Taxpayers with assets hidden in offshore accounts will get a second chance to voluntarily declare their assets to the IRS in return for reduced penalties under the new Offshore Voluntary Disclosure Initiative (“OVDI”).

This newest offshore amnesty program offers a reduced, 25% penalty which will be calculated based on the highest aggregate amount in the taxpayer’s offshore account between 2003 and 2010. In addition to penalties, program participants will be required to pay eight years of back taxes plus interest, accuracy related penalties, and delinquency penalties.  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 offshore issues in Advisor’s Journal, see IRS Planning New Voluntary Disclosure Program for Offshore Assets (CC 10-118), Offshore’s Limited Shelf Life (CC 10-47) & IRS Proposed FATCA Guidance Expands Offshore Compliance Initiatives (CC 10-52)

Why is this Topic Important to Wealth Managers? This topic discusses the evaluation report of the financial crisis issued by a Congressionally appointed body. The report presents discussion of events and causes leading up to the ordeal, as well as indications and factors which presented its forthcoming. The discussion is aimed to allow wealth managers to intelligently discuss some causes of the financial crisis with clients and colleagues.

There was a new report issued earlier this year by the Financial Crisis Inquiry Commission, which was created to “examine the causes of the current financial and economic crisis in the United States.” [1] In this report, the Commission presents to the President, the Congress, and the general public the results of its examination and its conclusions as to the causes of the crisis.

The Commission was established as part of the Fraud Enforcement and Recovery Act passed by Congress and signed by the President in May 2009. [2] The independent panel was selected by Congress and composed of private citizens with experience in areas such as housing, economics, insurance, market regulation, banking, and consumer protection.

The report is intended to provide a historical accounting of what brought our financial system and economy to a precipice and to help policy makers and the public better understand how this calamity came to be.

Below are some of the findings issued in the report:

The financial crisis was avoidable. Despite the expressed view of many on Wall Street and in Washington that the crisis could not have been foreseen or avoided, there were warning signs. These were ignored or discounted. There was an explosion in risky subprime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red flags.

The widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets. The report notes that more than 30 years of deregulation and reliance on self-regulation by financial institutions, championed by former Federal Reserve chairman Alan Greenspan and others, supported by successive administrations and Congresses, and actively pushed by the powerful financial industry at every turn, had removed key safeguards, which could have helped avoid catastrophe. 

The dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis. There was a view that instincts for self-preservation inside major financial firms would shield them from fatal risk-taking without the need for a steady regulatory hand, which, the firms argued, would stifle innovation. Too many of these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding. In many respects, this reflected a fundamental change in these institutions, particularly the large investment banks and bank holding companies, which focused their activities increasingly on risky trading activities that produced hefty profits. 

A combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis. In the years leading up to the crisis, too many financial institutions, as well as too many households, borrowed to the hilt, leaving them vulnerable to financial distress or ruin if the value of their investments declined even modestly.

The government was ill prepared for the crisis, and its inconsistent response added to the uncertainty and panic in the financial market. The report notes that key policy makers—the Treasury Department, the Federal Reserve Board, and the Federal Reserve Bank of New York—who were best positioned to watch over our markets were ill prepared for the events of the financial crisis.  Other agencies were also behind the curve. They were hampered because they did not have a clear grasp of the financial system they were charged with overseeing, particularly as it had evolved in the years leading up to the crisis. This was in no small measure due to the lack of transparency in key markets. They thought risk had been diversified when, in fact, it had been concentrated. Time and again, policy makers and regulators were caught off guard as the contagion spread, responding on an ad hoc basis with specific programs to put fingers in the dike. There was no comprehensive and strategic plan for containment, because they lacked a full understanding of the risks and interconnections in the financial markets. Some regulators have since conceded this error.

Tomorrow’s blogticle will discuss new and exciting planning aspects of 2011.

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

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[1] The Financial Crisis Inquiry Report. Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States.

January 201.  http://c0182732.cdn1.cloudfiles.rackspacecloud.com/fcic_final_report_full.pdf.  Last Accessed 2/27/2011.

[2] See Public Law 111-21.

Last month, we discussed the obvious relevance of pricing competitiveness to overall life insurance product suitability. This month, we discuss the stability of pricing representations which is also a factor of suitability.  After all, pricing that appears competitive at the time of sale/purchase but which cannot be maintained can be worse than a less-competitive product with more stable pricing representations.

