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157 Cards in this Set

  • Front
  • Back
General Partners are also called?
What do general partners do?
Managers or sponsors
They manage the entity and have unlimited liability
Limited partners limit their liability to what?
The amount of AT RISK investment in the entity.
How much is the AT RISK investment for limited partners?
The AT RISK amount is equal to the original investment in the entity + any recourse loans.
The (adjusted) cost basis of the investment in a limited partnership (or DPP) is calculated how?
Original investment
-cash distributions and depletion allowances.
+reinvestment
=(adjusted) cost basis
The adjusted cost basis is important why?
The adjusted cost basis is the max a limited partner can write off.
Talk about the difference between corporate entities and limited partnership entities.
Corporate entities pay taxes. The revenue made on a corporate entity is matched off against the operating expenses then the corporation pays taxes on the net revenue.
The profits are then passed to the individual shareholders. Then the shareholders pay taxes on their gains/dividends from the corporation. THIS IS DOUBLE TAXATION.

Limited partnership entities - the profits and expenses are paid by the partners and the resulting gain is subject to tax. SINGLE TAXATION.
History of DPP's
Since 1980's
Originally losses from DPP's

-could be used to offset real estate, security, and some ordinary income tax.

-People started taking advantage of DPP's and creating scams. The scams were using DPP's to make it look like investors were taking huge losses just so they could offset other income taxes and get away paying virtually no tax period.

In 1986 reform came. The reform disallowed taking the losses against any other sort of gain.
Why should you avoid investing in a DPP?
Suitability
Liquidity
Recourse Loans
Recourse Loans increase the investor's at adjusted cost basis and the investor's at risk investment
Non recourse loans
Do not hold the investor personably responsible. Here, the partnership puts up property for collateral.
Highly leveraged DPP's usually have which type of loans?`
Recourse loans
Advantages of DPP's
Single tax status - limited partnership must file a tax return, but the entity itself does not pay federal tax status. A limited partner files a K-1 form

Limited liability - the capital risk is limited to the initial cash investment

Capital costs can be DEPRECIATED

Flexibility in types of investment

Diversification

Professional management (managing partner_
Disadvantages of LP's (DPP's)
LACK OF LIQUIDITY! Even after you find a buyer, you need general partner's approval

Lack of control of management - limited partners are SILENT partners

Possible changes of tax code may change the tax advantages

Loss of part or all of investment

POSSIBLE ASSESSMENTS meaning that in the future you may be required to put up additional monies. If you don't, your overall percentage ownership is going to decrease.
You should consider these items before investing in an LP / DPP
Loss of principal - some LPs are high risk

You are a SILENT partner - no control of management

Possible changes in tax code

Projected rate of return

NEVER CONSIDER THE FINANCIAL CONDITION OF OTHER LIMITED PARTNERS BECAUSE THAT DOES NOT MATTER TO YOU
4 characteristics of limited partnerships
Must be in writing

Intent must be to make a PROFIT! In the 80's people were setting up LLP's to create fake losses...

Profits and losses may be shared in any agreed upon percentages

A certificate of limited partnership must be filed with the SECRETARY OF STATE in the state where the LLP is formed to PROTECT THE LIMITED PARTNERS
Certificate of Limited Partnership must contain:
Information about future contributions by limited partners (assessments)

Manner of which new partners may be added

Manner of which profits and losses will be shared

Explanation of general partner's role
Amendments to a certificate of limited partnership must be made if:
-There is an increase in the contribution amount of a limited partner

-There are changes in the profit sharing plan

-A mistake is found in the original certificate

-A NET LOSS IN A FISCAL YEAR DOES NOT REQUIRE AN AMENDMENT
DPP public offerings
A managing partner who sets up the public sale of limited partnership interests may be considered a, "SYNDICATOR"

If the managing partner does not set up the public sale, he turns to a wholesaler - this is called a managed offering

In either case, the syndicator or wholesaler must be registered with FINRA (NASD)

The responsibility for due diligence in prospectus statements is borne by the managing underwriter

