The Tax Court has reopened the question of whether limited partners are entitled to an exemption from self-employment taxes—an issue that’s been in hibernation for over 13 years.  The Tax Court recently concluded that status as a limited partner does not necessarily exempt a partner from self-employment taxes; the exemption depends on the partner’s level of participation in partnership business. 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 small businesses in Advisor’s Journal, see IRS Announces Lenient Lien Program for Small Business (CC 11-48)

For in-depth analysis of partnership taxation, see Advisor’s Main Library: H–Partnership Taxation

Why is this Topic Important to Wealth Managers? This blogticle presents an interesting discussion topic about technology and insurance. It also provides information into global life insurance market trends for those wealth managers who may seek a broader knowledge base.

Yesterday Mobile Telephone Networks (MTN) and Hollard Insurance Group announced that the companies are offering life insurance for purchase through customer’s cell phones. The mobile phone service provider announced that the cell phone life insurance contracts are now being offered to residents of Ghana. [1] Notably the cell phone life insurance policy is the first of its kind in the world. The program is designed primarily to provide insurance to low-income individuals who may not have a traditional bank account. MTN says the new program “will bring life insurance to people without bank accounts who could not previously buy policies.” [2] Jeremy Leach, head of micro-insurance for Hollard said, “[u]ntil now insurance hasn’t really been made available or targeted at that low-income market. It allows us to reach our market in a fantastic way”. [3]

The cell phone life insurance policy allows MTN mobile phone users to buy life insurance by sending a text message to a number that will take them to a series of menus. Alternatively, the customers can purchase a policy at an MTN service center and manage the policy by cell phone. However, brokers are not missing out on much. The premiums offered though the service can be as low as $0.65 per month. [4] The company also intends to introduce similar products in other countries, citing a 2009 study by Lloyds which found “the market for simple and affordable insurance in developing countries is between 1.5 billion and three billion policies.” [5]

The business model is novel, but raises a number of questions. First, even at low monthly premium levels the large number of policies the company intends to sell will create significant liabilities. How accurately and effectively will the insurance company be able to determine actuarial mortality rates for large groups of diverse customers by using just text messaging? Secondly, the issues of fraudulent identities and insurable interest must be a concern when taking out a life insurance policy in 160 characters or less. Will those with multiple cell phone lines have access to multiple policies? If so, the opportunity for abuse of market conditions may be certain. Will it also increase the ability for those seeking policies on other’s lives to purchase multiple policies without the insured’s knowledge?

We don’t imagine that here in the States we will be seeing a duplicate of the program anytime soon. Although, as technology continues to improve it would not be surprising that insurers find competitive advantages and new product delivery methods through alternative mediums.

Tomorrow’s blogticle will continue discussion related to finance.

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

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[1] Washington Post. “South Africa-based MTN launches life insurance program via mobile banking in Ghana”. 3/23/2011. http://www.washingtonpost.com/world/south-africa-based-mtn-launches-life-insurance-program-via-mobile-banking-in-ghana/2011/03/23/ABZEGVJB_story.html. Last Accessed 3/23/2011.

[2] Yahoo! News. “MTN launches life insurance via cell phones in Ghana”. 3/23/2011. http://news.yahoo.com/s/afp/20110323/tc_afp/ghanasafricatelecominsurancemobile. Last Accessed 3/23/2011.

[3] Yahoo! News. “MTN launches life insurance via cell phones in Ghana”.

[4] Washington Post. “South Africa-based MTN launches life insurance program via mobile banking in Ghana”.

[5] See The Sidney Morning Herald. “MTN launches life insurance via cell phones in Ghana”. 3/23/2011. http://news.smh.com.au/breaking-news-technology/mtn-launches-life-insurance-via-cell-phones-in-ghana-20110323-1c6ud.html. Last Accessed 3/23/2011.

Producers and carriers may soon face more stringent compliance requirements, and increased liability for making unsuitable recommendations, when selling annuities. The regulatory change will happen at the state level as a result of the National Conference of Insurance Legislators (NCOIL) executive committee voting unanimously on March 6 to adopt the National Association of Insurance Commissioners (NAIC) Suitability in Annuity Transactions Model Regulation.  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 insurance regulations in Advisor’s Journal, see NCOIL Adopts Model Act Requiring Insurers to Inform Consumers of Settlement Options (CC 10-104).

Why is this Topic Important to Wealth Managers? In keeping with this week’s trend, this blogiticle discusses the Federal Reserve banking system and the recent publication of its annual financial statements. Wealth managers who are interested in economic policy may find the information interesting. Thus we have presented a review of the Central Bank’s operations via financial statement analysis.