For instance, while premiums are often considered the price/cost of a life insurance policy, the premium is not the price/cost of a life insurance policy (unless contractually guaranteed like in term life insurance or guaranteed universal life insurance) any more than the $2,000 contributed to an Individual Retirement Account (IRA) is the cost of the IRA. In both cases, the cost is the sum of what is deducted from the premium/contribution.  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 suitability in Advisor’s Journal, see Life Insurance Product Suitability (CC 10-90), Financial Strength and Claims-Paying Ability (CC 10-115) & Cost Competitiveness of Life Insurance (CC 11-11).

Why is this Topic Important to Wealth Managers? This topic discusses the new regulatory agency that will have an effect on most life insurance companies doing business in New York.  Because the new regulatory agency will oversee insurance and banking, it is likely that changes in the insurance compliance law are just around the corner.  After the financial crisis of 2008, it appears New York is taking action to prevent future disruptions in the market.  Wealth managers should be aware of the new agency as changes to insurance regulation and compliance are sure to result from the creation of this organization.

New York State is in the process of creating a new Department of Financial Regulation (DFR) which is designed to harnesses the regulatory powers and expertise of the Banking and Insurance Departments, as well as the Consumer Protection Board, by combining the functions of each, to make the State’s oversight of financial services responsive to the 21st century needs of the industry and its consumers.

This new State agency, created pursuant to legislation submitted as part of the 2011-2012 State Executive Budget, consolidates the functions, operations and staff of the Banking and Insurance Departments, along with related segments of the Consumer Protection Board, into a single State agency.

Consolidation of these agencies and activities within a single agency platform is intended to afford the State the ability to unify the State’s regulation of financial services and to more rapidly and capably respond to changing market practices and consumer preferences, thereby ensuring the industry’s continued integrity while shielding consumers from abuses.

In addition to enhancing and refining the State’s regulatory oversight of the industry, the consolidation will provide the State with the opportunity to reduce overall spending with the use of shared services.

The Superintendent of the Department of Financial Regulation will be appointed by the Governor, with the consent of the Senate. The Department’s main offices will be located in Albany and New York City.

The Department’s main responsibilities will be carried out through two major programs: regulation and consumer protection.

Regulation

To ensure the safety and soundness of all regulated entities, the Department will monitor banks, insurance companies and other financial institutions to identify problems and will work with management to promptly solve them.  The Department will carry out this responsibility through annual on-site examinations, regular review of institutional financial reports, and periodic site visits.

Consumer Protection

To ensure that State-chartered banking institutions are complying with State laws and regulations and that no individuals are unfairly denied credit, Department employees will conduct consumer compliance examinations and resolve consumer complaints.  Staff will monitor whether institutions are helping to meet the credit and banking needs of local communities as required by various State laws.

The Department will strive for the fair treatment of insurance policyholders, claimants and the public through the regulation of company claim payments and sales practices, responses to consumer complaints, and the timely review of insurance company denials of coverage.  The Department hopes to promote high standards of industry conduct and competence through testing, oversight, and pre-licensing and enforcing educational standards of licensees.

Furthermore, the Department will proactively educate consumers regarding unscrupulous financial industry practices and products and will advocate on behalf of consumers who have been defrauded or harmed by such abuse.

The State Executive Budget recommends just over a half of a billion dollars in Special Revenue Funds for the Department of Financial Regulation for fiscal year 2011-2012. The Department of Financial Regulation’s operations will be primarily funded through assessments charged to regulated insurance and banking institutions and organizations. The remainder of the Department’s operating budget will be derived from various fees, such as those paid by entities applying for licensure or charter.

Next week’s blogticle will discuss new and exciting planning aspects of 2011.

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

NB: This work or parts thereof originated from previous official Government publication available to the public.

Life Partners Holdings, Inc. investors have filed a class-action lawsuit against the Waco Texas based life settlement provider, alleging that its directors and officers violated securities laws. The lawsuit comes a month after an announcement was made that the publically-traded company is the subject of an SEC investigation into the life expectancies the company uses to value the life insurance policies it sells to its customers. Life Partners is accused of misleading its customers—investors in life insurance policy—about the life expectancies of insureds on the policies it sells, with insureds outliving the life settlement company’s life expectancy estimates 90% of the time.  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 life settlements in Advisor’s Journal, see Life Settlement Provider Accused of Falsifying Life Span Reports (CC 11-23), Life Settlements Funds Performance Fees under Scrutiny (CC 10-116) & Should the Basis of a Life Contract be Adjusted by Mortality Charges? Rev. Rul. 2009-13 Says Yes in Context of Life Settlements; Certain Amounts over Adjusted Basis Treated as Capital Gains (CC 09-19).