The maximum underwriting spread is 10%
DPP suitability
- normally for accredited investors worth 1 mil or more
-Investment objectives should match
-investor should have the intention of holding the DPP interest long term (it's not liquid)
-Investment experience & tax bracket
-Risk tolerance
-Understanding of risks and benefits of the DPP
-Need for a tax advantaged investment

WE HAVE TO LOOK AT THE DPP's ECONOMIC VIABILITY meaning that it is set up for long term profit and its not just a scam for tax benefits
What do we NOT care about in the subscription agreement of a DPP (the way an investor says yes, I want to buy or subscribe to this DPP investment) ?
We don't care about the source of the investor's funds. We want to make sure he has the funds to buy the DPP interest, but we don't care how he got them.
When does a sale of a DPP interest become final?
The sale becomes final when the general partner signs it. Even though the new limited partner must sign it first, it is not official until the general partner accepts it with his signature.
Limited partner's rights:
Inspect the books and records

Get a complete accounting report about operations

Share in profits and other distributions provided that there are sufficient assets to cover the entities liabilities

Demand dissolution by court decree

Sue general partners for good cause

Return of capital contributions

Receive agreed upon disposition of proceeds upon the death of another limited partner if a death clause is stated in the partnership agreement. If there is not a death clause, the estate of the dead guy will get the LLP interest.
Limited partners CAN NOT:
Sell partnership assets.

Take part in the management of the entity. If they do so they will automatically take on the liabilities of a GENERAL partner. Which is bad..

When a partner in a LLP makes a bona fide loan to the LLP, the partner becomes a GENERAL CREDITOR of the LLP for that loan, but the interest of the limited partnership remains unchanged for all other purposes
General partners can not do these things without the approval of limited partners:
Admit other general partners / limited partners

Confess a judgement against the partnership

Violate the partnership agreement

Prevent the ordinary business of the partnership

Assign or possess partnership property for purposes other than partnership

can not continue business of the entity upon the death, insanity, or retirement of another general partner

COMPETE WITH THE PARTNERSHIP (buy an interest in a competing partnership)

When limited partnership approval is needed for a general partner's action, this is called "partnership democracy" or "partnership provisions"
Dissolution of a limited partnership
LPs can be dissolved for the following reasons:

- The loss of a general partner
- Actions by limited partners such as class action lawsuits for damages
-Winding up of the partnership on agreement of the partners, bankruptcy of a partner, or an event that makes it unlawful to continue the partnership

- canceling of the certificate of limited partnership by the secretary of state - normally only in fraud cases
***Claims would be paid upon the dissolution of a limited partnership in the following order***
Creditors - secured, then general (unsecured)

LIMITED PARTNERS - PROFIT CLAIMS then capital claims

general partners - PROFIT CLAIMS then capital claims
Four characteristics used to distinguish a corporation from other types of business entities:
1) Continuity of life
2) Centralization of management
3) Limited liability
4) Free transferability of beneficial interest

IF A BUSINESS ORGANIZATION CONTAINS 3 OF THESE 4 FACTORS, IT WILL BE CLASSIFIED AS A CORPORATION FOR FEDERAL TAX PURPOSES
Which two of the four characteristics of corporations do LP's avoid and how?
Continuity of life. All limited partnerships have a termination date. Which I assume can be changed.

Free transferability - that's why limited partnerships are so illiquid. The general partner's approval is always required which makes it not freely transferable.
What is the characteristic of corporations is hardest for LPs to avoid?
Centralization of management. The general partner has management control. It's always going to be centralized.
Tax Reform Act of 1986 and passive income
Tax Reform Act of 1986 determined that individuals could no longer deduct losses on passive activities from other income.

Passive income is income received from activities where the taxpayer does not materially participate.

This does not include portfolio income - in portfolio income the investor does not actively participate and he is not a partner so this is a separate type of income called portfolio income. Passive losses cannot be deducted from portfolio income either
Passive activity losses can be deducted from what?
Losses from passive activities can be offset to income from other PASSIVE activities. If the losses exceed the gains, the losses can be carried forward to reduce PASSIVE income from subsequent years.

