Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 63.—Taxable Income Defined

Ct. D. 2085

SUPREME COURT OF THE

UNITED STATES

No. 06–1286

KNIGHT, TRUSTEE OF WILLIAM

L. RUDKIN TESTAMENTARY TRUST v. COMMISSIONER OF

INTERNAL REVENUE

CERTIORARI TO THE UNITED STATES COURT

OF APPEALS FOR THE SECOND CIRCUIT

January 16, 2008

Syllabus

Individuals may subtract from their federal taxable income certain itemized deductions, 26 U. S. C. §63(d), but only to the extent the deductions exceed 2% of adjusted gross income, §67(a). A trust may also take such deductions subject to the 2% floor, §67(e), except that when the relevant cost is “paid or incurred in connection with the administration of the . . . trust” and “would not have been incurred if the property were not held in such trust,” the cost may be deducted without regard to the floor, §67(e)(1). After petitioner Knight (Trustee), the trustee of a testamentary trust (Trust), hired the Warfield firm to advise as to Trust investments, the Trust deducted in full on its fiduciary income tax return the investment advisory fees paid to Warfield. Respondent Commissioner found the fees subject to the 2% floor and therefore allowed the deduction only to the extent the fees exceeded 2% of the Trust’s adjusted gross income. The Tax Court decided for the Commissioner, and the Second Circuit affirmed, holding that because such fees were costs of a type that could be incurred if the property were held individually rather than in trust, their deduction by the Trust was subject to the 2% floor.

Held: Investment advisory fees generally are subject to the 2% floor when incurred by a trust. Pp. 5–13.

(a) In asking whether a particular type of cost incurred by a trust “would not have been incurred” if the property were held by an individual, §67(e)(1) excepts from the 2% floor only those costs that it would be uncommon (or unusual, or unlikely) for such a hypothetical individual to incur. The question whether a trust-related expense is fully deductible turns on a prediction about what would happen if a fact were changed—specifically, if the property were held by an individual rather than by a trust. Predictions are based on what would customarily or commonly occur. Thus, in the context of making such a prediction, when there is uncertainty about the answer, the word “would” is best read to express concepts such as custom, habit, natural disposition, or probability. Although the statutory text does not expressly ask whether expenses are “customarily” incurred outside of trusts, that is the direct import of the language in context. The Second Circuit’s approach, which asks whether the cost at issue could have been incurred by an individual, flies in the face of the statutory language. Had Congress intended the Court of Appeals’ reading, it easily could have replaced “would” with “could” in §67(e)(1), and presumably would have. The Trustee’s argument that the proper inquiry is whether a particular expense of a particular trust was caused by the fact that the property was held in trust fails because the statute by its terms does not establish a straightforward causation test, but instead looks to the counterfactual question whether an individual would have incurred such costs in the absence of a trust. Further, under the Trustee’s approach, every trust-related expense would be fully deductible, thus allowing the exception to the 2% floor in §67(e)(1) to swallow the general rule. Pp. 5–10.

(b) The Trust’s investment advisory fees are subject to the 2% floor. The Trustee—who has the burden of establishing entitlement to the deduction, see, e.g., INDOPCO, Inc. v. Commissioner, 503 U. S. 79, 84—has not demonstrated

that it is uncommon or unusual for individuals to hire an investment adviser. His argument is that individuals cannot incur trust investment advisory fees, not that individuals do not commonly incur investment advisory fees. Indeed, his essential point is that he engaged an investment adviser because of his fiduciary duties under Connecticut law, which requires a trustee to invest and manage trust assets “as a prudent investor would.” This prudent investor standard plainly does not refer to a prudent trustee, but looks instead to what a prudent investor with the same investment objectives handling his own affairs would do— i.e., a prudent individual investor. Because a hypothetical prudent investor in petitioner’s position would reasonably have solicited investment advice, it is quite difficult to say that the investment advisory fees “would not have been incurred”— i.e., that it would be unusual or uncommon for such fees to have been incurred—if the property were held by an individual investor with the same objectives as the Trust in handling his own affairs. While Congress’s decision to phrase the pertinent inquiry in terms of a prediction about a hypothetical situation inevitably entails some uncertainty, that is no excuse for judicial amendment of the statute. The Code elsewhere poses similar questions, see, e.g., §§162(a), 212, and the inquiry is in any event what §67(e)(1) requires. Although some trust-related investment advisory fees may be fully deductible if an investment adviser were to impose a special, additional charge applicable only to its fiduciary accounts, there is nothing in the record to suggest that Warfield did so, or treated the Trust any differently than it would have treated an individual with similar objectives, because of the Trustee’s fiduciary obligations. Nor does the Trust assert that its investment objectives or balancing of competing interests were so distinctive that any comparison with those of an individual investor would be improper. Pp. 10–13.

