April, 2004 Newsletter
Note: The items in this newsletter are provided to bring certain information
or opinions to the attention of the reader in capsulized form. The information
is generally not complete and has been oversimplified for the sake of
brevity. Readers should therefore not make decisions based solely upon
the information in these newsletters without first contacting
us or other sources of more complete information.
INCOME TAXES
RECENT TAX LEGISLATION
Right before election break Congress sent a last minute tax bill to President
Bush’s desk. This fresh piece of legislation primarily benefits
large corporations, especially manufacturers and energy producers, but
a few provisions affect individuals: 1) taxpayers that itemized their
deductions may now deduct either state and local income taxes or
state and local sales taxes (not both); 2) legal fees paid in certain
court settlements or awards will be deductible “above the line”
in 2005 and not subject to the limitations imposed on itemized deductions;
3) regulations regarding the deductible value of items donated to charity
have become more restrictive, as well as the required recordkeeping pertaining
to the deduction.
OTHER TAX NOTES
Hardship exception for IRA Rollovers after 60 days –
In revenue procedure 2003-16 the IRS described: 1) when an automatic
waiver of the 60 day rollover period is warranted (if the delay was due
to a financial institution error); and 2) how to request a hardship waiver
when the failure of the taxpayer to complete the rollover within the 60
day period was beyond the taxpayer’s control. The IRS has issued
several recent letter rulings to taxpayers waiving the initial rollover
period. Interested taxpayers should consult these rulings for guidance
as to what the IRS considers to be the circumstances enabling it to permit
the waiver.
Late or invalid S Corporation elections – This
item has been mentioned in earlier newsletters, but it’s worth repeating.
The IRS has the authority to grant S Corporation status to prior elections
that for some reason or another were determined to be invalid, or that
were filed late. Previously, taxpayers had until the 15th day of the third
month after the tax year began to file an S Corporation election that
would be effective retroactively to the beginning of the year, or, in
the case of a new corporation, to the time that the corporation was deemed
to have begun doing business. In addition, if the original election was
determined to be invalid, even though it was timely filed, the IRS had
no authority to grant retroactive S Corporation status. Now, pursuant
to IRS Code Sections 1362(f) (for invalid elections) and 1362(b)(5) (for
elections filed late), the IRS may treat the elections as having been
timely filed, if the shareholders filing the election meet the conditions
stated in those code sections.
Contribution limits for regular and Roth IRA’s
– For 2004 the limit on permissible contributions to both Regular
IRA’s and Roth IRA’s is $3,000. That limit increases to $4,000
for years 2005 through 2007 and to $5,000 for years 2008, with inflation
indexing thereafter. This means that between January 1, 2005 and April
15, 2005 an eligible taxpayer that has not yet made any IRA contributions
for 2004 or 2005 may contribute as much as $7,000 ($3,000 for 2004 and
$4,000 for 2005) to a Regular IRA or to a Roth IRA, or a total contribution
of $7,000 may be divided between both account types. In addition, due
to the “catch-up” provisions of the EGTRRA (see below), if
an individual is 50 years or older before the end of 2004, the amount
of the contribution during that same time period and under the same circumstances
may be an additional $500 for each year ($500 more for 2004 and $500 more
for 2005), increasing the total allowable combined contribution for 2004
and 2005, if made between January 1, 2005 and April 15, 2005, to $8,000.
SIMPLE Plan annual elective deferral limits are $9,000 for 2004 and $10,000
for 2005. (see also “catch-up” provisions below).
Catch-up provisions – The Economic Growth and
Relief Reconciliation Act of 2001 (the EGTRRA) contains certain provisions
to enable older taxpayers to “catch-up” on their retirement
plan contributions by raising the limits on elective deferrals for certain
401(k) plans, tax sheltered annuities, SEP’s, SIMPLE plans and Section
457 plans of state and local municipalities. Although this provision has
been designed primarily to assist women whose cumulative retirement plan
contributions may be deficient due to career interruptions, all those
reaching the age of 50 by the end of the calendar year (beginning in 2002)
will benefit. For example: a participant in a SIMPLE plan that is age
50 or greater by the end of 2004 may make an additional $1,500 in elective
contributions for the year 2004 (a total permissible elective contribution
of $10,500). The limit is increased to $2,000 for 2005 and $2,500 for
years 2006, with indexing for inflation thereafter.
The catch-up provisions for Regular IRA’s and Roth IRA’s
(for individuals 50 years of age and older by the end of the applicable
calendar year) are $500 for 2004 through 2005 and $1,000 for years 2006
and thereafter.
Electronic filing of forms 1120 and 1120S (Corporate income taxes)
– In February of this year the IRS began accepting corporate income
tax forms 1120 and 1120S electronically.
SECURITIES REGULATORY NOTES
EXPENSE SHARING AGREEMENTS WITH HOLDING COMPANIES
In our December, 2003 newsletter we discussed expense sharing arrangements
between broker/dealers and affiliated entities, such as holding companies.
Because these arrangements have led to certain abuses, the Securities
and Exchange Commission has now significantly restricted their use. Due
to the predominance of these agreements, we feel that the following information
bears repeating.
In a letter issued to both the NASD and NYSE during July of 2003, the
Securities and Exchange Commission (SEC) significantly restricted the
ability of broker/dealers to allow affiliates to provide any services
and pay for any expenses of the broker/dealer and not record the expense
and related liability on the books of the broker/dealer. Based upon our
reading of the aforementioned SEC letter and the additional information
provided in NASD Notice to Members 03-63, a broker/dealer may not be required
to record expenses and liabilities associated with services or expenses
provided by a non-broker/dealer affiliate if all of the following conditions
exist:
1) The non-registered broker/dealer affiliate must enter into a written
agreement with the broker/dealer to pay such expenses without anticipating
any reimbursement from the broker/dealer.