Any of these carried forward deductions may be used WHEN AND IF an investor sells their limited partnership interest.
Exception to the passive loss rule:
$25,000 can be deducted each year against ordinary income from RENTAL REAL ESTATE ACTIVITIES. BUT in order to qualify for this tax benefit, you must ACTIVELY participate in the rental real estate activity. THIS BASICALLY SAYS THAT YOU MUST GIVE UP YOUR LIMITED PARTNER STATUS AND BE RECLASSIFIED AS A GENERAL PARTNER (you have unlimited liability now - no good)
Talk about land and straight-line depreciation, and real estate
Land can never be depreciated. Things built on the land and things extracted from the land can be depreciated. Not land itself.

Real estate is something built on land. When depreciation real estate, we use STRAIGHT-LINE DEPRECIATION.

With straight-line depreciation there is no RECAPTURE
What is recapture?
Recapture is an amount of money that the government "takes back" when you use accelerated forms of depreciation. Since accelerated forms of depreciation allow large chunks of $ to be depreciated in the early years of the investment, the government compensates by taking a part of the profits when you sell the "real" investment
What happens to a taxpayer when the IRS determines they have been using a tax shelter abusively (as happened in the late 80's after the reform act of 1986)?
-The tax deductions from the shelter are disallowed.
-The taxpayer is charged interest on back taxes
-The taxpayer is charged penalties
-The taxpayer may be charged with intent to defraud
What does an LP usually do when they have "used up" all their tax benefits?
The LP changes another one of the four characteristics of a corporation - Free transferability. They list the LP on an exchange and it becomes a corporation. The "units" of the LP turn into "shares" of a corporation and the business entity is no longer illiquid.
Tax Reform Act of 1986 and passive income
Tax Reform Act of 1986 determined that individuals could no longer deduct losses on passive activities from other income.

Passive income is income received from activities where the taxpayer does not materially participate.

This does not include portfolio income - in portfolio income the investor does not actively participate and he is not a partner so this is a separate type of income called portfolio income. Passive losses cannot be deducted from portfolio income either
Passive activity losses can be deducted from what?
Losses from passive activities can be offset to income from other PASSIVE activities. If the losses exceed the gains, the losses can be carried forward to reduce PASSIVE income from subsequent years.

Any of these carried forward deductions may be used WHEN AND IF an investor sells their limited partnership interest.
Exception to the passive loss rule:
$25,000 can be deducted each year against ordinary income from RENTAL REAL ESTATE ACTIVITIES. BUT in order to qualify for this tax benefit, you must ACTIVELY participate in the rental real estate activity. THIS BASICALLY SAYS THAT YOU MUST GIVE UP YOUR LIMITED PARTNER STATUS AND BE RECLASSIFIED AS A GENERAL PARTNER (you have unlimited liability now - no good)
Talk about land and straight-line depreciation, and real estate
Land can never be depreciated. Things built on the land and things extracted from the land can be depreciated. Not land itself.

Real estate is something built on land. When depreciation real estate, we use STRAIGHT-LINE DEPRECIATION.

With straight-line depreciation there is no RECAPTURE
What is recapture?
Recapture is an amount of money that the government "takes back" when you use accelerated forms of depreciation. Since accelerated forms of depreciation allow large chunks of $ to be depreciated in the early years of the investment, the government compensates by taking a part of the profits when you sell the "real" investment
What happens to a taxpayer when the IRS determines they have been using a tax shelter abusively (as happened in the late 80's after the reform act of 1986)?
-The tax deductions from the shelter are disallowed.
-The taxpayer is charged interest on back taxes
-The taxpayer is charged penalties
-The taxpayer may be charged with intent to defraud
What does an LP usually do when they have "used up" all their tax benefits?
The LP changes another one of the four characteristics of a corporation - Free transferability. They list the LP on an exchange and it becomes a corporation. The "units" of the LP turn into "shares" of a corporation and the business entity is no longer illiquid.
Oil and gas programs
Investors bear more risk than an investor in a real estate program, but they will get to write off more in the early years of the investment
Main advantages of oil and gas programs as a tax shelter are:
Intangible drilling costs
Depletion
Tax deferral
flow through of tax benefits (single taxation)
Depreciation of equipment
Talk about depletion
Based on the amount of OIL SOLD.