467 F. 3d 149, affirmed. ROBERTS, C. J., delivered the opinion for a unanimous Court.

2008–17 I.R.B. 828 April 28, 2008

SUPREME COURT OF THE

UNITED STATES

No. 06–1286

MICHAEL J. KNIGHT, TRUSTEE

OF THE WILLIAM L. RUDKIN

TESTAMENTARY TRUST, PETITIONER v. COMMISSIONER

OF INTERNAL REVENUE

ON WRIT OF CERTIORARI TO THE

UNITED STATES COURT

OF APPEALS FOR THE SECOND CIRCUIT

January 16, 2008

CHIEF JUSTICE ROBERTS delivered the opinion of the Court.

Under the Internal Revenue Code, individuals may subtract from their taxable income certain itemized deductions, but only to the extent the deductions exceed 2% of adjusted gross income. A trust may also claim those deductions, also subject to the 2% floor, except that costs incurred in the administration of the trust, which would not have been incurred if the trust property were not held by a trust, may be deducted without regard to the floor. In the case of individuals, investment advisory fees are subject to the 2% floor; the question presented is whether such fees are also subject to the floor when incurred by a trust. We hold that they are and therefore affirm the judgment below, albeit for different reasons than those given by the Court of Appeals.

I

The Internal Revenue Code imposes a tax on the “taxable income” of both individuals and trusts. 26 U. S. C. §1(a). The Code instructs that the calculation of taxable income begins with a determination of “gross income,” capaciously defined as “all income from whatever source derived.” §61(a). “Adjusted gross income” is then calculated by subtracting from gross income certain “above-the line” deductions, such as trade and business expenses

and losses from the sale or exchange of property. §62(a). Finally, taxable income is calculated by subtracting from adjusted gross income “itemized deductions”—also known as “below-the-line” deductions—defined as all allowable deductions other than the “above-the-line” deductions identified in §62(a) and the deduction for personal exemptions allowed under §151 (2000 ed. and Supp. V). §63(d) (2000 ed.).

Before the passage of the Tax Reform Act of 1986, 100 Stat. 2085, below-theline deductions were deductible in full. This system resulted in significant complexity and potential for abuse, requiring “extensive [taxpayer] recordkeeping with regard to what commonly are small expenditures,” as well as “significant administrative and enforcement problems for the Internal Revenue Service.” H. R. Rep. No. 99–426, p. 109 (1985). In response, Congress enacted what is known as the “2% floor” by adding §67 to the Code. Section 67(a) provides that “the miscellaneous itemized 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.” The term “miscellaneous itemized deductions” is defined to include all itemized deductions other than certain ones specified in §67(b). Investment advisory fees are deductible pursuant to 26 U. S. C. §212. Because §212 is not listed in §67(b) as one of the categories of expenses that may be deducted in full, such fees are “miscellaneous itemized deductions” subject to the 2% floor. 26 CFR §1.67–1T(a)(1)(ii) (2007).

Section 67(e) makes the 2% floor generally applicable not only to individuals but also to estates and trusts, ¹ with one exception relevant here. Under this exception, “the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual, except 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 treated as al

lowable” and not subject to the 2% floor. §67(e)(1).

