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Pros and Cons of Asset Management Fees

 

A transition is underway within investment firms. Increasingly, the people you hire to manage your money don’t refer to themselves as brokers or stockbrokers. Instead, they’re now financial advisers, financial planners, or financial consultants.

The titles may not be important, but the method of compensation can be crucial. Traditionally, brokers were paid by commissions. When you bought or sold stocks or certain mutual funds, you paid money to the broker. That’s still true for some investment professionals.

However, many financial advisers are reducing or eliminating commission income in favor of fees; therefore, the money you pay these advisers does not depend on the trading you do. Various types of fees may apply, but an “assets under management (AUM)” approach is probably the most common.

With AUM, you pay a fee to the adviser that’s based on your portfolio value.

Example 1: Nora Collins has a $500,000 portfolio that’s managed by a financial adviser. The adviser has a 1% AUM fee. Thus, Nora pays $5,000 (1% of $500,000) a year to the adviser. If her portfolio increases to $550,000, Nora’s annualized fee would increase to $5,500; if her portfolio drops to $450,000, the fee would be $4,500, and so on. (Many advisers reduce AUM percentages as portfolio size increases.)

Common interest

Advisers who favor the AUM method may contrast it with the traditional way of paying commissions on trades. Some brokers have been charged with “churning” clients’ accounts—trading heavily to boost their income, even if there was no good reason to do so. With AUM, churning isn’t an issue; Nora will pay the 1% fee no matter how many or how few trades are made.

Instead, AUM supporters assert they are on “the same side of the table” as investors. The better these advisers perform, the more money clients will have and the more fees advisers can collect. Investment losses, on the other hand, will decrease AUM fees. So, advisers charging this way have ample incentive to perform well.

After all, if Nora sees her account grow by $50,000, she probably won’t mind paying an extra $500 to her adviser, will she?

Getting your money’s worth

Those reasons have merit, but there are possible drawbacks to paying AUM to an adviser. For instance, the amounts involved may not be inconsequential. Nora might be paying $4,000–$6,000 a year to her adviser, depending on investment results.

Will Nora be getting value for her money with a truly personalized investment plan? Will her adviser help her reduce the tax impact on her investment activity? Will he or she advise her on which investments go inside her 401(k) plan and which go into taxable accounts?

Ultimately, it’s up to Nora and other clients paying advisers by AUM to decide if the investment advice they’re receiving, perhaps supplemented by other financial planning, is worth the money they pay every year.

In addition, some investors may not have easy access to advisers who charge AUM fees.

Example 2:  Mark Lane invests largely in real estate and has relatively little in stocks, bonds, or mutual funds. Advisers who work on an AUM basis may have a minimum portfolio size for clients, so Mark won’t qualify.
The same is true for Mark’s sister, Kathy, who runs a small business and puts most of her spare cash back into the company. However, Mark and Kathy both have some investment assets that could benefit from astute advice, as well as a substantial need for personal financial guidance.

Other options

Besides AUM, what alternatives do you have for investment management? You can do it yourself, if you have the time and inclination, by choosing no-load mutual funds and perhaps paying discount brokerage commissions for selected securities transactions. Another possibility is to work with an adviser who still charges commissions, if the total of those commissions is less than an AUM fee.

Some financial advisers work on a retainer basis for clients such as Mark and Kathy, who have significant net worth but relatively little in the way of liquid assets to manage. The retainer typically is based on the adviser’s estimate of the time necessary for financial planning. The retainer might be high for a new client, reflecting considerable planning, but then drop in subsequent years until an event such as a business sale requires more effort again.

Hourly fees and flat fees for an upfront financial plan also may be among possible modes of compensation for financial advice. Some advisers will offer a combination of compensation arrangements to suit a client’s needs. For investors, the key is to get complete disclosure of an adviser’s compensation method and periodically confirm that you’re getting value for the amount you pay.