Can apply to oil, minerals, and timber
Intangible drilling costs
deductible expenses on labor, supplies, fuel, repairs, and other items with NO SALVAGE VALUE

Drilling costs incurred on a well that does not produce oil become intangible drilling costs.

INTANGIBLE DRILLING COSTS ARE DEDUCTIBLE AS THEY ARE INCURRED AND PAID AND NORMALLY REPRESENT A MAJOR PORTION OF THE FIRST YEAR'S DEDUCTIONS!
***What are the four types of drilling and what are some keywords about them?***
Exploratory drilling - "wildcatting"
Areas without proven reserves

Developmental drilling -
Areas with proven reserves
returns are less in a successful developmental than a successful exploratory

Balanced drilling - Both

Oil & Gas Income - not really a drilling. Buy properties that are already producing. No intention for tax shelter. Intent is income. Lowest capital risk.
If an investor does not meet the assessment
their share of the revenue, expenses, and overall percentage of ownership will DECREASE. (Because everyone is contributing more money except for them.)
Sharing arrangements for oil and gas
1) Overriding royalty - The sponsor does not pay any costs of drilling, but shares in revenues.

2) Disproportionate sharing - Sponsor gets a disproportionately larger share of the revenues than the costs he pays. He may pay for 10% of the costs and get 25% of the revenues.

3) Subordinated working interest (reversionary interest) - Sponsor does not bear any costs, but also does not share in revenues until the limited partners recover their cost of investment.

***Functional allocation*** - most common and attractive for investors. Sponsor takes the tangible costs (those that are depreciated over time) and investors take intangible drilling costs (those that can be written off immediately.
Equipment leasing is?
An LP arrangement where investors buy computers, rail cars, and airplanes and lease them to businesses.
What are the advantages of equipment leasing?
Depreciation deductions
Interest deductions
Revenue from lease payments
Limited liability for limited partners
Equipment leases do not depend on?
Appreciation. The equipment is going to go down in value not up.
Phantom income on DPP's
A few years after investing in some DPP's, depreciation deductions decline and you start to see phantom income.

Phantom income is taxable income to an investor that has no corresponding cash flow (inflow)

Phantom income is a product of a leveraged tax shelter investment and occurs after the CROSSOVER POINT
Crossover point
AKA
burnout point or turnaround point
It is the point at which a tax shelter stops generating losses for you to be able to write off and starts generating phantom income
Blind pool arrangement means
investors do not know the identity of the assets until after the partnership is formed
4 ways to compute return on investment in a tax sheltered investment
1) payback method - an investor measures the time required for the after tax income to equal the after tax original expenditure

* Present value method - this method attempts to measure future returns in relation to today's value of the dollar (takes into consideration the time value of money)

* Internal rate of return - discounts future cash flows from an investment to an amount that equals the amount invested. (takes into consideration the time value of money)

The cash on cash method - NOT A GOOD METHOD
The annual return is divided by the original investment to see how many years it will take to break even. This does not take into account the effect of taxes. Some investors use this method because it is simple.
S (subchapter) corporation
TREATED LIKE A PARTNERSHIP, NOT A CORPORATION.

- 100 or fewer shareholders
-Issues only 1 class of stock
- Other corporations are prohibited from being shareholders
-NON-RESIDENT ALIENS ARE PROHIBITED FROM BEING SHAREHOLDERS
Limited Liability Companies

(LLC)
TREATED LIKE A PARTNERSHIP

NO LIMIT OF NUMBER OF MEMBER "OWNERS"
Annuities
- a series of periodic payments paid to an annuitant for life or can be paid to an annuitant and their beneficiary for a minimum "period certain" like a ten year period

annuities are sold by insurance companies

They are paid for by either one lump sum payment (called a single premium) or in installment payments (called periodic premiums)
Fixed vs variable annuities
Fixed annuity - fixed payment to annuitant every month, ex. 100 bucks per month

Variable annuity - The monthly payment to the annuitant fluctuates every month, ex 103 in Jan, 101 in Feb, 97 in March - THE AMOUNT PAID VARIES BASED ON THE VALUE OF THE SECURITIES IN THE ANNUITY'S SEPARATE ACCOUNT

Fixed annuities are technically not securities. Variable annuities are securities because they are based on a portfolio of securities that the insurance company owns
Simple way to say "variable annuity"
"changing" "stream"
SEPARATE ACCOUNT
a special, tax deferred account that contains a portfolio of securities for an annuity.

