Category: Deductions & Credits; Individuals, Compensation & Employee Benefits
Subject: Individual Retirement Account
Title: IRA Investment Advisory Fees, Deductibility of
IRC Sections: 212
Filename: 1389.html
Date Produced: 04/98

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Background
Taxpayer has a very substantial individual retirement account (IRA) for which he personally pays investment advisory fees. Apparently, the assets of the IRA are actively managed, and there is considerable trading in various exchange-traded investments. The investment fee is based on a percentage of IRA assets under management. There is no separate charge for trading commissions.

Issue
Are these investment management fees deductible as an itemized deduction subject to the 2% of AGI limitation?

Answer
Without a credible allocation of the fee between trading commissions and investment advice, the fee is arguably not deductible as an itemized deduction to any extent. As such, payment of the fee would constitute in its entirety an additional IRA contribution. Of course, this could easily give rise to an excess contribution.

If a supportable allocation can be made, the portion consisting of investment advice is deductible under Section 212 subject to the 2% of AGI limitation. The portion attributable to trading commissions is deemed to be an additional IRA contribution. Care should be taken that the portion related to trading commissions does not exceed the maximum allowable contribution to the IRA.

Discussion
It is clear that IRA trustee fees--if directly paid by the IRA beneficiary rather than from the IRA itself--are deductible as an itemized deduction under Section 212, subject to the 2% of AGI limitation of Section 67. See Revenue Ruling 84-146, 1984-2 CB 61.

Various private letter rulings have linked other kinds of expenses, including investment advisory fees, to the treatment set forth in Rev. Rul. 84-146.

-Letter Ruling 8830061 deals directly with the issue of separate deductibility of investment advisory fees for IRA's. The ruling holds that separately-paid investment advisory fees are not an additional IRA contribution and are deductible under Section 212.

--Letter Ruling 925029 addresses the same issue with respect to an employer's payment of investment advisory fees with respect to its qualified retirement plans. The ruling hold that such separately-paid investment advisory fees are not an additional plan contribution and are deductible by the employer under Section 162

--Letter Ruling 9005010 addresses the issue not of deductibility but rather whether separately-paid investment management fees are additional IRA contributions. The ruling, citing Revenue Ruling 84-146, holds that payment of such fees do not count as additional IRA contributions.

While the letter rulings cannot be cited as precedent--Section 6510(j)(3)--I think the reasoning employed in these rulings is quite sound. An investment advisory fee is a classic example of an expense incurred for the production or collection of income, and as such, would clearly be deductible in any other context. Moreover, I think these fees are indeed of the same character vis-a-vis the IRA as trustee fees, the subject of Revenue Ruling 84-146. Accordingly, it seems reasonable to conclude that payment of these fees should be treated similarly in terms of not being considered additional IRA contributions.

While it seems clear that separately-paid investment advisory fees are deductible, it is equally clear that separately-paid charges for trading commissions are not deductible and are indeed considered additional contributions to the IRA or qualified retirement plan. Revenue Ruling 86-142, 1986-2 CB 60. Both Revenue Ruling 84-146 and the various letter rulings cited above are quite explicit that the investment advisory fees in question are not in lieu of trading commissions.

Since there is no separate charge in the instant case for trading commissions--and since it is reasonable to expect considerable trading activity--it seems inescapable that the investment advisory fee is both for investment advice and for trading commissions. This presents a problem: we have a combined figure which includes both deductible and nondeductible amounts and no way to separate one from the other.

The taxpayer bears the burden of proving his entitlement to any deduction claimed. Absent the ability to separate commissions from the total fee, I believe the whole fee is tainted (i.e., nondeductible). In addition, it is clear that separately-paid commissions constitute IRA contributions. It seems quite possible that a large, actively-traded portfolio could easily produce annual commission expense in excess of the $2,000 maximum IRA contribution thereby raising the possibility of excess contributions.

I suggest the following approach.

Approach the investment advisory firm and either A) reach an understanding that can be committed to writing that a certain portion of the advisory fee relates to commissions; or B) have the advisory firm produce an annual accounting for the cost of commissions based on the number of trades executed on the taxpayer's behalf. I would prefer the latter alternative. Since the taxpayer and the investment advisory firm do not have adverse tax positions with respect to allocation of the fee--it should make no tax difference to the advisory firm how the fee is allocated--I think a fee based on actual trading activity is more supportable from the taxpayer's perspective.

If the investment firm can provide an allocation, there should be some mechanism by the which the taxpayer can annually choose how much of the trading commissions are paid personally versus the amount that should be paid from IRA assets. Clearly, the taxpayer's situation will change from year-to-year. I would assume that in some years, the commission portion will exceed the $2,000 maximum contribution amount. I would assume also that at some point, the taxpayer could possibly lack the requisite earned income for a given year in order to make a deductible IRA contribution, either because of retirement or in the event of prolonged illness or disability. Absent some mechanism for annually choosing the source of funding, problems could result.