HLB Appoints New Member Firm in Oman

HLB International, one of the leading global accountancy networks with presence in 140 countries, continues its growth with the recent signing of a new member firm in Oman – Chartered Accountants Group.

Established in 2015, the firm is based in Muscat, the capital and largest metropolitan city in Oman. The firm specialises in the provision of audit, tax, business advisory and accounting services with a team comprising of Chartered Accountants and ACCAs with experience from highly reputed firms and experience spanning over multiple years. Chartered Accountants Group is one of the fastest growing professional services firms in Oman. The firm has been formed to serve the business and advisory needs of businesses in a wide range of industries.

Sultan Al Siyabi, Managing Partner of Chartered Accountants Group commented: “It is a great privilege to be a part of HLB International. We look forward to collaborating with the HLBI community and representing Oman in the network. HLBI is a leading name in the industry and Oman has great opportunities which we believe shall be better explored through the fusion of HLBI’s reputation and our hard work.”

Oman has become an important country for the HLB network, with increased international interest in this diverse country. Chartered Accountants Group will be a welcome addition to HLB International’s growing presence in the Middle East.

New Audit Guidelines for Partnerships

The Bipartisan Budget Act of 2015 (the Budget Act) includes major changes in the way the IRS will audit entities that are classified as partnerships for federal income tax purposes.  In general the Budget Act repeals current-law audit and adjustment procedures for partnerships (commonly referred to as TEFRA) and rules for electing large partnerships (ELP) and replaces them with a centralized system for the audit, adjustment, assessment, and collection of tax applicable to all partnerships other than eligible partnerships that elect out.  This includes any adjustments to items of “income, gain, loss, deduction, or credit.”  Those partnerships audited under this new regime will have taxes, interest and penalties assessed and collected directly at the entity level, from the partnership itself at the time of the audit, unless the partnership elects to pass the adjustment through to its partners.

Mandatory implementation of this new audit regime begins for audits of partnership tax years starting ON OR AFTER JANUARY 1, 2018. 

A summary of the main points of the new audit regime are as follows:

APPLICABILITY OF NEW RULES

There are an estimated 1 million-plus partners under the U.S. tax system.  In 2014, more than 99.7 percent of partnerships had fewer than 100 partners (and nearly 94.4 percent of partnerships had fewer than 10 partners.)  The new audit and adjustment rules generally apply to all partnerships.  However, consistent with the statute, a partnership may elect out of the new regime if it meets two conditions.  First, a partnership must have 100 or fewer partners.  Second, a partnership must have only “eligible partners” which according to the statute include C corporations, foreign entities that would be treated as a C corporation if they were domestic, S corporations (even if one of its shareholders is not), and estates of deceased partners.  If an eligible partner is an S corporation, the number of shareholders would add to the total count of eligible partners for the partnership.  For example, if a partnership had 95 eligible partners including an S corporation and that S corporation had 6 shareholders, then the partnership would be considered to have 101 “eligible partners” according to the new audit rules.  Also unlike TEFRA, a husband and wife are not treated as a single partner for these purposes.

Regarding tiered partnership structures, the regulations would not expand the definition of “eligible partner” to include a disregarded entity.  Also the term “eligible partner” does not include partnerships, trusts, foreign entities that are not eligible foreign entities, and estates that are not estates of a deceased partner.

The election to opt out of the new partnership audit regime would be made on a timely-filed partnership return (including extensions) for the tax year to which the election relates.  The partnership would have to disclose to the IRS the names, correct TINs and federal tax classifications of all partners and all shareholders of a partner that is an S corporation.  In addition, a partnership electing out of the regime must notify each of its partners of the election within 30 days.

Issues

There is little or no guidance from the IRS about tiered structured partnerships, particularly lower-tiered partnerships.  As the statute stands, lower-tiered partnerships will not be eligible to opt out of the new audit regime because they have partnerships as partners and therefore cannot make the 100-or-fewer partners election.