The Separate Account has two types of units.
Accumulation units are for when you are paying into the units.
Annuity units are for when you are receiving payments from the plan
Accumulation units (pay-in period)
Accumulation units are used to determine the contract owner's (investor) interest in the Separate Account

- The value IS NOT DETERMINED BY MORTALITY TABLES

Investments are tax deferred until the annuity payments begin

The investor can withdraw the cash surrender value of the contract. They will incur a penalty for breaking the contract. This penalty is called surrender charges

During the accumulation period, a contract owner can
Annuity Units
After you retire you exchange the accumulation units for annuity units.

These units determine the amount of the payments you will receive on a monthly basis.

CHANGES IN THE VALUE OF THESE UNITS ARE DETERMINED BY THE VALUE OF THE ASSETS IN THE SEPARATE ACCOUNT
Purchasing methods of variable annuities
Periodic payment deferred annuity - investor makes monthly, quarterly, semi-annually or annually payments over a period of time at a fixed sales load

Single payment deferred annuity - investor pays a lump-sum now and defers payment until a later date

Single premium / lump sum purchase - investor makes a single lump sum purchase and begins receiving monthly payments immediately. (not deferred)
Pay out methods upon annuitization
annuitization means when you switch from accumulating to annuity units. AKA when you start RECEIVING payments

Life annuity - you receive regular payments until death, no matter how long you live

- Gives the investor the LARGEST PAYMENTS

- Upon death, insurance company keeps the remaining balance

Life annuity-period certain: Investor receives regular payments until death, but once he dies, payments would continue to be paid to his beneficiary for a predetermined period.

Joint and last survivors - Payments made to a couple. The payments don't stop until the last person dies.

Unit Refund - Investor or beneficiary is guaranteed the payment of a set number of units (not a fixed number of dollars)

Installments for a period certain - the investor receives payments for a certain period. Payments stop at the end of the period no matter if the investor is still alive or not. If the investor dies during the period, the beneficiary would receive the payments until the end of the period.


Installments for a fixed amount. Investor receives the fixed amount stated in the contract until the account is extinguished
Premature withdrawals from an annuity (and most other retirement plans) will result in what kind of penalty?
10% penalty
More facts about annuitization
The number of units that the investor receives on a monthly basis will vary based on the payout method chosen.

Variable annuities will pay out the same units every month, but the value of the unit will fluctuate corresponding to the value of the Separate Account.

Prior to retirement the contract holder (investor) must carefully decide upon the payout method. Once the payout method is chosen, it is locked and the investor CANNOT WITHDRAW MONEY OR CHANGE INVESTMENTS
Other names for the Separate Account

Who manages the separate account?
Sub Account
Investment Account

The Separate Account is managed by a board of managers
When are annuity units valued?
Annuity units are valued once a month just prior to payout
What happens on annuity date?
An interest rate is used called the AIR - assumed investment return - which is not guaranteed
The contract holder / investment holder:
Must receive a prospectus at time of purchase

Will receive Statement of Additional Information UPON REQUEST

Have the right to vote (by PROXY)

Has a choice of investments and thus HAS INVESTMENT RISK AND IS NOT PROTECTED FROM CAPITAL LOSS IF THE VALUE OF THE SEPARATE ACCOUNT DECLINES
QUALIFIED OR TAX-QUALIFIED ANNUITIES
THE INVESTOR PUTS IN PRETAX DOLLARS
- Usually part of an employer's retirement plan

Upon retirement, distributions will be made as ordinary income. (usually the retiree is in a lower tax bracket then before retirement)
NON-TAX QUALIFIED ANNUITIES `
AFTER TAX DOLLARS ARE PUT INTO THE ANNUITY

Upon retirement, the investor will receive a return on capital which he doesn't have to pay taxes on. THE AMOUNT THAT EXCEEDS the money he put in will be taxed as ORDINARY INCOME
Variable annuity salespeople must be registered with:
The state insurance department

