduction on line 15a of its tax return for "deductions not subject to the 2% floor"; the Trust claimed no deduction on line 15b for "[a]llowable miscellaneous itemized deductions subject to the 2% floor."

On December 5, 2003, the Internal Revenue Service (the "IRS") sent the Trust a notice of deficiency for the year 2000. In the notice, the IRS indicated that it rejected the Trust's itemized deduction for investment-advice fees in the amount of $22,241, and permitted such a deduction only in the amount of $9,780 (that portion of the fees which exceeded two percent of adjusted gross income of $623,050); as a result, the Trust owed $4,448 in taxes. The parties subsequently became aware that the notice contained an error in its calculation of the Trust's adjusted gross income and stipulated that the correct amount was $613,263. The parties therefore agreed that the corresponding deduction for investment-advice fees would be $9,976, but, for reasons not relevant here, agreed further that the resulting deficiency calculated in the December 5 notice would remain unchanged.

The Trust thereafter filed a petition disputing the assessed deficiency. It argued that the trustee's fiduciary duty—specifically, the investment duties defined under the Connecticut Uniform Prudent Investor Act, Conn. Gen.Stat. §§ 45a-5411 (2005)—required investment advisory services for the proper administration of the Trust's sizable stock portfolio and that the investment-advice fees were therefore fully deductible under § 67(e)(1). Following a trial in the United States Tax Court in Hartford, Connecticut, the tax court held that the "investment advisory fees paid by the trust are not fully deductible under the exception provided in section 67(e)(1) and are deductible only to the extent that they exceed 2 percent of the trust's adjusted gross income pursuant to section 67(a)." Rudkin Testamentary Trust v. Comm'r, 124 T.C. 304, 311, 2005 WL 1503675 (2005). This timely appeal followed.

DISCUSSION

This appeal, which we have jurisdiction to consider under 26 U.S.C. § 7482(a)(1) (2000), presents a question of statutory interpretation. In interpreting a statute, "[w]e start, as always, with the language of the statute." Williams v. Taylor, 529 U.S 420, 431, 120 S.Ct. 1479, 146 L.Ed.2d 435 (2000). "We give the words of a statute their ordinary, contemporary, common meaning, absent an indication Congress intended them to bear some different import." Id. (internal quotation marks omitted). "Our inquiry must cease if the statutory language is unambiguous and the statutory scheme is coherent and consistent." Robinson v. Shell Oil Co., 519 U.S. 337, 340, 117 S.Ct. 843, 136 L.Ed.2d 808 (1997) (internal quotation marks omitted). "The plainness or ambiguity of statutory language is determined by reference to the language itself, the specific context in which that language is used, and the broader context of the statute as a whole." Id. at 341, 117 S.Ct. 843. "[A]lthough a court appropriately may refer to a statute's legislative history to resolve statutory ambiguity, there is no need to do so" if the statutory language is clear. Toibb v. Radloff, 501 U.S. 157, 162, 111 S.Ct. 2197, 115 L.Ed.2d 145 (1991).

In considering the question of statutory interpretation presented on this appeal, we review the legal conclusions of the tax court de novo. Reimels v. Comm'r, 436 F.3d 344, 346 (2d Cir.2006); 26 U.S.C. § 7482(a)(1) (providing that the courts of appeals "shall have exclusive jurisdiction to review the decisions of the Tax Court ... in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury"). "In particular, `[w]e owe no deference to the Tax Court's statutory interpretations, its relationship to us being that of a district court to a court of appeals, not that of an administrative agency to a court of appeals.'" Callaway v. Comm'r, 231 F.3d 106, 115 (2d Cir.2000) (quoting Exacto Spring Corp. v. Comm'r, 196 F.3d 833, 838 (7th Cir.1999) (Posner, C.J.)).

I. Statutory Framework

Under the IRC, "the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual," subject to one exception relevant to this appeal. 26 U.S.C. § 67(e). The exception provides that "the deductions for 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" shall be fully deductible from gross income in calculating adjusted gross income. Id. § 67(e)(1). In order to understand this provision's operation, it is necessary first to comprehend the manner in which adjusted gross income is calculated for individuals.

Section 1 of the IRC imposes a tax on all "taxable income" of individuals and trusts. 26 U.S.C. § 1. In calculating taxable income, a taxpayer must first determine the amount of "gross income," which is defined as "all income from whatever source derived." Id. § 61(a). The taxpayer then arrives at "adjusted gross income" by subtracting from gross income certain "above-the-line" deductions, such as trade and business expenses and losses from the sale of property. Id. § 62(a). Finally, "taxable income" is calculated by subtracting from adjusted gross income any "itemized" (or "below-the-line") deductions. Id. § 63. In the case of an individual, "below-the-line" deductions include, inter alia, "all the ordinary and necessary expenses paid or incurred during the taxable year ... for the management, conservation, or maintenance of property held for the production of income." Id. § 212.

Again in the case of an individual, "the miscellaneous itemized deductions [i.e., "below-the-line" deductions] for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income." Id. § 67(a). Stated differently, the rule creates a "two-percent floor" for an individual's itemized deductions of the sort at issue here. Section 67(b) exempts from the two-percent floor certain specifically enumerated itemized deductions. Id. § 67(b). Investment-advice fees are generally treated as itemized deductions under § 212. 26 C.F.R. § 1.212-1(g) (specifying the circumstances in which "[f]ees for services of investment counsel ... are deductible under section 212"). They are not listed in § 67(b), so are therefore not exempt from the two-percent floor established by § 67(a). Temp. Treas. Reg. § 1.67-1T(a)(1)(ii) (1988) (stating that "investment advisory fees" are subject to the two-percent floor of § 67(a)).

As noted, under § 67(e), trusts are generally subject to the same rules for calculating adjusted gross income that apply to individuals, with one exception that is relevant to this appeal. A trust's costs are fully deductible, rather than subject to the two-percent floor, if they satisfy both of the following two requirements: (1) they are "paid or incurred in connection with the administration of the ... trust"; and (2) they "would not have been incurred if the property were not held in such trust." 26 U.S.C. § 67(e)(1). There is no dispute here that the investment-advice fees at issue meet the requirement of the first clause, that is, that the fees Knight paid to Warfield were incurred in connection with the administration of the Trust. Instead, the issue presented here, on which some of our sister circuits have disagreed, is whether the investment-advice fees also satisfy the requirement of the second clause of § 67(e)(1) and therefore are fully...