The Federal Reserve System on Tuesday released the 2010 combined annual comparative financial statements for the Federal Reserve Banks, as well as for the 12 individual Federal Reserve Banks, the limited liability companies (LLCs) that were created to respond to strains in financial markets, and the Board of Governors.

Total Reserve Bank assets as of December 31, 2010, were $2.428 trillion, which represents an increase of $193 billion from the previous year. The composition of the balance sheet changed notably. Holdings of U.S. Treasury securities increased $261 billion and holdings of federal agency and government-sponsored enterprise (GSE) mortgage-backed securities (MBS) increased $86 billion. These increases were partly offset by a $96 billion decrease in loans to depository institutions and a $23 billion decrease in loans extended under the Term Asset-Backed Securities Loan Facility, largely due to early repayments by borrowers.

The Reserve Banks’ comprehensive income increased $28 billion over the previous year to $82 billion for the year ended December 31, 2010. The increase was primarily attributable to an increase of $24 billion in interest earnings on the federal agency and GSE MBS holdings.

The Reserve Banks transferred $79 billion of their $82 billion in comprehensive income to the U.S. Treasury in 2010, a $32 billion increase from the amount transferred in 2009.

The combined annual financial statements for the Federal Reserve Banks and the consolidated annual financial statements for the Federal Reserve Bank of New York include information about the assets and income of each of the consolidated LLCs, such as overall financial results, portfolio composition, asset quality, and asset value information. The statements also contain summaries of the associated credit and market risks for each significant holding.

The consolidated LLCs also contributed to the increase in Reserve Banks’ 2010 comprehensive income, with net earnings of $8 billion for the year ended December 31, 2010, a $2 billion increase from the 2009 net earnings of $6 billion.

The twelve Federal Reserve Banks  re part of the Federal Reserve System created by Congress under the Federal Reserve Act of 1913, which established the central bank of the United States.  The Reserve Banks are chartered by the federal government and possess a unique set of governmental, corporate, and central bank characteristics.

The Reserve Banks perform a variety of services and operations.  These functions include participating in formulating and conducting monetary policy; participating in the payment system, including large-dollar transfers of funds, automated clearinghouse operations, and check collection; distributing coin and currency; performing fiscal agency functions for the U.S. Department of the Treasury,  certain Federal agencies, and other entities; serving as the federal government’s bank; providing short-term loans to depository institutions; providing loans to individuals, partnerships, and corporations in unusual and exigent circumstances; serving consumers and communities by providing educational materials and information regarding financial consumer protection rights and laws and information on community development programs and activities; and supervising bank holding companies, state member banks, and U.S. offices of foreign banking organizations.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which was signed into law and became effective on July 21, 2010, changed the scope of some services performed by the Reserve Banks.  Among other things, the Dodd-Frank Act establishes a Bureau of Consumer Financial Protection as an independent bureau within the Federal  Reserve System that will have supervisory authority over some institutions previously supervised by the Reserve Banks under delegated authority from the Board of Governors in connection with those institutions’ compliance with consumer protection statutes; limits the Reserve Banks’ authority to provide loans in unusual and exigent circumstances to lending programs or facilities with broad-based eligibility; and vests the Board of Governors with all supervisory and rule-writing authority for savings and loan holding companies.

Tomorrow’s blogticle will continue discussion related to finance.

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

Why is this Topic Important to Wealth Managers? This blogiticle discusses how financial statements are used in connection with business insurance planning. The information is presented because valuations become an important factor in a number of situations where wealth managers are working with clients.

First, properly kept financial statement can help ensure easier access to capital as well as give a truer understanding of the business’ financial position. Second, insurance underwriters are concerned with risk exposure. Thus most businesses are required to provide financial information of the company through the financial statements when a substantial amount of insurance is purchased.

In addition, the financial statements are commonly used in the risk management processes. Assets are usually examined to determine what amount of exposure the business may have. Further, outstanding liabilities in connection with cash flow may present operational and risk issues.

But one area where financial statements are really important is: business valuation. Most if not all business valuation is based primarily on financial statement analysis. This process generally begins with an examination of the assets of the business. Further, as was discussed yesterday the amount that a business’ assets exceed its liabilities is called owner’s equity.  During personal planning situations with closely held corporations and other entities, owner’s equity is an important amount, as this is what the owners are entitled to after all liabilities are settled with assets on hand.

Moreover, business valuation is important when drafting buy-sell agreements or purchasing insurance in connection with a buy-sell or otherwise on a key employee, including but not limited to owners of such organizations.  Small businesses are especially sensitive to the exposure of ownership ending up with individuals the surviving owner(s) don’t want to do business with.

