Knight v. Commissioner

Michael Knight (plaintiff) was the trustee of the William L. Rudkin Testamentary Trust (the trust). In the tax year 2000, the trust held about $2.9 million in marketable securities as assets. Knight paid Warfield Associates, Inc., $22,241 for investment advisory fees related to the trust’s assets. That year, the trust reported income of $624,816 in its fiduciary income-tax return and deducted the fees paid to Warfield in full. The Commissioner of Internal Revenue (defendant) ruled in an audit that those fees were subject to a 2 percent adjusted-gross-income floor and were only deductible to the extent they exceeded that mark. Accordingly, there was a deficiency of $4,448. In general, the Internal Revenue Code provided that a trust was taxed the same as an individual, except that deductions for costs paid in connection with administering the trust that would not have been incurred if the property were not held in trust were allowed in full, rather than being subject to a 2 percent adjusted-gross-income floor, as those administrative costs would be with an individual taxpayer. Knight filed suit in the Tax Court, arguing that the fees had been incurred in fulfilling his duty as trustee and thus should be deductible in full. The government argued that because investment fees were commonly or customarily incurred by individuals, they were not exempted from the 2 percent floor. The tax court ruled for the government. Knight appealed, and the Second Circuit found likewise. Knight then appealed to the United States Supreme Court, which granted certiorari.