For in-depth analysis of life settlements, see Advisor’s Main Library: A—Life Settlements—Introduction.

Why is this Topic Important to Wealth Managers? This topic discusses the potential consequences of not playing by the rules; it is important to constantly keep in mind the balance between providing the most efficient and effective services to clients and crossing the line into illegal territory. Clients may not realize the harsh penalties associated with offshore activity, and although when performed by expert planners under the proper circumstances, that some offshore transactions may be legal and beneficial, it is the job of informed wealth managers to keep clients abreast of information that is useful in making long-term financial decisions.

Four bankers at an international bank incorporated and with its headquarters in Zurich, Switzerland, with offices worldwide, including New York City and Miami, were indicted by a federal grand jury in the Eastern District of Virginia and charged with conspiring with other Swiss bankers to defraud the United States, the Justice Department and the Internal Revenue Service (IRS) announced Wednesday.

According to the indictment, the international bank’s managers and bankers engaged in illegal cross-border banking that was designed to assist U.S. customers evade their income taxes by opening and maintaining secret bank accounts at the bank and other Swiss banks. As of the fall of 2008, the international bank maintained thousands of secret accounts for customers in the United States with as much as $3 billion in total assets under management in those accounts.

The Justice Department announced the scheme dates back to 1953 and involved two generations of U.S. tax evaders including U.S. customers who inherited secret accounts at the international bank.

The indictment asserts that four foreign individuals, members of senior management, bankers and others assisted U.S. taxpayers in evading their U.S. taxes through the use of secret bank accounts in Switzerland.

According to the indictment, the defendants and their co-conspirators solicited U.S. customers to open secret accounts because Swiss bank secrecy would permit them to conceal from the IRS their ownership of accounts at the bank and other Swiss banks. It is further alleged that they provided unlicensed and unregistered banking services and investment advice to customers in the United States in person while on travel to here, including at the international bank’s representative office in New York City and by mailings, e-mail and telephone calls to and from the United States.

The indictment further alleges that the defendants and their co-conspirators caused U.S.  customers to travel outside the United States, to destinations including Switzerland and the Bahamas, to conduct banking related to their secret accounts; opened secret accounts in the names of nominee tax haven entities for U.S. customers; accepted IRS forms that falsely stated under penalties of perjury that the owners of the secret accounts were not subject to U.S. taxation; advised U.S. customers to structure withdrawals from their secret accounts in amounts less than $10,000 in an attempt to conceal the secret account and the transactions from American authorities; and advised U.S. customers to utilize offshore credit, and debit cards linked to their secret accounts and provided the customers with such cards, including cards issued by American Express, Visa and Maestro.

According to the indictment, after the bank decided to close the secret accounts maintained by U.S. customers, the defendants encouraged and assisted the customers to transfer their secret accounts to other banks in Switzerland and Hong Kong as a means of continuing to hide their assets from the IRS and discouraged the customers from disclosing their secret accounts to the IRS through the Voluntary Disclosure Program.  In addition, one observer notes the coincidence that this announcement comes not long after the announcement of the second Voluntary Disclosure Program initiative made earlier this month.

A criminal indictment is only an accusation and a defendant is presumed innocent until proven guilty. If convicted, the defendants each face a maximum of five years in prison and a maximum fine of $250,000.

Tomorrow’s blogticle will discuss important planning aspects of 2011.

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

NB: This work or parts thereof originated from previous official Federal Government publication available to the public.

The Tax Court recently calculated the fair market value (“FMV”) of life insurance policies distributed by a terminated 419 welfare benefit plan. The FMV of the policies—which must be included in the taxpayers’ income—was determined by the court based on: (1) surrender charges, (2) conditions imposed on the taxpayers by the insurance company, and (3) “paid-up insurance coverage remaining on the policies as of the date of distribution.”  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 policy valuation in Advisor’s Journal, see Tax Courts Holds Employee Taxable for Value of Life Insurance Owned by Welfare-Benefit Plan (CC 11-14).

