Administrative Expenses of Bankruptcy Estate Are Deductible from Gross Income

Is a trustee of a Chapter 7 bankruptcy estate entitled to deduct expenses of administering the estate "above the line," as a deduction from gross income under Sec. 67(e), or is he limited to deducting the expenses as an itemized deduction subject to the two-percent floor for miscellaneous deductions under Sec. 67(a)?

Analysis

Sec. 1398 allows special tax treatment for individuals who are in bankruptcy pursuant to Chapter 7 or Chapter 11 of the Bankruptcy Code. Sec. 1398(c)(1) sets forth the general rule that the taxable income of a bankruptcy estate is computed in the same manner as it is computed for an individual. Sec. 1398(e)(3) states that, except as otherwise provided in this section, the determination of whether any amount paid or incurred by the estate is allowable as a deduction must be made as if the amount were paid or incurred by the debtor.

According to Sec. 1398(h)(1), "[a]ny administrative expense allowed under section 503 of title 11 of the United States Code, ... to the extent not disallowed under any other provision of this title, shall be allowed as a deduction."

Sec. 61(a) defines gross income as all income from whatever source, except as otherwise provided. Sec. 62(a) defines adjusted gross income (AGI) as gross income minus the deductions listed in that subsection. Under Sec. 63(d), itemized deductions are the deductions allowed under this chapter, other than the deductions allowed in arriving at AGI (i.e., those listed in Sec. 62(a)) and personal exemptions.

Under Sec. 67(a), for an individual taxpayer, miscellaneous itemized deductions are allowed only to the extent that the aggregate of such deductions exceeds two percent of gross income. Sec. 67(b) lists the itemized deductions that are not miscellaneous itemized deductions and thus not subject to the two-percent floor. Administrative expenses are not specifically listed in Sec. 62(a) or 67(b). Therefore, absent another provision, taxpayers would treat such expenses as miscellaneous itemized deductions subject to the two-percent floor. However, under Sec. 67(e), the taxpayer treats deductions for costs paid or incurred in connection with the administration of an estate or trust, that would not have been incurred if the property were not held in such trust or estate, as allowable in arriving at AGI.

In In re Miller, 252 DC 110 (Bankr. DC TX 2000), a bankruptcy court decided this issue in favor of the trustee, holding that no reason existed to render the Sec. 67(e) exception inapplicable to administrative expenses associated with bankruptcy estates. In Miller, the IRS argued that bankruptcy estates are not encompassed by the "estates and trusts" contemplated by Sec. 67(e) and that, accordingly, the Sec. 67(e) exception should be viewed as inapplicable to bankruptcy estates. The court rejected this argument, reasoning that the Service's interpretation of Sec. 67(e) was inconsistent with a plain reading of its language. According to the court, including costs incurred by bankruptcy estates among those deductible under Sec. 67(e), by effectively reducing the amount on which trustees are required to pay income taxes, actually is consistent with Congress's stated objective "to maximize distributions to creditors whose rights have been altered as a result of the filing of a bankruptcy case."

Conclusion

Sec. 67(c) applies to the administrative expenses of an individual debtor's estate in bankruptcy. Therefore, deductions for expenses that would not have been incurred if the property had not been held by the bankruptcy estate were allowed in arriving at AGI.

IRS Letter Ruling 200136004 (5/17/01)