Petitioner Michael J. Knight is the trustee of the William L. Rudkin Testamentary Trust, established in the State of Connecticut in 1967. In 2000, the Trustee hired Warfield Associates, Inc., to provide advice with respect to investing the Trust’s assets. At the beginning of the tax year, the Trust held approximately $2.9 million in marketable securities, and it paid Warfield $22,241 in investment advisory fees for the year. On its fiduciary income tax return for 2000, the Trust reported total income of $624,816, and it deducted in full the investment advisory fees paid to Warfield. After conducting an audit, respondent Commissioner of Internal Revenue found that these investment advisory fees were miscellaneous itemized deductions subject to the 2% floor. The Commissioner therefore allowed the Trust to deduct the investment advisory fees, which were the only claimed deductions subject to the floor, only to the extent that they exceeded 2% of the Trust’s adjusted gross income. The discrepancy resulted in a tax deficiency of $4,448.

The Trust filed a petition in the United States Tax Court seeking review of the assessed deficiency. It argued that the Trustee’s fiduciary duty to act as a “prudent investor” under the Connecticut Uniform Prudent Investor Act, Conn. Gen. Stat. §§45a–541a to 45a–541 l (2007), ² required the Trustee to obtain investment advisory services, and therefore to pay investment advisory fees. The Trust argued that such fees are accordingly unique to trusts and therefore fully deductible under 26 U. S. C. §67(e)(1). The Tax Court rejected this argument, holding that §67(e)(1) allows full deductibility only for expenses that are not commonly incurred outside the trust setting. Because investment advisory fees are commonly incurred by individuals, the Tax Court held that they are subject to the 2% floor when incurred by a trust. Rudkin Testamentary Trust v. Commissioner, 124 T. C. 304, 309–311 (2005). The Trust appealed to the United States Court of Appeals for the Second Circuit.

1 Because this case is only about trusts, we generally refer to trusts throughout, but the analysis applies equally to estates.

2 Forty-four States and the District of Columbia have adopted versions of the Uniform Prudent Investor Act. See 7B U. L. A. 1–2 (2006) (listing States that have enacted the Uniform Prudent Investor Act). Five of the remaining six States have adopted their own versions of the prudent investor standard. See Del. Code Ann., Tit. 12, §3302 (1995 ed. and 2006 Supp.); Ga. Code Ann. §53–12–287 (1997); La. Stat. Ann. §9:2127 (West 2005); Md. Est. & Trusts Code Ann. §15–114 (Lexis 2001); S. D. Codified Laws §55–5–6 (2004). Kentucky, the only remaining State, applies the prudent investor standard only in certain circumstances. See Ky. Rev. Stat. Ann. §286.3–277 (Lexis 2007 Cum. Supp.); §§386.454(1), 386.502 (Supp. 2007).

April 28, 2008 829 2008–17 I.R.B.

The Court of Appeals concluded that, in determining whether costs such as investment advisory fees are fully deductible or subject to the 2% floor, §67(e) “directs the inquiry toward the counterfactual condition of assets held individually instead of in trust,” and requires “an objective determination of whether the particular cost is one that is peculiar to trusts and one that individuals are incapable of incurring.” 467 F. 3d 149, 155, 156 (2006). The court held that because investment advisory fees were “costs of a type that could be incurred if the property were held individually rather than in trust,” deduction of such fees by the Trust was subject to the 2% floor. Id., at 155–156.

The Courts of Appeals are divided on the question presented. The Sixth Circuit has held that investment advisory fees are fully deductible. O’Neill v. Commis- sioner, 994 F. 2d 302, 304 (1993). In contrast, both the Fourth and Federal Circuits have held that such fees are subject to the 2% floor, because they are “commonly” or “customarily” incurred outside of trusts. See Scott v. United States, 328 F. 3d 132, 140 (CA4 2003); Mellon Bank, N. A. United States, 265 F. 3d 1275, 1281 (CA Fed. 2001). The Court of Appeals below came to the same conclusion, but as noted announced a more exacting test, allowing” full deduction only for those costs that could not have been incurred by an individual property owner.” 467 F. 3d, at 156 (emphasis added). We granted the Trustee’s petition for certiorari to resolve the conflict, 551 U. S. __ (2007), and now affirm.

