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November, 2005 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

The Social Security Contribution base increases from $90,000 in 2005 to $94,200 in 2006.

Standard mileage rates for 2005 – From January 1, 2005 through September 30, 2005, the standard mileage rate for the business use of an auto is 40.5¢ per mile. However, due to the significant increase in the cost of gasoline, the standard mileage for the business use of an auto after September 30, 2005 (Oct. 1, 2005 through Dec. 31, 2005) will be 48.5¢.

Extension of time period for employees to spend unused FSA funds – IRS Notice 2005-42 now allows employees in flexible spending accounts (FSAs) an additional 2½ months after the end of the plan year to spend unused money in their accounts from the prior year. However, the plan must be amended to allow the additional grace period. Prior to this notice, employees lost any rights to FSA funds that were not used by year end.

Contribution limits for regular and Roth IRA’s – For years 2005 through 2007, the limit on permissible contributions to both Regular IRA’s and Roth IRA’s is $4,000. The limit increases to $5,000 for 2008. In addition, the “catch-up” provisions for those 50 of age, or older before the end of the year allow an additional $500 for 2005 and $1,000 for 2006, increasing the total allowable combined contribution for those age 50 and older to $4,500 for 2005 and $5,000 for 2006.

SIMPLE Plan annual elective deferral limits are $10,000 for 2005 and years thereafter. In addition, a participant in a SIMPLE plan that is age 50 or older by the end of the applicable year may make an additional $2,000 in elective contributions for the year 2005 (a total permissible elective contribution of $12,000) and an additional “catch-up” contribution of $2,500 for years 2006 and thereafter (a total permissible elective contribution of $12,500).

Maximum dollar limitations for annual additions to Simplified Employee Pensions (SEPs) are $42,000 for 2005 and $44,000 for 2006. The additional “catch-up” contributions for those 50 and older are $4,000 for 2005 and $5,000 for 2006. These limitations and additional “catch-up” contributions apply to all defined contribution plans other than SIMPLE plans.

The 401(k) Plan annual elective deferral limit for 2005 is $14,000 and the additional “catch-up” contribution for those age 50 and older is $4,000 (a total elective deferral limit for those age 50 and over of $18,000). For 2006, the annual elective deferral limit increases to $15,000 and the additional “catch-up” contribution for those 50 and older increases to $5,000 (a total elective deferral limit for those age 50 and over of $20,000).

Form 1040 C-EZ – The IRS has raised the business expense limit to $5,000 for filing form 1040 C-EZ, allowing more individuals to use this simplified expense form for 2005.

Clean-Fuel Deduction – Those considering the purchase of an automobile before the end of 2005, might consider purchasing one that has been approved by the IRS for the clean-burning fuel deduction, such as the Toyota Prius. Taxpayers who purchase the vehicle (and are the original owner) may claim a $2,000 deduction as an adjustment to income and need not itemize deductions to make the claim.

Investment losses due to fraud or unethical sales practices may be deductible as an ordinary deduction instead of as capital losses if the provisions of IRC section 165(c)(2) are met. Although there are numerous technical requirements and the assertion often prompts an IRS oversight, there are several advantages to claiming this deduction. Some of these advantages are: the losses are not subject to the limitations imposed on capital losses; the deduction is not subject to the 2% floor for miscellaneous itemized deductions; and the deduction is excluded from the phase-out of itemized deductions. Although the taxpayer suffering the loss is not required to do so, the best course of action to take when confronted with such a loss is to first consult an attorney. Losses from embezzlement, blackmail, kidnapping for ransom, burglary, larceny and extortion may also be eligible for section 165 treatment.

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. Generally, 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 back 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.

SECURITIES REGULATORY NOTES

PIGGYBACK ARRANGEMENTS WITH CLEARING FIRMS

The NASD has amended Rule 3150, requiring clearing firms to report data to the NASD about each piggybacking firm separately from an intermediary firm’s data and has amended Rule 3230 to require intermediary firms to maintain data in a manner that will enable its clearing firm and the NASD to distinguish the proprietary and customer accounts of the intermediary from those of the piggybacking firm. Both amendments apply only to intermediary clearing arrangements established on or after February 20, 2006. (See Notice to Members 05-72)

NEW DEFINITION OF BRANCH OFFICE

In an effort to standardize the criteria used to determine whether or not a business location is a branch office, the NASD has amended the definition of a branch office contained in Rule 3010(g)(2). Under the current rule, a branch office is defined as “any location identified by any means to the public or customers as a location in which the member conducts an investment banking or securities business”. On the effective date of the amendment, May 1, 2006, a branch office will be defined as “any location where one or more associated persons of a member regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of any security or is held out as such, excluding…” [The exclusions listed thereafter, including an exemption for primary residences (subject to certain conditions), have been omitted from this newsletter.] The use of a vacation home that is used occasionally by associated persons is exempted from the definition of a branch office, under certain conditions.

In addition, as the result of a coordinated effort by the NASD, NYSE and NASAA, securities dealers will now submit information regarding branch offices on a centralized, CRD-based branch office application system, in “a single filing in order to simultaneously fulfill the branch office reporting and/or registration requirements of NASD, the NYSE and most states.” [Quoting from NASD Notice to Members 05-67]. Branch office information will now be submitted on Form BR, which replaces Schedule E of Form BD. The transition from Schedule E of Form BD to Form BR was to occur by the end of October, 2005. These changes will have a significant impact for many of our clients. Those broker/dealers with any sales personnel operating outside of their main office as either independent contractors, or as registered or unregistered branch office locations should thoroughly read NASD Notice to Members 05-67.

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. The Securities and Exchange Commission has now significantly restricted their use. Due to the predominance of these agreements, we feel that one condition in that prior newsletter bears repeating.

One of the conditions in which a broker/dealer may not be required to record expenses and liabilities associated with services provided or expenses paid by a non-broker/dealer affiliate is if 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. With respect to this condition, 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”. This virtually mandates that broker/dealers record services or expenses incurred on its behalf by an affiliated entity if that broker/dealer pays management fees or other remuneration to the affiliated entity.

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.

As an additional note, the fee is $200 per day for financial reports (monthly and/or quarterly FOCUS reports and annual audited financial statements) filed late with the National Futures Association (NFA).

Day-Trading Interpretations Revision – The New York Stock Exchange has issued revised interpretations of Rule 431(f)(8)(B), “Day-Trading”. Interested parties should consult NYSE Interpretation 05-6.

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 became effective for all non-public broker/dealers whose fiscal year began after December 15, 2003. Therefore all broker/dealers should review (or have legal counsel review) any bylaws, articles of partnership, operating agreements, shareholder agreements, subscription agreements, etc. to determine if there exists any such provisions and make appropriate amendments. [NASD Notice to Members 04-33 and/or New York Stock Exchange Information Memo 04-23]

REGISTRATION OF BROKER/DEALER AUDITORS

The Sarbanes-Oxley Act was directed toward auditors of publicly held companies. Section 205 of that act contains a provision amending Sections 17(e) and 17(f) of the Securities and Exchange Act of 1934 to substitute the term “registered public accountant” for the term “independent public accountant”, meaning a public accounting firm registered with the Public Company Accounting Oversight Board (PCAOB). All auditors of registered broker/dealers are therefore required to register with the PCAOB whether or not the broker/dealer they audit is publicly held. Although two registration extensions have been previously granted, all audited financial statements submitted by broker/dealers for years ending after December 31, 2005 must be submitted by accountants that are registered with the PCAOB.

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