Thus, under the traditional buy-sell agreement the owners enter into a binding buy-sell agreement among themselves. They contract to purchase the interest of any other owner who dies; each stockholder agrees and contracts for the sale of his or her interest at death. Alternatively, the agreement may be between the owners and the entity, obligating the business to purchase the shares of a deceased owner and either hold the shares as treasury stock or retire them. Either route that is exercised must nevertheless be based upon some valuation. This is where the financial statements come into use.

In other words, key employee insurance and buy-sell agreements are generally based on some total dollar amount that represents the value of the business. This figure is usually based on some number that is related to the financial statements and accounting of the business. Whether it’s the total assets, a factor of revenue or income, or some other determination, the need for a basic knowledge of financial accounting for small businesses is essential.

What’s more, because a price or method of establishing the sales price is generally set out in the agreement, the accuracy of financial reporting and presentation within the financial statements is critical. Since the amount to be paid for the deceased’s stock is set out in the contract, and since the terms of payment are agreed upon in advance those keeping unsound records and accounts will likely incorrectly value the business which could negatively affect other planning aspects.

For a detailed analysis on business valuation and how it relates to buy sell agreements see Advanced Markets AdvisorFX: Insurance Needs Revealed in Financial Statements.

For sample buy-sell and cross purchase agreements see Advanced Markets AdvisorFX: Sample Close Corporation Buy-Sell Agreements.

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

Individuals in the fastest growing class of investors—the mass affluent—need your advice. And according to a recent report these investors are underserved by financial professionals and lack confidence in their ability to meet their financial goals, making them ideal candidates for professional services.

The mass affluent are investors occupying the upper tier of the mass market—the biggest group of consumers. But “mass affluent” isn’t just a synonym for “upper middle-class”; it’s a subset of the upper middle-class with $50,000 to $250,000 in “investable assets.”

Depending on your career trajectory, the mass affluent can be a great stair-step in the process of building a successful practice. A majority (55 percent) of the mass affluent believe they will be wealthy one day. Although only a small number of the mass affluent will move into high-net-worth territory, you can get in on the ground floor of the upward career trajectory of those who will. 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 affluent client issues in Advisor’s Journal, see Appealing to Your Affluent Clients’ Retirement Planning Values (CC-11-42).

Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? This blogiticle presents discussion on the basics of financial statements which is designed to provide wealth mangers with an overview of business accounting. The blogticle is a lead-up to tomorrow’s feature which presents in detail how financial statements can be effectively used by wealth managers in connection with business insurance planning.

Accrual or Cash Accounting Methods

We know that in making business decisions financial statements are important. In fact, after entity formation one of the first determinations a company must make is deciding if the business will account using an accrual or cash receipts and disbursements system. Generally, an accrual accounting method recognizes revenues and expenses in the period in which they occur. This method is designed to match the revenue in the accounting period it was earned and expenses in the period expensed. On the other hand, a cash receipts and disbursements accounting method recognizes transactions as cash payments are received and made in connection with the business.

For example, an accrual taxpayer that performs services will account for income earned when the service is actually performed and not when the actual cash payment is received. A cash method of accounting applies only when the cash from these performed services is received from the customer. Expenses follow the same logic. For example, if a service company that uses the accrual method incurs $500 of communication expenses in December 2010 and the payment is not due until January 2011, the company will still account for the phone expense on its books in 2010 for December’s usage, while the cash method business does not account for the expense until 2011.

Accounting System

The end result of each accounting system is to provide information, specifically financial statements. The information is generally entered into an accounting system using debits and credits or otherwise known as the double entry booking system. The discussion of actual bookkeeping using this method will be explored at a later date, for now it is enough to know these entries, in sum, will represent the data presented in the financial statements.

The general accounting reports that comprise the standard financial statements includes a balance sheet, income statement or profit and loss statement, cash flow statement, and statement of owner’s equity. Each statement provides a view through a different window into the financial operation of the business.

The balance sheet generally provides wealth managers and others who may study the information with a view of the current position of the business. In other words, the balance sheet equation is assets equal liabilities plus owner’s equity. The balance sheet provides values for all the assets of the company and all the liabilities of the company listed at any given point in time. Whatever assets are “left-over” after paying all the liabilities is considered owner’s equity, as this figure is representative of what the owner’s rights upon liquidation would be after payment of all creditors.

The income statement is easy to understand. It provides for all the revenues minus all the expenses of the business which in turn shows a profit (or loss if expenses are a higher amount than revenues).

The cash flow statement is essentially a variation of the income statement. However the cash flow statement will show the ability of the business to operate on a periodic basis given the inflows and outflows of cash payments.

Lastly, the statement of owner’s equity is essentially the owner’s equity section of the balance sheet provided in more detail.

As discussed above, tomorrow’s blogticle will address how financial statements relate to business insurance and financial planning.