II

We start, as always, with the language of the statute.” Williams v. Taylor, 529 U. S. 420, 431 (2000). Section 67(e) sets forth a general rule: “[T]he adjusted gross income of [a] . . . trust shall be computed in the same manner as in the case of an individual.” That is, trusts can or

dinarily deduct costs subject to the same 2% floor that applies to individuals’ deductions. Section 67(e) provides for an exception to the 2% floor when two conditions are met. First, the relevant cost must be “paid or incurred in connection with the administration of the . . . trust.” §67(e)(1). Second, the cost must be one “which would not have been incurred if the property were not held in such trust.” Ibid . In applying the statute, the Court of Appeals below asked whether the cost at issue could have been individuals’ deductions. Section 67(e) provides for an exception to the 2% floor when two conditions are met. First, the relevant cost must be “paid or incurred in connection with the administration of the . . . trust.” §67(e)(1). Second, the cost must be one “which would not have been incurred if the property were not held in such trust.” Ibid .

In applying the statute, the Court of Appeals below asked whether the cost at issue could have been incurred by an individual. ³ This approach flies in the face of the statutory language. The provision at issue asks whether the costs “would not have been incurred if the property were not held” in trust, ibid., not, as the Court of Appeals would have it, whether the costs “could not have been incurred” in such a case, 467 F. 3d, at 156. The fact that an individual could not do something is one reason he would not, but not the only possible reason. If Congress had intended the Court of Appeals’ reading, it easily could have replaced “would” in the statute with “could,” and presumably would have. The fact that it did not adopt this readily available and apparent alternative strongly supports rejecting the Court of Appeals’ reading. ⁴

Moreover, if the Court of Appeals’ reading were correct, it is not clear why Congress would have included in the statute the first clause of §67(e)(1). If the only costs that are fully deductible are those that could not be incurred outside the trust context—that is, that could only

be incurred by trusts—then there would be no reason to place the further condition on full deductibility that the costs be “paid or incurred in connection with the administration of the . . . trust,” §67(e)(1). We can think of no expense that could be incurred exclusively by a trust but would nevertheless not be “paid or incurred in connection with” its administration.

The Trustee argues that the exception in §67(e)(1) “establishes a straightforward causation test.” Brief for Petitioner 22. The proper inquiry, the Trustee contends, is “whether a particular expense of a particular trust or estate was caused by the fact that the property was held in the trust or estate.” Ibid . Investment advisory fees incurred by a trust, the argument goes, meet this test because these costs are caused by the trustee’s obligation “to obtain advice on investing trust assets in compliance with the Trustees’ particular fiduciary duties.” Ibid . We reject this reading as well.

On the Trustee’s view, the statute operates only to distinguish costs that are incurred by virtue of a trustee’s fiduciary duties from those that are not. But all (or nearly all) of a trust’s expenses are incurred because the trustee has a duty to incur them; otherwise, there would be no reason for the trust to incur the expense in the first place. See G. Bogert & G. Bogert, Law of Trusts and Trustees §801, p. 134 (2d rev. ed. 1981) (“[T]he payment for expenses must be reasonably necessary to facilitate administration of the trust”). As an example of a type of trust-related expense that would be subject to the 2% floor, the Trustee offers “expenses for routine maintenance of real property” held by a trust. Brief for Petitioner 23. But such costs would appear to be fully deductible under the Trustee’s own reading, because a trustee is obligated to incur maintenance expenses in light of the fiduciary duty to maintain trust property. See 1 Restatement (Second) of Trusts §176, p. 381 (1957) (“The trustee is under a duty to the ben

3 The Solicitor General embraces this position in this Court, arguing that the Court of Appeals’ approach represents the best reading of the statute and establishes an easily administrable rule. See Brief for Respondent 17–20, 22. Indeed, after the Court of Appeals’ decision, the Commissioner adopted that court’s reading of the statute in a proposed regulation. See Section 67 Limitations on Estates or Trusts, 72 Fed. Reg. 41243, 41245 (2007) (notice of proposed rulemaking) (a trust-related cost is exempted from the 2% floor only if “an individual could not have incurred that cost in connection with property not held in an estate or trust” (emphasis added)). The Government did not advance this argument before the Court of Appeals. See Brief for Appellee in No. 05–5151–AG (CA2), pp. 3–4, 22–24. In fact, the notice of proposed rulemaking appears to be the first time the Government has ever taken this position, and we are the first Court to which the argument has been made in a brief. See Brief for United States in Mellon Bank v. United States, No. 01–5015 (CA Fed.), p. 27 (“[I]f a trust-related administrative expense is also customarily or habitually incurred outside of trusts, then it is subject to the two-percent floor”); Brief for United States in Scott v. United States, No. 02–1464 (CA4), p. 27 (same).