For in-depth analysis of welfare benefits plans, see Advisor’s Main Library: B—Welfare Benefit Funds.

Why is this Topic Important to Wealth Managers? This topic presents discussion on the individual and nonbusiness deductions offered under the Internal Revenue Code.  Since April 15^th is fast approaching, it is important to review common tax positions with regards to client planning. 

In addition this blogticle presents a excerpted preview of new, updated material from Advanced Markets which will be available soon (see www.advisorfx.com).   Over the coming 9 months, the entire AUS service is being revised and will be rolling out monthly.  The updating will include many new areas and a sharper focus with practical explanations and client presentation aides for current areas.  We look forward to helping you secure your next sale.  

An expense of an individual may be business, nonbusiness, or personal, depending upon which of the individual’s spheres of activity gave rise to the expense.  This Blogticle discusses personal and nonbusiness expenses generally. 

Personal Expenses

Personal expenses are all expenses incurred by an individual that are not business or nonbusiness expenses. These would include, for example, food and clothing for the individual and his family, repairs on the family home, and premiums paid on the individual’s personal life insurance. Generally, no deduction is permitted for personal expenses. [1] By specific statutory provision, however, deductions are allowed for some personal expenses, such as certain personal taxes, a limited amount of charitable contributions, medical expenses, certain interest on a principal residence, and alimony.

Most deductible personal expenses are “itemized deductions” and thus may be taken only if the taxpayer chooses to itemize his deductions instead of claiming the standard deduction.

Nonbusiness Expenses

A nonbusiness expense is generally an investment expense incurred in connection with the production of income, other than a trade, business or profession. Expenses of this type would include, for example, fees for tax or investment advice, and the cost of a safe deposit box used to store taxable securities. The deduction of nonbusiness expenses is governed by Code section 212. Specifically, Section 212 allows a deduction for expenses incurred in connection with: (1) the production or collection of income; (2) the management, conservation, or maintenance of property held for production of income; or (3) the determination, collection or refund of any tax.

The deductibility of nonbusiness expenses may be limited or deferred if they arise in connection with a “passive activity” or are interest expenses. Very generally, a “passive activity” is any activity which involves the conduct of a trade or business in which the taxpayer does not “materially participate.” [2] A passive activity also includes any rental activity, without regard to whether the taxpayer materially participates in the activity. Special rules apply to rental real estate activities. Aggregate losses from “passive activities” may generally be deducted in a year only to the extent they do not exceed aggregate income from passive activities in that year; credits from passive activities may be taken only against tax liability allocated to passive activities. Disallowed losses and credits may be carried over to offset passive income in later years. [3]

Once other limitations have been applied to the deductibility of nonbusiness expenses (e.g., the passive loss rule), they are generally deductible only to the extent that the aggregate of these and other “miscellaneous itemized deductions” exceeds 2% of adjusted gross income. “Miscellaneous itemized deductions” are deductions from adjusted gross income other than deductions for (1) interest, (2) taxes, (3) non-business casualty losses and gambling losses, (4) charitable contributions (including charitable remainder interests), (5) medical and dental expenses, (6) impairment-related work expenses for handicapped employees, (7) estate taxes on income in respect of a decedent, (8) certain short sale expenses, (9) certain adjustments under the Code’s claim of right provisions, (10) unrecovered investment in an annuity contract, (11) amortizable bond premium, and (12) certain expenses of cooperative housing corporations. [4]

A nonbusiness expense must also be “ordinary and necessary” to be deductible. [5] It must, therefore, be reasonable in amount and must bear a reasonable and proximate relation to (a) the production or collection of taxable income, or (b) the management, conservation, or maintenance of property held for the production of income. [6]

Tomorrow’s blogticle will discuss important planning aspects of 2011. 

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

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[1] IRC Sec. 262(a).

[2] IRC Sec. 469(c).

[3] IRC Sec. 469(b). 

[4] IRC Sec. 67(b).

[5] IRC Sec. 212.

[6] Treasury Reg. §1.212-1(d).

Repeal of the health reform law’s business-to-business 1099 reporting requirement is a step closer, with the U.S. Senate passing an amendment on February 2 that would repeal the provision.  Praising passage of the Senate amendment, Senator Stabenow said, “Today we provided a common-sense solution for business owners so they can focus on creating jobs, not filling out paperwork for the IRS…. If left unchecked, 40 million small businesses would see their IRS 1099 paperwork increase 2000 percent.”

