Why is this Topic Important to Wealth Managers? Presents discussion on the basics of Simplified Employee Pension (SEP) plans.  Discusses the requirements of SEP plans for employers as well as providing the necessary steps to establish a SEP plan.    

SEP is a written plan that allows a business to make contributions toward executive’s retirement and employees’ retirement without getting involved in a more complex qualified plan.

Under a SEP, the business makes the contributions to a traditional individual retirement arrangement (called a SEP-IRA) set up by or for each eligible employee.   A SEP-IRA is owned and controlled by the employee, and the business makes contributions to the financial institution where the SEP-IRA is maintained.

SEP-IRAs are set up for, at a minimum, each eligible employee.  An eligible employee means an individual who meets all the following requirements: the individual has reached age 21, has worked for the business in at least 3 of the last 5 years, and has received at least $550 in compensation from the business in 2010. [1]

There are three basic steps in setting up a SEP.

1. The business must execute a formal written agreement to provide benefits to all eligible employees.
2. The business must give each eligible employee certain information about the SEP.
3. A SEP-IRA must be set up by or for each eligible employee.

In many situations, a SEP’s formal written agreement requirement can be satisfied by adopting an IRS model SEP using Form 5305-SEP.

The SEP rules permit the business to contribute a limited amount of money each year to each employee’s SEP-IRA.  Also, generally, the business does not have to make contributions every year.   But if it does make contributions, they must be based on a written allocation formula and must not discriminate in favor of highly compensated employees.  [2]

When the business contributes, it must contribute to the SEP-IRAs of all participants who actually performed personal services during the year for which the contributions are made, including employees who die or terminate employment before the contributions are made.  These contributions are deductible within limits, so long as the contribution is made by the due date for the taxable year, and are generally not taxable to the plan participants.  [3]

Deductible contributions the business makes for 2010 to a common-law employee’s SEP-IRA cannot exceed the lesser of 25% of the employee’s compensation or $49,000. [4]

Example 1: Employee 1, Mary Plant, earned $21,000 for 2010.  The maximum contribution the business may make to her SEP-IRA is $5,250 (25% x $21,000).

Example 2: Employee 2, Susan Green, earned $210,000 for 2010.  Because of the maximum contribution limit for 2010, the business can only contribute $49,000 to her SEP-IRA.

Further, if a business made SEP contributions that are more than the deduction limit (nondeductible contributions), the business may carry over and deduct the difference in later years.   Nevertheless, the carryover, when combined with the contribution for the later year, is subject to the deduction limit for that year.

For more information on SEP plans, please visit our subscriber library through Advanced Markets Advisor FX: SEPs And Simple Plans. 

Tomorrow’s blogticle will begin our discussion on additional changes and hot topics in 2011. 

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] I.R.C. §408(k)(2).

[2] I.R.C. §408(k)(3). 

[3] I.R.C. §402(h)(2).

[4] I.R.C. §402(h)(2).;  I.R.C. §415(c)(1)(A).

Wikileaks is set to release confidential Swiss banking documents, and although the scope of information included in the documents isn’t yet clear, the release could pave the way for a new IRS surge against tax evaders.  Similar disclosures by bank insiders were at the heart of the Justice Department’s UBS investigation.   This most recent leak came from a former senior private banker and chief operating officer of Julius Baer’s Caribbean operation.   He’s currently on trial in Switzerland for allegedly leaking client documents in 2005.

… the statute of limitations for criminal tax offenses is generally three years, but there are a number of exceptions that extend the statute to six years, including “willfully attempting to evade or defeat any tax.” Leaked documents from prior to 2002 would reveal activities that would generally fall outside the six-year statute of limitations; however, the six year statute only begins to run on the day the last affirmative act is committed by the defendant, so criminal prosecution of accountholders revealed by the leak may still be viable.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the IRS’s offshore enforcement efforts in Advisor’s Journal, see Offshore’s Limited Shelf Life (CC 10-47), IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52), and IRS Planning New Voluntary Disclosure Program for Offshore Assets (CC 10-118).