TAX ASSESSED AND COLLECTED FROM PARTNERSHIP

Any tax attributable to items of income, gain, loss, deduction, or credit of the partnership is generally assessed and collected at the partnership level (not the partner level).  This partnership-level tax is assessed and collected in the same manner as if it were imposed in the “adjustment year” (generally, the year the notice of the final partnership adjustment is mailed unless the partnership disputes the adjustment in court).

The tax then payable by the partnership, which is called an “imputed underpayment,” is calculated by netting the adjustments to the income and loss items of the partnership and multiplying the amount by the highest individual or corporate tax rate for the reviewed year.

As an alternative to the partnership’s paying the tax assessed on the imputed underpayment, a partnership may elect to pass the adjustment through to its partners or what is termed a “push-out” election.  This election must happen no later than 45 days after the date of the notice of final partnership adjustment by the IRS.  Under this alternative, the partnership furnishes the IRS and each reviewed-year partner with a statement of the partner’s share of any adjustment to income, gain, loss, deduction, and credit as determined in the notice of final partner adjustment.  THIS TAX IS IMPOSED AS A TAX FOR THE CURRENT YEAR, NOT THE REVIEWED YEAR.  The partner’s increase in tax equals the aggregate of the “adjustment amounts” which include the additional tax that would have been due in the year under review and any intervening year as if the adjustment had been taken into account by the partner on his or her return for the reviewed year and all subsequent returns up to and including the current-year return.  Interest is determined at the partner level, computed at a rate that is two percent higher than the normal rate applicable to underpayments.  Penalties are still determined at the partnership level, but reviewed-year partners are liable for such amounts.

Issues

Once again, there is little or no guidance from the IRS about tiered structured partnerships and how they relate to passing the adjustments out to partners. It is not clear how it would work if an upper-tiered partnership received a statement from a lower-tiered partnership to pay the taxes from the reviewed year.  It would seem logical that any taxes or adjustments would flow from the lower-tiered partnerships through the upper-tiered partnerships and out to the partners, there is nothing in the regulations to give guidance to this.

The push-out election also exacerbates due process concerns in that it results in personal liability for adjustment-year partners who may not have even been aware of the proceedings, much less had any opportunity to participate in them.  The partnership is liable for the imputed underpayments, and liability is shifted to reviewed-year partners only as a consequence of their voluntary agreement to indemnify the partnership or file amended returns.  Hypothetically therefore, new partners to the partnership may have to take on an added tax burden during the adjustment year that was brought upon partners no longer in the partnership, but were partners during the review year.  A review of the audit procedures contained in partnership agreements should take place as soon as possible to attempt to avoid any unfair allocation of audit adjustments.

PARTNERSHIP REPRESENTATIVE

The repeal of TEFRA means that under the new partnership audit regime there will no longer be a tax matters partner.  The new regime would require a partnership to designate an eligible partnership representative that has the sole authority to act on behalf of the partnership.  The partnership representative may be any person, including an entity, and need not be a partner.  If an entity is designated, however, the partnership must also appoint and identify an individual to act on the entity’s behalf.  The partnership must have substantial presence in the US – generally meaning that the representative is able to meet or speak with the IRS at a reasonable time or place, be reachable during normal business hours at a US address and have a phone number with a US area code, and have a US Taxpayer Identification Number.

IF THE PARTNERSHIP FAILS TO DESIGNATE A PARTNERSHIP REPRESENTATIVE, THEN THE IRS WILL DO SO IN THE EVENT OF AN AUDIT.  The IRS must send notice of proceedings and adjustments to the partnership and the partnership representative, but has no obligation to provide notice to individual partners.  Partners have no statutory rights individually to initiate or participate in administrative or judicial proceedings (including settlement conferences and claims for refunds), or even to be kept informed of such proceedings by the partnership representative.