4 In pressing the Court of Appeals’ approach, the Solicitor General argues that “to say that a team would not have won the game if it were not for the quarterback’s outstanding play is to say that the team could not have won without the quarterback.” Brief for Respondent 19. But the Solicitor General simply posits the truth of a proposition—that the team would not have won the game if it were not for the quarterback’s outstanding play—and then states its equivalent. The statute, in contrast, does not posit any proposition. Rather, it asks a question: whether a particular cost would have been incurred if the property were held by an individual instead of a trust.

2008–17 I.R.B. 830 April 28, 2008

incurred outside of trusts,” Reply Brief for Petitioner 15, but that is the direct import of the language in context. The text requires determining what would happen if a fact were changed; such an exercise necessarily entails a prediction; and predictions are based on what would customarily or commonly occur. Thus, in asking whether a particular type of cost “would not have been incurred” if the property were held by an individual, §67(e)(1) excepts from the 2% floor only those costs that it would be un common (or unusual, or unlikely) for such a hypothetical individual to incur.

III

Having decided on the proper reading of §67(e)(1), we come to the application of the statute to the particular question in this case: whether investment advisory fees incurred by a trust escape the 2% floor.

It is not uncommon or unusual for individuals to hire an investment adviser. Certainly the Trustee, who has the burden of establishing its entitlement to the deduction, has not demonstrated that it is. See INDOPCO, Inc. v. Commis- sioner, 503 U. S. 79, 84 (1992) (noting the “‘familiar rule’ that ‘an income tax deduction is a matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer’” (quoting Interstate Transit Lines v. Commissioner, 319 U. S. 590, 593 (1943))); Tax Court Rule 142(a)(1) (stating that the “burden of proof shall be upon the petitioner,” with certain exceptions not relevant here). The Trustee’s argument is that individuals cannot incur trust investment advisory fees, not that individuals do not commonly incur investment advisory fees.

Indeed, the essential point of the Trustee’s argument is that he engaged an investment adviser because of his fiduciary duties under Connecticut’s Uniform Prudent Investor Act, Conn. Gen. Stat. §45a–541a(a) (2007). The Act eponymously requires trustees to follow the “prudent investor rule.” See n. 2, supra . To satisfy this standard, a trustee must “invest and manage trust assets as a pru- dent investor would, by considering the purposes, terms, distribution requirements and other circumstances of the trust. “§45a–541b(a) (emphasis added). The prudent investor standard plainly does not

eficiary to use reasonable care and skill to preserve the trust property”).

Indeed, the Trustee’s formulation of its argument is circular: “Trust investment advice fees are caused by the fact the property is held in trust.” Brief for Petitioner 19. But “trust investment advice fees” are only aptly described as such because the property is held in trust; the statute asks whether such costs would be incurred by an individual if the property were not. Even when there is a clearly analogous category of costs that would be incurred by individuals, the Trustee’s reading would exempt most or all trust costs as fully deductible merely because they derive from a trustee’s fiduciary duty. Adding the modifier “trust” to costs that otherwise would be incurred by an individual surely cannot be enough to escape the 2% floor.

What is more, if the Trustee’s position were correct, then only the first clause of §67(e)(1)—providing that the cost be “incurred in connection with the administration of the . . . trust”—would be necessary. The statute’s second, limiting condition—that the cost also be one “which would not have been incurred if the property were not held in such trust”—would do no work; we see no difference in saying, on the one hand, that costs are “caused by” the fact that the property is held in trust and, on the other, that costs are incurred “in connection with the administration” of the trust. Thus, accepting the Trustee’s approach “would render part of the statute entirely superfluous, something we are loath to do.” Cooper Industries, Inc. v. Aviall Services, Inc., 543 U. S. 157, 166 (2004).

