THE LEGAL FEES INCURRED for estateplanning and administration can be consider-able. It is incumbent on advisers to do their bestto make sure that these fees are deductible. Thisarticle reviews the rules for deductibility, offerspractical suggestions for improving the chances

of deducting given expenses, and points out thetraps waiting for the unwary.

ALLOWABILITY OF ADMINISTRATIONEXPENSES DEPENDS ON STATE LAW •Section 2053(a) of the Internal Revenue Code

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Frank S. Berall, a member of the editorial board of The Practical Tax Lawyer, is senior partner in Copp & Berall, LLP, andSenior Tax Counsel to Andros, Floyd & Miller, PC, both firms in Hartford, Connecticut. © 2003 by Frank S. Berall. Allrights reserved.

Frank S. Berall

Help the client plan, then help the client deduct!

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Deduct ib i l i ty of

Legal Fees for

Estate Planning

and Admin i strat ion

(“Code”) allows deductions from a decedent’sgross estate for “such amounts…for administra-tion expenses…as are allowable by the laws ofthe jurisdiction…under which the estate isbeing administered.” (All section references areto the Code unless otherwise indicated.)

Legal FeesThe willingness of clients to pay legal fees

can be increased and their pain in so doing de-creased if they can obtain a tax deduction fortheir payment. Both legal fees and fiduciarycommissions incurred in estate administrationare deductible in computing the taxable estatefor federal estate tax purposes. Ordinarily, anestate’s largest administration expenses are ex-ecutor’s commissions and attorney’s fees. Thesemust be for post-death services and are shownon Schedule J of Form 706. Alternatively, theymay be deducted for income tax purposes onthe estate’s fiduciary income tax return.

Legal fees for pre-death services are debts ofthe estate, deductible under section 2053(a)(3)and reportable on Schedule K. Furthermore,they may also be deductible as deductions in re-spect of a decedent (under section 691(b)) on theestate’s fiduciary income tax return.

A portion of those fees deducted for incometax purposes may be disallowed. The portiondisallowed will be equal to two percent of theestate’s adjusted gross income. §67(a). To the ex-tent the fees are passed through to the benefi-ciaries (other than trust entities) a portion mayalso be subject to this two percent rule.

The deductibility of legal fees in estate plan-ning is largely governed by section 212. It al-lows “a deduction [for] all the ordinary and nec-essary expenses paid or incurred during the tax-able year”—(1) For the production or collection of income;(2) For the management, conservation, or main-tenance of property held for the production ofincome; or(3) In connection with the determination, collec-tion, or refund of any tax.”

This has been construed as allowing a de-duction of expenses for the production of in-come for a portion of the fees incurred in estateplanning. Merians v. Commissioner, 60 T.C. 187(1973), acq. 1973-2 C.B. 2, the principal authorityfor the deduction for tax advice in estate plan-ning, allowed a section 212(3) deduction forlegal fees allocable to such advice. But the courtpermitted deduction of only the portion (20 per-cent) of the taxpayers’ estate planning fees itconsidered attributable to tax advice. The rela-tively small portion considered to be for tax ad-vice was due to the lack of specific records, al-though taxpayers’ attorney testified that most ofhis time was spent on tax matters. However, thecourt found no other evidence (such as an item-ized bill for legal services) on which to base adeduction for his entire fee.

There were several concurring and dissent-ing opinions. One concurrence stated that thecase should be reopened to allow the taxpayersto prove what portion of their legal fee wouldbe deductible under section 212(2). Anothersaid that expenses incurred for estate planningtax advice are ordinary and necessary manage-ment expenses and thus deductible under sec-tion 212(2). The remaining concurring opinionand two dissenting ones would have allowed asection 212(3) deduction solely for legal expens-es incurred in the preparation of gift tax returns,reasoning that this section addresses deductionsfor tax counsel for settled events, not for plan-ning future ones. Thus, the dissents would notpermit a deduction for legal expenses incurredin estate planning, because there is no currenttax liability.

The entire deduction for legal advice attrib-utable to estate planning and general businessadvice was disallowed when the taxpayer failedto produce evidence as to the amount, if any, ofhis legal fees for the above-mentioned cate-gories. McDonald v. Commissioner, 52 T.C. 82(1969). Similarly, when there was no showing ofthe fee allocable to estate planning and a will,the deduction was denied. Schultz v. Commis-sioner, 50 T.C. 688, aff’d per curiam on other issues,

36 The Practical Tax Lawyer Spring 2003

Deductibility of Legal Fees 37

420 F.2d 490 (3d Cir. 1970). Legal fees for ser-vices and advice in connection with the meritsand legal aspects of plans submitted to a tax-payer by a firm of estate planners for the re-arrangement and reinvestment of her entire es-tate were deductible. Bagley v. Commissioner, 8T.C. 130 (1947), acq. 1947-1 C.B. 1.

Wong v. Commissioner, 58 T.C.M. (CCH) 1073(1989), cited Merians and held that 20 percentof legal fees for estate planning services wasdeductible as tax advice under section 212(3).However, the Tax Court found no portion of itdeductible under sections 212(1) or (2), be-cause nothing was incurred for the productionor collection of income. Furthermore, the tax-payers did not itemize the time spent on theservices performed.

Citing Luman v. Commissioner, 79 T.C. 846(1982), the court held that the expenses incurredfor rearranging title to income-producing prop-erty, for planning personal and family affairs, orfor retaining ownership of property were sec-tion 262 nondeductible personal ones. Id., at 856;Epp v. Commissioner, 78 T.C. 801, 804-805 (1982).