The SEC

NASD / FINRA

BUT NOT WITH THE STATE BANKING DEPARTMENT
Annuity contracts contain a non forfeiture provision:
This means that if the investor stops making payments, they will not lose claim to their previous investments.
Contract holders of variable annuities handle dividends how?
They are not taxed on the dividends annually because the tax is deferred until retirement
Variable annuities are considered to be .... but not... ?
They are considered to be securities, but not insurance.
Tax treatment of early withdrawals
One time withdrawals on a variable annuity are handled last in first out
Sales charge breakpoint discounts on annuities depend on
the amount of money invested
1035 exchanges
This allows the taxpayer to switch from one variable annuity to another without additional taxes.

SURRENDER CHARGES CAN STILL BE APPLIED and a new surrender charge period usually begins in the new variable annuity
Bonus annuities
Bonus annuities add a percentage to your pay ins.

If you pay in $100 into the separate account, the payment will actually look like $103 or $105.

With this benefit comes higher costs and longer surrender periods
Equity indexed annuities
Provide annuity payments linked to a specific index.

- if the index increases, the contract holder is credited with at least part of the gain

- if the index declines, the contract holder will suffer a loss, but is guaranteed at least a minimum return (e.g. 3%)
When referring to a variable annuity in sales literature / prospectus
THE VARIABLE ANNUITY CAN NOT BE CALLED A MUTUAL FUND (because it isn't one...)

It can be called a sub account, an underlying account, or an investment account
RR's who sell variable units must hold these licenses:
life insurance license
and securities license

The branch office manager need only a securities license

The broker/dealer must have a sales agreement with the issuer
Define an IRA
Individual retirement account - a PERSONAL account for a person (and their spouse) who is employed that provides either a tax - deferred or a tax - free way of saving for retirement

AN IRA IS AN ACCOUNT

It is a container or "wrapper" to hold securities/investments

IRA accounts can be opened and held at almost any custodian institution - banks, brokerages, insurance companies

Not everyone can participate in every kind of IRA. There are eligibility restrictions, contribution limits, and penalties for early withdrawal of assets.
Investments we can and can not hold in IRA's
We can hold stocks, bonds, mutual funds, and other securities

Certain US Gov't or State issued gold, silver, platinum, and other bullion

Real Estate

WE CAN NOT HOLD COLLECTIBLES - such as paintings, antiques, diamonds, stamps, and rugs

WE CAN NOT HOLD LIFE INSURANCE
Talk about when the investor dies and the spouse is listed as the beneficiary of an IRA
A surviving spouse may treat the IRA like her own. She may make contributions and rollover the IRA
What happens when a non spouse inherits and IRA?
A non spouse does not get to become the owner of an IRA. They can not rollover the IRA into another IRA.

Any distributions made will be treated as ordinary income for tax purposes
What happens when a trust, or group of individuals, inherit and IRA?
The trust becomes the owner of the IRA and the beneficiaries of the trust become the beneficiaries of the IRA.

The maximum payout period is based on the OLDEST BENEFICIARY'S AGE
Traditional IRA (Introduction)
Designed to encourage EMPLOYED INDIVIDUALS to save for retirement

Advantages: contributions (within a certain limit) are tax deductible and that the taxes on contributions and earnings in the account are deferred generally until the investor retires and is in a lower tax bracket.

The only condition for being eligible to contribute to an IRA is to have sufficient earned income
Contributions to an IRA
Contributions may be made annually up to specified limits. All contributions to traditional and Roth IRAs ARE AGGREGATE (ADDED TOGETHER), you can not put the max contribution in the traditional and the max contribution into a Roth. You must split the max contribution among all of your IRAs

individuals who will be 50 years or older within the tax year may contribute additional CATCH UP contributions.
How much is the maximum contribution to an IRA right now?
How about a catch up contribution?