Federal interference in the regulation of the insurance industry could be around the corner, but the states are not going to cede their authority without a fight.

State legislators fear that “important funds and jobs could be lost if Congress authorizes a federal insurance charter and creates a new bureaucracy to regulate insurance.” According to a letter sent by NCOIL (The National Conference of Insurance Legislators) to every member of the 112th Congress, a federal insurance charter could cost states as much as $16 billion in revenue annually—representing lost fees and taxes generated for the states by insurance business. ….

Although the FIO itself is not given regulatory authority by the Wall Street Reform Act, the studies mandated by the Act may signal that the Feds are interested in expanding their reach into the insurance industry. And, it would be naïve to think that the FIO studies will find that federal regulation of insurance companies is absolutely unnecessary—given the role of insurance companies like AIG in the financial crisis.  Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the Federal Insurance Office in Advisor’s Journal, see The Federal Insurance Office (CC 10-55).

Why is this Topic Important to Wealth Managers? Discusses alternative tax and interest calculations available to certain taxpayers with regards to Passive Foreign Investment Company income as part of the Voluntary Disclosure Programs. 

A significant number of Offshore Voluntary Disclosure Practice cases (remember the Swiss Bank Accounts) involve Passive Foreign Investment Company (PFIC) investments.  A lack of historical information on the cost basis and holding period of many PFIC investments, the Service notes, may make it difficult for taxpayers to prepare statutory PFIC computations and for the Internal Revenue Service to verify them.  As a result, resolution of many Disclosure Practice cases are said to be unduly delayed.  Therefore, for purposes of this initiative, the Internal Revenue Service is offering taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in Internal Revenue Code section 1296 but will not require complete reconstruction of historical data. [1]

The terms of the alternative resolution offered by the Internal Revenue Service are as follows:

• If elected, the alternative resolution will apply to all PFIC investments in cases that have been accepted into the Disclosure Practice and that qualify for the special civil penalty framework announced by the IRS on March 23, 2009.  [2]
• The initial MTM computation of gain or loss under this methodology will be for the first year of the Disclosure Practice application but could be made after 2003 depending on when the first PFIC investment was made.  Generally, under the terms of the March 23, 2009 framework, the first year of the Disclosure Practice application will be for the calendar year ending December 31, 2003.   This will require a determination of the basis for every PFIC investment, which should be agreed between the taxpayer and the Service based on the best available evidence.  
• A tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the Disclosure Practice period. [3]
• A rate of 7% of the tax computed for PFIC investments marked to market in the first year of the Disclosure Practice application will be added to the tax for that year. [4]
• MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment-by-investment basis in the same manner as section 1296. During the Disclosure Practice period, these MTM losses will be treated as ordinary losses [5]and the tax benefit is limited to the tax rate of 20%.  This limitation is accomplished by multiplying the MTM loss by 20% and applying the result as a credit against the tax liability for the year. 
• Regular and Alternative Minimum Tax are both to be computed without the PFIC dispositions or MTM gains and losses.  The tax from the PFIC transactions (20% plus the 7% for 2003, if applicable) is added to (or subtracted from) the applicable total tax, either regular or AMT, whichever is higher.  The tax and interest (i.e., the 7% for the first year of the Disclosure Practice) computed under the Disclosure Practice alternative MTM will then be added to the applicable total tax. 
• Generally, underpayment interest and penalties on the deficiency are computed in accordance with the Internal Revenue Code and the terms of the Disclosure Practice.
• For any PFIC investment retained beyond 12/31/2008, the taxpayer must continue using the MTM method, but will apply the normal statutory rules of section 1296 as well as the provisions of sections 1291-1298, as applicable.

However, if the taxpayer does not elect to use the alternative PFIC computation, then the PFIC provisions of Sections1291-1298 apply.  The IRS recommends for those considering the alternative calculation to seek professional tax advice with regards to these Disclosure Practices.    

Next week’s blogticles will discuss new hot topics in 2011.  

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] Internal Revenue Service.  Offshore Voluntary Disclosure Initiative: Passive Foreign Income Company Investment Computations.  September 2010.   http://www.irs.gov/taxpros/.  Last Accessed 1/27/2011.

