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Conference Call summarizes the roughly 15 percent of all non-pauper petitions that are the most likely candidates for certiorari. The Supreme Court’s jurisdiction is almost entirely discretionary, and justices in recent years have annually selected roughly 80 petitions from the approximately 7,500 that are filed. Conference Call is prepared by the law firms Akin Gump Strauss Hauer & Feld and Howe & Russell, which together publish the Supreme Court weblog. Tom Goldstein, who is the head of Supreme Court litigation for Akin Gump, selects the petitions from the docket of non-pauper petitions. Various attorneys for the firms then prepare summaries of the cases. If either firm is involved in a case mentioned in this column, that fact will be disclosed.
More than a trillion dollars in assets is believed to be held in trusts and estates in the United States. The fees incurred by trustees to obtain advice in investing and managing these assets — often referred to as “investment advice fees” — are estimated to total in the billions of dollars each year. The tax treatment of these fees is thus of primary importance to both the beneficiaries of trusts and the financial services industry that provides investment advice. Although the tax code makes clear that investment advice fees are deductible expenses for trusts and estates, the extent to which those investment advice fees are deductible remains uncertain. In its private conference on June 21, the Supreme Court will consider whether to grant review in No. 06-1286, Rudkin Testamentary Trust v. Commissioner, and clarify the deductability of these fees. At issue in Rudkin is 26 U.S.C. �67(e)(1), which allows certain administrative costs to be fully deducted — rather than deducted only to the extent they exceed the 2 percent of adjusted gross income threshold established by 26 U.S.C. �67(a) — when computing the trust’s or estate’s adjusted gross income. The exception created by Section 67(e)(1) applies only when two requirements are met. First, the costs must have been “paid or incurred in connection with the administration of the . . . trust.” The second requirement, known as the “exclusivity test,” is that the costs must have been expenses “which would not have been incurred if the property were not held in such trust.” In 1967, Henry Rudkin established the William L. Rudkin Testamentary Trust 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 (the makers of the world-famous Mint Milano cookies) to Campbell Soup Co. In 2000, trustee Michael Knight engaged Warfield Associates Inc. to provide investment management advice. In its 2000 tax return, the trust reported a 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, which is reserved for “deductions not subject to the 2% floor”; the trust did not claim a deduction on line 15b for “[a]llowable miscellaneous itemized deductions subject to the 2% floor.” In 2003, the Internal Revenue Service sent the trust a notice of deficiency for the year 2000, in which it indicated that it had rejected the itemized deduction of $22,241. The IRS explained that because the trust was entitled to a deduction of only $9,780 (the portion of the fees which exceeded 2 percent of the trust’s adjusted gross income), it owed $4,448 in taxes. The trust filed a petition disputing the assessed deficiency, but the U.S. Tax Court sustained the assessment. It reasoned that the “investment advisory fees paid by the trust are not fully deductible under the exception provided in section 67(e)(1).” Instead, the court explained, such fees are deductible only to the extent that they exceed 2 percent of the trust’s adjusted gross income pursuant to section 67(a). On appeal, the U.S. Court of Appeals for the 2nd Circuit held that “the plain meaning of [the exclusivity test] excludes from full deduction those costs of a type that could be incurred if the property were held individually rather than in a trust.” In other words, for a trust to avoid the 2 percent floor and take advantage of the full deduction, it must be clear that a particular cost could not have been incurred if the property were not held in trust. The 2nd Circuit emphasized that even if the statutory language were deemed ambiguous, its holding comports with the canon of statutory construction requiring disputes as to the availability of a tax deduction to be resolved in favor of the government, and nothing in the legislative history suggests any reason to depart from the plain meaning of the statute. In its petition for certiorari, the trust — represented by professor Peter Rubin of Georgetown University Law Center — emphasizes that the 2nd Circuit’s holding conflicts with not only that of the 6th Circuit, which deems all investment advice fees attributable to a trustee’s fiduciary duty fully deductible, but also those of the 4th and Federal Circuits, which hold that Section 67(e) allows full deduction only of administrative expenses that are unique to the administration of a trust and are “not customarily” incurred outside of trusts. Such a conflict, the petition posits, creates the “untenable” reality that taxpayers in identical circumstances will be subject to different federal tax obligations based on the circuit in which they reside. The petition also highlights a practical reality counseling in favoring of certiorari: The conflicting interpretations of Section 67(e) may cause trusts to migrate to either the 6th Circuit or the circuits that have not addressed the issue, with disastrous effects for the financial services industry in New York. Lastly, the petition argues, this case is an appropriate vehicle for resolving the split because it cleanly presents the Section 67(e) question and is in a procedural posture in which the Court “routinely grants certiorari” — that is, a court of appeals has affirmed a Tax Court position to which the Tax Court adhered, notwithstanding that it had been reversed on the same question by another court of appeals. Although it acknowledges the conflict among the circuits, the IRS nonetheless urges the Court to deny certiorari on the ground that it intends to issue a regulation addressing the issue — possibly as soon as July 2007. Moreover, the IRS contends that future courts, including those that have already weighed in on the issue, would most likely be required to defer to the new rule. In reply, the trust counters that no regulation can resolve the current split of authority. Even if it could, the trust argues, such a regulation would not eliminate the need for review in this case or those of other similarly situated taxpayers who filed tax returns before the effective date of the regulation. Moreover, the trust notes, the mere possibility that action by some other branch will affect the need for review should not (as it has not in the past) affect the Court’s decision whether to grant certiorari. The Supreme Court may announce whether it will hear the case as early as June 25. — Troy D. Cahill
OTHER CASES UP FOR REVIEW INCLUDE THE FOLLOWING: • 06-1307, Jones v. Peralta (2nd Circuit) Whether the rule of Balisok and Heck bars a challenge to a prison disciplinary proceeding that resulted in mixed sanctions if the prisoner abandons any claim affecting the loss of good-time credits. • 06-1341, Regents of the University of California v. Merrill Lynch (5th Circuit) Whether liability exists under Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 where an actor knowingly uses deceptive devices and contrivances as part of a scheme to defraud investors in another public company but itself makes no affirmative misrepresentations to the market. • 06-1429, Fitch v. Early (2nd Circuit) Whether, under the Antiterrorism and Effective Death Penalty Act, the “clearly established Federal law” upon which the state prisoner bases his claim for habeas relief must be clearly established as a rule of federal law binding on the states in criminal proceedings. • 06-1440, Lorillard Tobacco v. Engida (10th Circuit) Whether undisputed evidence that a retailer sold counterfeit goods establishes “irreparable harm” that supports the entry of a preliminary injunction in a trademark infringement case.

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