The Trustee’s reading is further undermined by our inclination, “[i]n construing provisions . . . in which a general statement of policy is qualified by an exception, [to] read the exception narrowly in order to preserve the primary operation of the provision.” Commissioner v. Clark, 489 U. S. 726, 739 (1989). As we have said, §67(e) sets forth a general rule for purposes of the 2% floor established in §67(a): “For purposes of this section, the adjusted gross income of an estate or trust shall be computed in the same manner as in the case of an individual.” Under the Trustee’s reading, §67(e)(1)’s exception would swallow the general rule; most (if not all) expenses incurred by a trust would be fully deductible.

“Given that Congress has enacted a general rule . . ., we should not eviscerate that legislative judgment through an expansive reading of a somewhat ambiguous exception.” Ibid .

More to the point, the statute by its terms does not “establis[h] a straightforward causation test,” Brief for Petitioner 22, but rather invites a hypothetical inquiry into the treatment of the property were it held outside a trust. The statute does not ask whether a cost was incurred be- cause the property is held by a trust; it asks whether a particular cost “would not have been incurred if the property were not held in such trust,” §67(e)(1). “Far from examining the nature of the cost at issue from the perspective of whether it was caused by the trustee’s duties, the statute instead looks to the counterfactual question of whether in- dividuals would have incurred such costs in the absence of a trust.” Brief for Respondent 9.

This brings us to the test adopted by the Fourth and Federal Circuits: Costs incurred by trusts that escape the 2% floor are those that would not “commonly” or “customarily” be incurred by individuals. See Scott, 328 F. 3d, at 140 (“Put simply, trust-related administrative expenses are subject to the 2% floor if they constitute expenses commonly incurred by individual taxpayers”); Mellon Bank, 265 F. 3d, at 1281 (§67(e) “treats as fully deductible only those trust-related administrative expenses that are unique to the administration of a trust and not customarily incurred outside of trusts”). The Solicitor General also accepts this view as an alternative reading of the statute. See Brief for Respondent 20–21. We agree with this approach.

The question whether a trust-related expense is fully deductible turns on a prediction about what would happen if a fact were changed—specifically, if the property were held by an individual rather than by a trust. In the context of making such a prediction, when there is uncertainty about the answer, the word “would” is best read as “express[ing] concepts such as custom, habit, natural disposition, or probability.” Scott, supra, at 139. See Webster’s Third New International Dictionary 2637–2638 (1993); American Heritage Dictionary 2042, 2059 (3d ed. 1996). The Trustee objects that the statutory text “does not ask whether expenses are ‘customarily’

April 28, 2008 831 2008–17 I.R.B.

Section 7701.—Definitions

26 CFR 301.7701–2: Business entities; definitions.

T.D. 9388

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 301

Classification of Certain Foreign Entities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains temporary and final regulations relating to certain business entities included on the list of foreign business entities that are always classified as corporations for Federal tax purposes. The regulations are needed to make the Federal tax classification of Bulgarian public limited liability companies consistent with the Federal tax classification of public limited liability companies organized in other countries of the European Economic Area. The regulations will affect persons owning an interest in a Bulgarian aktsionerno druzhestvo on or after January 1, 2007. The text of the temporary regulations serves as the text of the proposed regulations (REG–143468–07) set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin.

DATES: Effective Date: These regulations are effective on March 21, 2008.

Applicability Date: For the dates of applicability of these regulations, see §301.7701–2T(e)(7).

FOR FURTHER INFORMATION CONTACT: S. James Hawes, (202) 622–3860 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

The IRS and the Treasury Department issued final regulations concerning the Federal tax classification of entities under section 7701 of the Internal Revenue Code on December 18, 1996. See T.D. 8697,

refer to a prudent trustee ; it would not be very helpful to explain that a trustee should act as a prudent trustee would. Rather, the standard looks to what a prudent investor with the same investment objectives handling his own affairs would do— i.e., a prudent individual investor. See Restatement (Third) of Trusts (Prudent Investor Rule) Reporter’s Notes on §227, p. 58 (1990) (“The prudent investor rule of this Section has its origins in the dictum of Harvard College v. Amory, 9 Pick. (26 Mass.) 446, 461 (1830), stating that trustees must ‘observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested’”). See also, e.g., In re Musser’s Estate, 341 Pa. 1, 9–10, 17 A. 2d 411, 415 (1941) (noting the “general rule” that “a trustee must exercise such prudence and diligence in conducting the affairs of the trust as men of average diligence and discretion would employ in their own affairs”). And we have no reason to doubt the Trustee’s claim that a hypothetical prudent investor in his position would have solicited investment advice, just as he did. Having accepted all this, it is quite difficult to say that investment advisory fees” would not have been incurred”—that is, that it would be unusual or uncommon for such fees to have been incurred—if the property were held by an individual investor with the same objectives as the Trust in handling his own affairs.