2) The non-registered broker/dealer affiliate must be self-supporting.
It must have some other source of income other than fees or dividends
paid to it by the broker/dealer. This requirement may be satisfied if
the non-broker/dealer affiliate is a registered investment advisor or
provides other services or products not requiring securities registration,
such as providing financial planning services or selling non-securities
insurance products.
3) For any expense paid to a vendor or other third party, all or part
of which benefits or is paid on behalf of the broker/dealer, the vendor
or other third party must agree in writing that the broker/dealer is not
directly or indirectly liable to the third party for the expenditure or
service(s) provided.
4) There is no indication that the broker/dealer is directly or indirectly
liable to the vendor or other third party for the expenditure or service(s)
provided.
5) The liability for the expense or service(s) provided is not a liability
of the broker/dealer according to Generally Accepted Accounting Principals
(GAAP).
With respect to item 3 above, Notice to Members 03-63 states that “if
the broker/dealer remits funds [such as the payment of management fees]
to such third party [the holding company or affiliate], the broker/dealer
is viewed as being indirectly liable for the expenses assumed
by the third party”. The same notice also states that “an
arbitration award rendered against the broker/dealer is a liability of
the broker/dealer until it is satisfied in an appropriate manner”
and reminds its members that commission payments to registered representatives
must be made by an entity registered as a broker/dealer with the Securities
and Exchange Commission, thereby necessitating that the broker/dealer,
not an affiliate, pay its registered personnel.
It is important to note that even if all of the above conditions are
met and the broker/dealer is not required to record these items as expenses
and liabilities, the new requirements still mandate that broker/dealers
keep a record of all expenses paid and services performed on its behalf
by the non-broker/dealer affiliate. Since it is already necessary to report
this information in a “related party” footnote included with
the broker/dealer’s annual certified financial statements, this
additional condition should provide no significant additional burden to
the broker/dealer, other than possibly necessitating that this information
be accumulated and retained on a more frequent basis than annually for
its incorporation into the certified financial statements.
According to Notice to Members 03-63, broker/dealers were required to
be able to demonstrate compliance with the new expense-sharing
requirements no later than December 1, 2003. It is also
important to note that the notice contains many other restrictions
regarding relationships with affiliated entities, such as capital
contributions made by non-broker/dealer affiliates to broker/
dealers. We strongly recommend that this notice be read in its
entirety with care.
OTHER REGULATORY NOTES
FOCUS and annual audit filing deadlines and related extension
requests – In NASD Notice to Members 04-35 (NTM 04-35)
and New York Stock Exchange Interpretation 04-5 (NYSE Interp. 04-5) ,
broker/dealers are reminded of the filing deadlines for monthly (if applicable)
and quarterly FOCUS reports, as well as for annual certified audit reports.
In addition, the publications state that extension requests for FOCUS
reports are to be received by the regulatory agency at least 3 days prior
to the due date for the report. According to the NASD’s By-Laws,
the penalty for the late filing of a report is $100 per day, for a maximum
of 10 days. In addition, NYSE Interp. 04-5 states
that extension requests for annual certified audits should be made at
least 10 days prior to the due date of the report. The same interpretation
also provides guidance and time frames for requests pertaining to a change
in fiscal year-end.
Additional disclosures to be made to subordinated lenders
– The NASD has proposed a requirement that all broker/dealers provide
to subordinated lenders information in addition to the Disclosure Document
already required. The additional information to be provided to the lender
would include: the intended use of the proceeds; the intended plan of
financing; information regarding the loan, such as interest rate(s), scheduled
maturity date(s), etc.; information regarding other subordinated loans;
and the broker/dealer’s most recent annual certified audited financial
statement. For more detailed information regarding the proposed new requirements
see NASD Notice to Members 04-75.
ACCOUNTING AND FINANCIAL REPORTING ISSUES
SFAS 150 CREATES POTENTIAL NET CAPITAL PROBLEM FOR SMALL BD’S
Statement of Financial Accounting Standards No. 150 (SFAS 142)
– “Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity” has created a potential net capital
problem for small broker/dealers with ownership interests that are redeemable
upon the death of a shareholder, partner, member, or owner. The SFAS requires
an issuer [for our purposes a broker/dealer] “to classify …
as liabilities … a financial instrument issued in the form of shares
that is mandatorily redeemable – that embodies an unconditional
obligation requiring the issuer [broker/dealer] to redeem it by transferring
its assets at a specified or determinable date (or dates) or upon an event
certain to occur [such as the death of the owner]”. This requirement
effectively mandates that applicable ownership interests be reclassified
from equity (capital) to a liability, thereby reducing a broker/dealer’s
net capital. The provisions of the SFAS become effective for all non-public
broker/dealers whose fiscal year began after December 15, 2003. Therefore
all broker/dealers whose fiscal year ends this December 31, 2004 and thereafter
should review (or have legal counsel review) any bylaws, articles of partnership,
operating agreements, shareholder agreements, subscription agreements,
etc. to determine if there exist any such provisions.
In a “No Action” letter dated February 19, 2004, the Securities
and Exchange Commission has provided some Net Capital relief to broker/dealers
(an additional year grace period for purposes of net capital only). For
further information see NASD Notice to Members 04-33 and/or New York Stock
Exchange Information Memo 04-23.
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