[2] See generally, Statement from IRS Commissioner Doug Shulman on Offshore Income.  http://www.irs.gov/newsroom/article/0,,id=206014,00.html, Last Accessed 1/27/2011; IRM 9.5.11.9, Revised IRS Voluntary Disclosure Practice. http://www.irs.gov/newsroom/article/0,,id=104361,00.html.  Last Accessed 1/27/11. 

[3] This arrangement is in lieu of the rate contained in section 1291(a)(1)(B) for the amount allocable to the current year and section 1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.

[4] This arrangement is in lieu of the interest charge mechanism described in sections 1291(c) and 1296(j).

[5] Under IRC 1296(c)(1)(B).

The SEC recently approved FINRA proposed rules—FINRA Rules 2090 and 2011—that amend and consolidate know-your-customer and suitability obligations for broker-dealers and their authorized representatives. The new rules are based on, and replace in-part, similar NYSE and NASD rules. According to FINRA, the amended know-your-customer and suitability rules are intended to protect investors by “promoting fair dealing with customers and ethical sales practices.”

The new rules are effective as of October 7, 2011.  For previous coverage of the suitability standard and the debate over the proposed fiduciary standard in Advisor’s Journal, see What You Don’t Know Yet Might Hurt You: A Broker’s Duties under the Financial Reform Act (CC 10-40) and Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97).

Under the know-your-customer rule, firms are required to use reasonable diligence respecting the opening and maintenance of every account and to know essential facts about every customer. “Essential facts” are facts required to …. Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

Why is this Topic Important to Wealth Managers? Discusses group term life insurance policies in general.  Provides a useful tool to consider for client business planning.

The Internal Revenue Code provides an exclusion from income for the first $50,000 of group-term life insurance coverage provided under a policy carried directly or indirectly by an employer. [1] Thus, there are no tax consequences to the individual if the total amount of such policies does not exceed $50,000.  However, the imputed cost of coverage in excess of $50,000 must be included in income to the individual, using the IRS Premium Table, [2] and are subject to social security and Medicare taxes.

A taxable fringe benefit arises if coverage exceeds $50,000 and the policy is considered carried directly or indirectly by the employer. A policy is considered carried directly or indirectly by the employer if:

1. The employer pays any cost of the life insurance, or
2. The employer arranges for the premium payments and the premiums paid by at least one employee subsidize those paid by at least one other employee (known as the “straddle” rule).

A policy that is not considered carried directly or indirectly by the employer has no tax consequences to the employee.  Also, because the employees are paying the cost and the employer is not redistributing the cost of the premiums through an insurance system, the employer has no reporting requirements.

Example 1 – All employees for Employer X are in the 40 to 44 year age group.  According to the IRS Premium Table, the cost per thousand is .10.  The employer pays the full cost of the insurance.  If at least one employee is charged more than .10 per thousand of coverage, and at least one is charged less than .10, the coverage is considered carried by the employer. Therefore, each employee is subject to social security and Medicare tax on the cost of coverage over $50,000.

Example 2 - The facts are the same as Example 1, except all employees are charged the same rate, which is set by the third-party insurer.  The employer pays nothing toward the cost.  Therefore there is no taxable income to the employees.  It does not matter what the rate is, as the employer does not subsidize the cost or redistribute it between employees.

However, under the first example, the employer may be entitled to a deduction for the premiums paid on the life insurance policies for each employee.  [3] Under the second example, that option is not available.

Example 3 - A 47-year old employee receives $40,000 of coverage per year under a policy carried directly or indirectly by her employer.  She is also entitled to $100,000 of optional insurance at her own expense.  This amount is also considered carried by the employer.  The cost of $10,000 of this amount is excludable; the cost of the remaining $90,000 is included in income.   If the optional policy were not considered carried by the employer, none of the $100,000 coverage would be included in income.

Tomorrow’s blogticle will continue with more 2011 market opportunities for wealth managers.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] IRC section 79

[2] At page 13.