We appreciate that the inquiry into what is common may not be as easy in other cases, particularly given the absence of regulatory guidance. But once you depart in the name of ease of administration from the language chosen by Congress, there is more than one way to skin the cat: The Trustee raises administrability concerns in support of his causation test, Reply Brief for Petitioner 6, but so does the Government in explaining why it prefers the Court of Appeals’ approach to the one it has successfully advanced before the Tax Court and two Federal Circuits. Congress’s decision to phrase the pertinent inquiry in terms of a prediction about a hypothetical situation inevitably entails some uncertainty, but that is no

excuse for judicial amendment of the statute. The Code elsewhere poses similar questions—such as whether expenses are “ordinary,” see §§162(a), 212; see also Deputy, Administratrix v. Du Pont, 308 U. S. 488, 495 (1940) (noting that “[o]rdinary has the connotation of normal, usual, or customary”)—and the inquiry is in any event what §67(e)(1) requires.

As the Solicitor General concedes, some trust-related investment advisory fees may be fully deductible “if an investment advisor were to impose a special, additional charge applicable only to its fiduciary accounts.” Brief for Respondent 25. There is nothing in the record, however, to suggest that Warfield charged the Trustee anything extra, or treated the Trust any differently than it would have treated an individual with similar objectives, because of the Trustee’s fiduciary obligations. See App. 24–27. It is conceivable, moreover, that a trust may have an unusual investment objective, or may require a specialized balancing of the interests of various parties, such that a reasonable comparison with individual investors would be improper. In such a case, the incremental cost of expert advice beyond what would normally be required for the ordinary taxpayer would not be subject to the 2% floor. Here, however, the Trust has not asserted that its investment objective or its requisite balancing of competing interests was distinctive. Accordingly, we conclude that the investment advisory fees incurred by the Trust are subject to the 2% floor.

The judgment of the Court of Appeals is affirmed.

It is so ordered.

2008–17 I.R.B. 832 April 28, 2008

(5 U.S.C. chapter 6), refer to the Special Analyses section of the preamble to the notice of proposed rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact.

Drafting Information

The principal author of these regulations is S. James Hawes of the Office of Associate Chief Counsel (International); however, other personnel from the IRS and the Treasury Department participated in their development.

- - - -

Amendments to the Regulations

Accordingly, 26 CFR part 301 is amended as follows:

PART 301—PROCEDURE AND ADMINISTRATION

Paragraph 1. The authority citation for part 301 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 301.7701–2(b)(8)(vi) and (e)(7) are added and the paragraph heading for paragraph (e) is revised to read as follows:

§301.7701–2 Business entities; definitions.

• • • • (b) - * (8) - * (vi) [Reserved]. For further guidance, see §301.7701–2T(b)(8)(vi).
• • • • (e) Effective/applicability date. - * * (7) [Reserved]. For further guidance, see §301.7701–2T(e)(7).

Par. 3. Section 301.7701–2T is added to read as follows:

§301.7701–2T Business entities; definitions (temporary).

(a) through (b)(8)(v) [Reserved]. For further guidance, see §301.7701–2(a) through (b)(8)(v).

1997–1 C.B. 215 [61 FR 66584] and §§301.7701–1 through 301.7701–3. Under those regulations, a business entity that is not specifically classified as a corporation can elect its classification for Federal tax purposes under certain circumstances. Section 301.7701–2(b)(8) provides a list of certain foreign business entities that are nevertheless always classified as corporations for Federal tax purposes. This list is known as the per se corporation list. The foreign business entities on this list are referred to as per se corporations. Recent changes in European law require the IRS and the Treasury Department to amend the per se list. See §601.601(d)(2)(ii)( b ).