Issues

The choice of partnership representative will be a crucial one that should not be taken lightly because of the broad powers given.  As each partnership is different, different factors could affect the decision as to who would become the partnership representative.  An existing partner may be accused of self-interest, while a non-partner, an independent advisory firm, for example, may find itself in the middle of political infighting.

There has been a slow response from the Internal Revenue Service to issue much needed guidance probably due to the freeze on new regulations as a part of a review by the Trump administration of all pending regulations packages by new department or agency heads.  Audits of tax years starting in 2018 are not likely until well into 2020 at the earliest, so partners and partnerships have been slow in preparing for these changes.  A partnership will also not wish to wait until an audit begins to have to think about adjustment allocations or partnership representatives, nor allow the IRS to make the choices for the partnership, so it is imperative to have a conversation with your HLB Gross Collins, P.C. representative and consider amending partnership agreements as soon as possible.

Employee Travel Expense Reimbursement

Often, clients ask for clarification on expense travel rules and the treatment of reimbursements when frequent flyer miles are used.  A couple common questions include:

  1. If employees use their personal frequent flyer miles to purchase airplane tickets for a work-related flight, should the employees be reimbursed by the company?
  2. If the employees are reimbursed, is this a taxable benefit?

Frequent Flyer Miles

Internal Revenue Service (“IRS”) Topic 511 addresses business travel expenses and states “if you’re provided with a ticket or you’re riding free as a result of a frequent traveler or similar program, your cost is zero”. The employee is considered to have paid nothing for the airplane ticket, so there is no cost on which to base a reimbursement by the company.

Reimbursement of Employee

There are two types of employer reimbursement programs – accountable and non-accountable.

An accountable plan must follow three rules. Reimbursements or allowances under an accountable plan can not be included as income by the employee. The three rules of an accountable plan are:

  1. The expenses must have been incurred while performing services as an employee.
  2. The employee must adequately account for the expenses within a reasonable time.
  3. Any excess reimbursement or allowance must be returned by the employee to the employer.

If the reimbursement plan does not meet all of the above rules, then the plan is a non-accountable plan. Reimbursements or allowances received under a non-accountable plan are included as wages on the employee’s Form W-2.

CONCLUSION

Employees should not be reimbursed by the company for work-related airplane tickets purchased using frequent flyer miles.

If the employees are reimbursed by the company, the company has a non-accountable plan and the reimbursement has to be included in the employee’s wages on Form W-2.

Contact your HLB Gross Collins, P.C. representative if you have additional questions.

HLB Raises Over 8,600 Euros for Charity

HLB International, one of the leading global accountancy networks with a presence in 140 countries, raised over eight thousand and six hundred euros for the Malta Community Chest Fund. The funds were presented to Noel Zarb, Chief Administrator of the Community Chest Fund when the network held its annual conference in Malta from October 18-22 .

The Malta Community Chest Fund is a charitable foundation under the patronage of the President of Malta. The aim of the institution is to help organizations and individuals in need. It helps a vast range of people throughout the year, with the major amounts going towards chemotherapy and specialized medicine which would not be part of the list of medicines given through state aid.

HLB International’s CEO Marco Donzelli commented “As a network, HLB International is committed to giving back to our local communities. Which is why, while we were in Malta for our international conference, we partnered with The Malta Community Chest Fund. We’re delighted to have been able to support such a vital cause.”

HLB’s International conference brought together 130 professionals from 33 countries. Sessions during the conference explored the need for successful firms to continuously grow and progress and featured presentations that explored the challenges of connectivity, leadership, trust and development. As well as insights from HLB International member firms, the conference presented well-received key note speakers, including Gale Crosley, a leading consultant in the accountancy field and Adrian Furnam, Professor of Psychology.

HLB International holds several international and regional conferences every year, which are an opportunity not only to hear about the latest developments within the industry but also for HLB professionals to network. It’s those close, personal relationships between HLB members that contribute to making HLB a personalized and cohesive network, which allows for the smooth running of clients’ business across borders.

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