[3] IRC Sec. 162(a); see Rev. Rul. 56-400, 1956-2 CB 116; Advanced Markets AdvisorFX Tax Facts: Q 174, Are the premiums paid for group term life insurance deductible business expenses?

Why is this Topic Important to Wealth Managers? Discusses self-employment taxes with regards to closely held corporations.  Provides insight from a recent court decision regarding how distributions may be treated.

Earlier this month we reported on legislation affecting closely held businesses and the self-employment tax.   We note that Stephen Sternberger, attentive AdvisorFX subscriber and tax lawyer, pointed out in his comments to that article that the the legislation had not passed.  However, that topic (Self-Employment Tax on wages versus distributions), has reared its head again – as shown by the recent Federal District Court case involving David E. Watson. [1]

The C.P.A. recently disputed and lost to the Government’s position which recharacterized dividend and loan payments from David E. Watson, P.C. (a Subchapter S corporation) to its sole shareholder and employee, David E. Watson.  The IRS assessed additional employment taxes, interest and penalties against Watson for each of tax years in which Watson’s salary was significantly lower than his total distributions.

The taxpayer made the contention that the closely held business unquestionably intended to pay Watson compensation of $24,000 per year, and that amounts distributed to Watson in excess of that amount were properly classified as dividends and/or loans.  Watson wanted to take a lower salary and larger distributions because wages or salaries are generally subject to self-employment taxes while distributions are not.  The self-employment tax rate is 15.3%.

The question the Court reviewed was whether the characterization of funds disbursed by an S corporation to its employees or shareholders is a salary or otherwise.  The Court determine that the answer to this question turns on an analysis of whether the “payments at issue were made . . . as remuneration for services performed.”

The Court made clear that a determination of whether funds are “remuneration for services performed,” must be made “in view of all the evidence.”   While intent is unquestionably a consideration in the analysis, it is by no means the only one.  Other relevant considerations include, but are not limited to:  1) the employee’s qualifications; 2) the nature, extent and scope of the employee’s work; 3) the size and complexities of the business; 4) a comparison of salaries paid with the gross income and the net income; 5) the prevailing general economic conditions; 6) comparison of salaries with distributions to stockholders; 7) the prevailing rates of compensation for comparable positions in comparable concerns; the salary policy of the taxpayer as to all employees; and 9) in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years.

The Court’s analysis concluded that payments to Watson were, in fact, “remuneration for services performed” and that a portion of those payments were subject to the self-employment tax.

The Wall Street Journal reported that Mr. Watson will appeal the decision. [2] Quoting Watson stating, “The IRS can disallow a tax deduction for unreasonably high compensation, but the law doesn’t give it the authority to raise pay in order to collect extra payroll taxes,”  The Journal also reported that “independent tax expert Robert Willens in New York says [Watson’s position] will be a hard argument to win.”

Tomorrow’s blogticle will revert back to 2011 market opportunities for wealth managers.

We invite your opinions or questions by posting them below, or by calling the Panel of Experts

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[1] David E. Watson, P.C. v. U.S. 107 A.F.T.R.2d 2011-311 (December 2010)(Westlaw).  Full case available at http://ia700202.us.archive.org/4/items/gov.uscourts.iasd.37557/gov.uscourts.iasd.37557.35.0.pdf.  Last accessed 10/25/2011.

[2] Laura Saunders.  Wall Street Journal.  The IRS Targets Income Tricks.  January 22, 2011.  http://online.wsj.com/article_email/SB10001424052748703951704576092371207903438-lMyQjAxMTAxMDIwMjEyNDIyWj.html.  Last accessed 10/25/2011.

Despite Congress’s best efforts after the recent economic meltdown, a cadre of Wall Street’s biggest banks still dominates the derivatives markets, leaving some observers wondering whether the transparency the Act was supposed to bring was just a well-intentioned but overly optimistic dream.

The Dodd-Frank Wall Street Reform Act (Act) gave the Commodity Futures Trading Commission (CFTC) and Securities and Exchange Commission (SEC) extensive new authority over participants in the derivatives and swaps markets. But the transparency and equity many hoped the Act would bring to the markets is bottlenecked in the agencies charged with implementing the legislation.