Creation of a trust was held not to have beendone to obtain investment advice nor for themanagement of taxpayers’ income-producingproperty; thus no portion of their legal expensewas deductible under section 212(2).

A deduction is probably not permissible forpreparation of a nonfunded revocable trust andcertainly not for a testamentary trust. However,it could be argued that a funded revocable trustis a protective arrangement for the managementand conservation of property and therefore de-ductible under section 212(2). But, when an ir-revocable trust is created and property is irrev-ocably transferred to the trust for the benefit ofothers, the origin of the transfer would seem tobe personal and, therefore, nondeductible.Mathews v. Commissioner, 61 T.C. 12 (1973), rev’d,520 F.2d 323 (5th Cir. 1975), cert. denied, 424 U.S.967 (1976). See William P. Streng, 800 T.M., EstatePlanning, pages A-201 and 202.

Suggested Way To ObtainDeduction for Pre-Death Legal Fees

To obtain a deduction for any legal fee, item-ize the bills in such a way that the tax-de-ductible portions are shown as such.

Break Bill for Pre-DeathFees into Three Categories

In both Merians and Wong, there were threedistinct categories of legal fees charged for es-tate planning:• Those incurred to prepare wills and othertestamentary documents, which are not allow-able as deductions;• Those incurred for tax advice and returnpreparation, which are deductible; and• Other estate planning expenses the deduc-tion of which will probably be disallowed bythe IRS, but might be sustained by a court, thusplacing them in a gray area. The argument fortheir allowance is that they are section 212(2) ex-penses incurred for arranging for the manage-ment, conservation, or maintenance of income-producing property that will be in the taxpay-er’s estate at death and, under section 212(3),were incurred in connection with the determi-nation (minimization) of the taxpayer’s futuretax liability.

Allocation of FeesIn billing clients for estate planning, allocate

legal fees to the above three categories, prepar-ing one or possibly two or even three separatebills. The allocation need not be strictly on atime basis. The preparation of a will and othertestamentary type documents is not worth asmuch to the client or as difficult for the lawyerto prepare as documents in the gray area of de-ductibility. The fully deductible work for themanagement of income-producing property(such as creating a funded trust and in connec-tion with current tax planning and propertymanagement) is more difficult to do and worthmore to the client.

Deductions of AdministrationExpenses Are limited to NecessaryOnes Allowed Under State Law

Section 2053(a) allows deductions from adecedent’s gross estate for “such amounts…foradministration expenses…as are allowable bythe laws of the jurisdiction…under which theestate is being administered.” The regulationslimit administration expenses to those “actuallyand necessarily incurred in the administrationof the decedent’s estate.” Treas. Reg. §20.2053-3(a). Deductions either for debts or administra-tion expenses may only be taken if, under thelocal law governing estate administration, theyare allowable. Treas. Reg. §20.2053-1(a). Buteven a state court decree allowing a claim or ex-pense will be followed only if the court actuallydecided “the facts upon which deductibility de-pends,” and it appears that the claim was de-cided upon its merits. Treas. Reg. §20.2053-1(b)(2). Decrees entered by consent of the par-ties are acceptable only if there was a bona fiderecognition of the claim by the consenting par-ties and the court accepted this on its merits. Id.Nevertheless, a court decree is not per se neces-sary to establish the deduction. Id. The casessuggest, however, that while a state court deci-sion as to allowability under local law will ordi-narily be accepted, it is not conclusive. SeeHibernia Bank v. U.S., 581 F.2d 741 (9th Cir. 1978).

Fees earned after death cannot be deductedon both the estate and income tax returns. Thosededucted on the estate tax return that were in-curred in administering property not subject toclaims should be listed on Schedule L, insteadof Schedule J. In all cases, the names and possi-bly the addresses of the lawyers to whom theywere paid should be shown.

CONDITIONS FOR DEDUCTIBILITY OFFIDUCIARY COMMISSIONS • Those com-missions which have actually been paid, agreedupon, or even estimated, so long as they are ex-pected to be paid, are deductible.

Court Decree UnnecessaryEven if they have not been fixed by court de-

cree (the usual case at the time of most federalestate tax audits), the deduction of fiduciarycommissions will ordinarily be allowed.

Supporting Data May Be RequiredExecutor’s commissions may need to be sup-

ported by fee affidavits or even time records,particularly when they are in addition to sub-stantial professional fees.

Three Conditions To SatisfyTreas. Reg. §20.2053-3(b)(1) provides that for

an executor’s commission to be deductible,three conditions must be met:• The District Director (now called the Territo-ry Director) is reasonably satisfied that the com-missions claimed will be paid;• The claimed deduction would be allowableunder local law; and• The amount claimed is in accordance withthe usually accepted practice in the jurisdictionfor estates of similar size and character.

Personal Representatives’ FeesMust Meet the Requirementsof Both Local Law and Section 2053

Finding an expense allowable under statelaw is simply a threshold requirement thatmust be satisfied before considering section2053’s federal requirements for allowability.Estate of Grant v. Commissioner, 294 F.3d 352 (2dCir. 2002), aff’g, 78 T.C.M. (CCH) 900 (1999)(and cases cited therein from the Fourth, Fifth,Sixth, Ninth and Eleventh Circuit Courts ofAppeal). For an expense to be deductibleunder section 2053, it must qualify as an ad-ministration expense under both applicablestate law and federal law as delineated in Trea-sury Regulations. Id.

The Tax Court in Grant, 78 T.C.M. (CCH)900 (1999), found that most of the personal rep-resentatives’ time was spent handling trust as-sets, rather than probate property. Because the

38 The Practical Tax Lawyer Spring 2003