President Obama even praised the repeal efforts in his state of the union address, receiving a resounding round of applause.  Acknowledging that his health care reform law has its share of flaws, and offering to work with the Congress to correct those flaws, he said that “We can start right now by correcting a flaw in the legislation that has placed an unnecessary bookkeeping burden on small businesses.”  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 Health Care Reform Act’s enhanced 1099 reporting requirement in Advisor’s Journal, see Health Care Reform Causes an Avalanche of 1099s (CC 10-84).

Why is this Topic Important to Wealth Managers? This topic presents a discussion on information reporting regarding nonresident aliens and domestic interest income.  Because some wealth managers work with international clients, or a family in which at least one family member like a spouse or child is foreign, it is helpful to discuss the new proposed reporting requirements as issued by the Department of the Treasury.  Having a better understanding of the reported information that will end up in the hands of the IRS will hopefully help wealth managers focus on compliance, as well as wealth preservation and growth.

The Internal Revenue Service recently released new proposed regulations regarding reporting interest payments made to nonresident aliens.  A nonresident alien is an individual who is neither a citizen of the United States nor a resident of the United States.[1] We will discuss in a later blogticle this week about how to determine if someone is either a US taxpayer or instead is a non-resident alien (not a US taxpayer).

The new proposed rules require the payor to make an information return on Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding” on interest payments aggregating $10 or more each year paid to a nonresident alien, that is otherwise reportable on a Form 1099 (interest income). [2]

The payor shall generally prepare and file Form 1042-S at the time and in the manner prescribed by the code and the regulations, for the calendar year in which the interest is paid. [3]

The IRS and Treasury Department first published, in 2001, a notice of proposed rulemaking which provided that U.S. bank deposit interest paid to any nonresident alien individual must be reported annually to the IRS. [4] Then in 2002, the Treasury Department and the IRS withdrew these regulations and proposed narrower regulations that would require reporting only on interest payments to nonresident alien individuals that are residents of certain designated countries or, at the option of the payor, on interest payments to all nonresident alien recipients of bank deposit interest. [5]

Under regulations currently in effect, reporting of U.S. bank deposit interest is required only if the interest is paid to a U.S. person or a nonresident alien individual who is a resident of Canada. [6]

The newest proposed regulations published this month withdraw previous regulations and provide proposed regulations that extend the information reporting requirement to include bank deposit interest paid to nonresident alien individuals who are residents of any foreign country.

The Treasury Department notes this extension is appropriate for several reasons:

First, since the 2002 proposed regulations were released, there is a growing global consensus regarding the importance of cooperative information exchange for tax purposes that has developed.

Second, requiring routine reporting to the IRS of all U.S. bank deposit interest paid to any nonresident alien individual is aimed to further strengthen the United States exchange of information program, consistent with adequate provisions for reciprocity, usability, and confidentiality in respect of this information.

Finally, the proposed regulations are designed to help to improve voluntary compliance by U.S. taxpayers by making it more difficult to avoid the U.S. information reporting system (such as through false claims of foreign status).

Who is concerned with the proposed enactment of these new rules?  The US financial services community including wealth management firms that have interest bearing assets of foreigners. Briefly, US financial firms think that foreigners will move their assets out of the US into other countries such as the City of London, Switzerland, Hong Kong, and Singapore) that do not have such reporting rules.  Historically, when countries have increased tax on interest, in general money does flee to other countries.  We will also cover this capital flight issue in a historical context in later blogs to provide a wealth manager a better understanding of the likely economic impact to their clients and the US economy should the new interest reporting rules inevitably be enacted.

Tomorrow’s blogticle will discuss important planning aspects of 2011.

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

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[1] IRC Section 7701(b)(1)(B).

[2] Internal Revenue Bulletin: 2011-8; REG-146097-09.

[3] For rules regarding the preparation of a Form 1042 see Treasury Regulations §1.1461-1(b); for rules for furnishing a copy of the Form 1042-S to the payee see Treasury Regulations §1.6049-6(e)(4).

[4] REG-126100-00, 2001-1 C.B. 862.

[5] .REG-133254-02.

[6] See Treasury Regulations § 1.6049-4(b)(5).