The CFTC was scheduled to consider conflict of interest rules for swap execution facilities, derivatives clearing organizations and designated contract markets at their January 13, 2011 meeting, but disagreement about the scope of the rules resulted in the items being nixed from consideration at the meeting.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of the Dodd-Frank Act in Advisor’s Journal, see Dodd-Frank Wall Street Reform and Consumer Protection Act (CC 10-35) and Wall Street Reform Act Mandates Study of Financial Planning Industry (CC 10-73).

As reported earlier this month in Advisor’s Journal [Qualified Charitable Distributions from an IRA (CC 11-03))], a qualified charitable distribution (QCD) of up to $100,000 made from an IRA will not be included in the taxpayer’s gross income, as long as the contribution is made directly from the trustee to a public charity or conduit private foundation when the account owner is at least 70½ years old.

One benefit of taking a QCD is that it can qualify as a required minimum distribution (RMD). For the taxpayer who does not have a financial need for the distribution, making a QCD is an opportunity to take the RMD—avoiding the severe tax penalties for not taking the distribution—while excluding the distribution from taxable income.

But because the QCD provision lapsed during 2010, taxpayers who took an RMD during 2010 are out-of-luck.  

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

Why is this Topic Important to Wealth Managers? Discusses standards of care study called for by Dodd-Frank legislation.  Presents an overview of the recommendations submitted to Congress. 

Last Friday, Jan. 22, The Securities and Exchange Commission (SEC) submitted to Congress a staff study recommending a uniform fiduciary standard of conduct for broker-dealers and investment advisers — no less stringent than currently applied to investment advisers under the Investment Advisers Act of 1940– when those financial professionals provide personalized investment advice about securities to retail investors. [1]

Section 913 of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required SEC to conduct a study to evaluate: 

• The effectiveness of existing legal or regulatory standards of care (imposed by current authorities) for providing personalized investment advice and recommendations about securities to retail customers; and  
• Whether there are legal or regulatory gaps, shortcomings, or overlaps in legal or regulatory standards in the protection of retail customers relating to the standards of care for providing personalized investment advice about securities to such customers that should be addressed by rule or statute. 

In the study, the SEC notes that investment advisers and broker-dealers are regulated extensively under different regulatory regimes. But, the study claims, many retail investors do not understand and are confused by the roles played by investment advisers and broker-dealers. The study finds that “many investors are also confused by the standards of care that apply to investment advisers and broker-dealers” when providing personalized investment advice about securities.

The study further states that “retail investors should not have to parse through legal distinctions to determine” the type of advice they deserve.  Instead, the study notes “retail customers should be protected uniformly when receiving personalized investment advice about securities regardless of whether they choose to work with an investment adviser or a broker-dealer.”

At the same time, the study notes that retail investors should “continue to have access to the various fee structures, account options, and types of advice that investment advisers and broker-dealers provide.”

As a result, the study “recommends that the Commission . . . adopt and implement, with appropriate guidance, the uniform fiduciary standard of conduct for broker-dealers and investment advisers when providing personalized investment advice about securities to retail customers.”  The standard, according to the study, should be “no less stringent than currently applied to investment advisers under [the Investment] Advisers Act.”

The study also “recommends that when broker-dealers and investment advisers are performing the same or substantially similar functions, the Commission should consider whether to harmonize the regulatory protections applicable to such functions. Such harmonization should take into account the best elements of each regime and provide meaningful investor protection.”

The study concludes that the “staff’s recommendations were guided by an effort to establish a uniform standard that provides for the integrity of personalized investment advice given to retail investors. At the same time, the staff’s recommendations are intended to minimize cost and disruption and assure that retail investors continue to have access to various investment products and choice among compensation schemes to pay for advice.”

Tomorrow’s blogticle will discuss 2011 market opportunities for wealth managers.  

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Study on Investment Advisers and Broker-Dealers–As Required by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  Staff of The Securities and Exchange Commission.  January 2011.  http://www.sec.gov/news/studies/2011/913studyfinal.pdf.  Last accessed 1/24/2011.