On October 8, 2001, the Council of the European Union adopted Council Regulation 2157/2001 (2001 Official Journal of the European Communities, L 294/1) (the EU Regulation) to provide for a new business entity called the European public limited liability company, which is also known as a Societas Europaea or SE. The EU Regulation entered into force October 8, 2004. The EU Regulation provides general rules that govern the formation and operation of an SE. With respect to many issues, however, the EU Regulation defers to the laws of the country in which the SE has its registered office. An SE must have a registered office in one of the Member States of the European Economic Area, which includes Norway, Iceland, Liechtenstein, and every country in the European Union. For further background, see T.D. 9197, 2005–1 C.B. 985 [70 FR 19697] and Notice 2004–68, 2004–2 C.B. 706. See §601.601(d)(2)(ii)( b ). The IRS and the Treasury Department stated in Notice 2004–68 that the SE is properly classified as a per se corporation for Federal tax purposes. Consequently, the IRS and the Treasury Department issued regulations modifying §301.7701–2(b)(8) to include the SE on the per se corporation list. Those regulations included certain public limited liability companies organized in Member States that did not already appear on the per se list. See T.D. 9197 and T.D. 9235, 2006–1 C.B. 338 [70 FR 74658]. With the entry of Bulgaria into the European Union on January 1, 2007, an SE can now have its registered office in Bulgaria.

Explanation of Provisions

Bulgaria’s SE is called an aktsionerno druzhestvo. The IRS and the Treasury Department stated in Notice 2007–10, 2007–4 I.R.B. 354, that §301.7701–2(b)(8) would be modified to include the aktsionerno druzhestvo on the per se corporation list. The temporary regulations in this document make that modification. In accordance with Notice 2007–10, these regulations will be effective for any Bulgarian aktsionerno druzhestvo formed on or after January 1, 2007. Notice 2007–10 also stated that the regulations would be effective for any Bulgarian aktsionerno druzhestvo formed before January 1, 2007, upon a 50 percent or greater change of ownership in such entity subsequent to that date. See section 7805(b)(1)(C) and §601.601(d)(2)(ii)( b ). The temporary regulations therefore provide that a Bulgarian aktsionerno druzhestvo formed before January 1, 2007, will become a per se corporation on the date that, in the aggregate, a 50 percent or more interest in the entity is owned by a person or persons who were not owners of the entity as of January 1, 2007. In the case of a partnership, an interest means a capital or profits interest. In the case of a corporation, an interest means an equity interest in the entity measured by vote or value.

The standard provided by these temporary regulations for determining the application of the regulations to a Bulgarian aktsionerno druzhestvo formed before January 1, 2007, clarifies the standard described in Notice 2007–10 and the standard to be applied with respect to entities listed in §301.7701–2(b)(8), including those entities listed in T.D. 8697, T.D. 9197, and T.D. 9235. Comments are requested with respect to this clarification.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) does not apply to this regulation. For the applicability of the Regulatory Flexibility Act

April 28, 2008 833 2008–17 I.R.B.

Linda E. Stiff, Deputy Commissioner for Services and Enforcement.

Approved March 12, 2008.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on March 20, 2008, 8:45 a.m., and published in the issue of the Federal Register for March 21, 2008, 73 F.R. 15064)

(b)(8)(vi) Certain European entities. The following business entity formed in the following jurisdiction:

Bulgaria, Aktsionerno Druzhestvo. (c) through (e)(6) [Reserved]. For further guidance, see §301.7701–2(c) through (e)(6).

(7) The reference to the Bulgarian entity in paragraph (b)(8)(vi) of this section applies to such entities formed on or after January 1, 2007, and to any such entity formed before such date from the date that, in the aggregate, a 50 percent or more

interest in such entity is owned by any person or persons who were not owners of the entity as of January 1, 2007. For purposes of the preceding sentence, the term interest means—

(i) In the case of a partnership, a capital or profits interest; and

(ii) In the case of a corporation, an equity interest measured by vote or value.

(8) Expiration date. The applicability of this section expires on or before March 18, 2011.

2008–17 I.R.B. 834 April 28, 2008