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

A recent IRS Revenue Ruling provides an important reminder for us of the rules for deducting interest that’s paid or accrued on a business life insurance policy loans. Knowing how and when policy loan interest is properly deductible can mean the difference between closing the sale in the first instance and an IRS audit down line if these rules are ignored.

In general, interest paid on a life insurance policy loan is not deductible for income tax purposes; but there are some exceptions for life insurance purchased for business purposes. The deductibility of policy loan interest has been eroded significantly over the past 20 years, so details are critical when selling or transacting on a policy that’s issued to a business.  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 Advisor’s Journal coverage of the exception to the pro rata limitation on interest deduction, see Obama Budget Would Undercut Utility of Life Insurance in Small Business Planning (CC-11-41).

For in-depth analysis of corporate-owned life insurance, see Advisor’s Main Library: D—Deductibility Of Business Insurance Premiums, E—Premiums As Taxable Income To The Insured & F—Taxability Of Corporate Owned Life Insurance Proceeds At Death.

Why is this Topic Important to Wealth Managers? This blogticle presents discussion on the investment revenue activities of commercial banks in the United States. It is useful for wealth managers to be aware of the financial conditions of major commercial banking institutions with regards to investment revenue as the information serves as one gauge on overall economic conditions. This information can thus help with client decision making.

The Office of the Comptroller of the Currency (OCC) announced yesterday that U.S. commercial banks reported trading revenue of $3.5 billion in the fourth quarter of 2010. The U.S. economic outlook is positive according the OCC report; commercial bank trading revenue was 80 percent higher than the $1.9 billion reported for the fourth quarter of 2009. [1] Overall for the full year of 2010, trading revenues totaled $22.5 billion, nearly matching the record $22.6 billion in 2009.

“[T]rading revenues for the year were very strong, only slightly below the record revenues in 2009” notes OCC’s Deputy Comptroller for Credit and Market Risk Martin Pfinsgraff.

Mr. Pfinsgraff added that the strong trading performance for the year occurred despite substantial reductions in risk, as measured by value-at-risk (VaR). “While some of the decline in trading VaR is due to lower volatility in financial markets, it’s also very clear that banks have reduced risk in their trading operations,” he said. Average VaR for the five largest banking companies fell 24 percent during 2010.

The OCC reported that net current credit exposure, the primary metric the OCC uses to measure credit risk in derivatives activities, declined $65 billion, or 15 percent, to $375 billion this quarter. In sum, net current credit exposure has fallen 53 percent from its peak of $800 billion at the height of the credit crisis.

“We were especially pleased to see that the number of banks reporting charged-off derivatives exposures fell sharply last quarter,” Mr. Pfinsgraff said. He noted that 23 banks, the largest total ever, reported charge-offs in the third quarter for a total of $284 million. In the fourth quarter, 15 banks reported charge-offs totaling $111 million. “All of the credit metrics for derivatives are heading in the right direction: net current credit exposure is down, as are charge-offs and delinquencies,” he said. Past due derivatives contracts fell 65 percent to $54 million.

In addition, the report shows that the notional amount of derivatives held by insured U.S. commercial banks decreased by $3.5 trillion (or 1.5 percent) in the fourth quarter to $231 trillion. Interest rate contracts declined $3 trillion (2 percent) to $193.5 trillion, while FX contracts increased 1 percent to $21 trillion.

The report also noted that:

• Banks hold collateral to cover 72 percent of their net current credit exposure. The quality of the collateral is very high, as 81 percent is cash (US dollar and non-dollar).
• Derivatives contracts are concentrated in a small number of institutions. The largest five banks hold 96 percent of the total notional amount of derivatives, while the largest 25 banks hold nearly 100 percent.
• Credit default swaps are the dominant product in the credit derivatives market, representing 97 percent of total credit derivatives.
• The number of commercial banks holding derivatives declined by 35 in the quarter to 1,070.

Next week’s blogticles will focus on financial planning concepts.

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

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[1] See Office of Comptroller of the Currency.  Quarterly Report on Bank Trading and Derivatives Activities. http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq410.pdf. Last Accessed 3/17/2011.

Investment advisors and broker-dealers may be required to disclose their incentive-based compensation programs under proposed rules approved by the Securities and Exchange Commission (SEC) on March 2. The proposed rule is the latest in a series of advisor and broker-dealer reporting rules issued under the mandate of the Dodd-Frank Wall Street Reform Act. 

The exponentially increasing compliance burden for advisory firms and B-Ds has the potential to radically alter business practices at affected firms. Many will need to overhaul their entire compensation platforms to comply with the new rules.  

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 advisor reporting requirements in Advisor’s Journal, see Advisors Hit with Another Round of SEC Reporting Rules (CC 11-30).