What happens to anything over the limit?
The max contribution is $5,000 (aggregate) and the catch up is $1,000 (age 50+)

A 6% CUMULATIVE excise tax is tacked onto any amount over the limit
What qualifies as IRA contribution money? What doesn't?
Earned income and alimony can count as IRA contributions, but pensions, annuities, and other deferred compensation does not.
Other contribution information
Contributions must be made in cash. They MAY BE MADE UP TO APRIL 15TH OF THE YEAR FOLLOWING THE TAX DEDUCTION (so basically by the time taxes are due )

Even if you are granted a tax deadline extension, YOU STILL MUST MAKE THE CONTRIBUTION BEFORE APRIL 15TH OF THE YEAR FOLLOWING THE DEDUCTION.
A DEDUCTION is?`
An amount subtracted off of a person's INCOME. Not as good as a tax credit
A tax credit is?
A dollar for dollar subtraction from a person's OWING TAXES. Much better than a deduction
IRA deductions
A person who is not active in a retirement plan at work may deduct the entire 5,000 max contribution

A person who is active in a work retirement plan may or may not get to deduct the full five grand. It depends on their adjusted gross income (AGI)

A person is considered to be active if they are ELIGIBLE for the plan even if they don't take part!
IRA and unemployed spouses
If you have an unemployed spouse, you can make a full contribution (and deduction) for yourself and your spouse.
IRA earnings
Taxes on ALL earnings are deferred until withdrawals are made from the IRA
IRA Distributions
In general, IRA distributions are taxed as ordinary income (the assumption is that you will be in a lower tax bracket in retirement)

A 10% tax is imposed on any distributions taken before age 59 and a half. The exceptions are first time home buyer, death, disability, medical expenses, higher education costs, and medical insurance premiums

REQUIRED MINIMUM DISTRIBUTIONS (RMDs) are mandatory at age 70 and a half. They must begin no later than APRIL 1ST following the calendar year that a person turns 70.5. THESE "LATE DISTRIBUTIONS" will be taxed at 50% for all of the distribution that is not sufficient (large enough) or the whole thing if the distributions haven't started yet..
Rollovers
Rollovers are allowed into another IRA, Keogh or qualified plan.

AN INDIVIDUAL HAS 60 DAYS TO INVEST BENEFITS FROM A RETIREMENT PLAN INTO THE NEW ACCOUNT BEFORE INCURRING A TAX LIABILITY
Roth IRA Introduction
Roth IRA CONTRIBUTIONS ARE NOT TAX DEDUCTIBLE.

SINCE TAX IS ALREADY PAID, ROTH IRA CONTRIBUTION DOLLARS CAN BE WITHDRAWN AT ANY TIME WITHOUT PENALTY

The big difference with Roth IRAs is that UPON RETIREMENT QUALIFIED DISTRIBUTIONS ARE TAX FREE

ROTH IRAS BENEFIT INDIVIDUALS WHO ANTICIPATE BEING IN A HIGHER TAX BRACKET UPON RETIREMENT
ROTH IRA contributions
$5,000

Contributions are taxable

CONTRIBUTIONS MAY BE MADE EVEN AFTER THE INDIVIDUAL TURNS 70 AND A HALF
ROTH IRA distributions
Qualified distributions are tax free

To be qualified, FIVE YEARS HAVE TO PASS AFTER THE INITIAL CONTRIBUTION AND one of the following;

The investor has to be 59 and a half

Dies or is disabled

uses the money for "first time homeowner" expenses

uses the money for educational expenses

or uses the money for medical insurance premiums

NON QUALIFIED DISTRIBUTIONS are hit with a 10% tax and a portion may be included in the owners adjusted gross income
ROTH rollovers
Rollovers between Roths are permitted.

Traditional IRAs can be rolled over into Roths but amounts transferred will be taxed as ordinary income.

Traditionals can't be rolled over into Roths IF:
The Owner's AGI exceeds $100,000
or the owner is "married filing separately"
SEP IRA Introduction
SEP IRA's are used by small businesses for the benefit of the owners and their employees

The business owner and employees create their own IRA accounts to which the employer deposits SEP contributions

Once contributions are deposited, they are property of the IRA account and subject to the same rules as a traditional IRA
SEP IRA Contributions
Contributions are tax deductible FOR THE EMPLOYER

Contributions are discretionary and can vary every year

Employees are 100% vested in the contributions made by the employer

Employees may make additional contributions to their accounts. Contributions by employees can be up to 25% of the employee's compensation not to exceed $49,000 (2009)
SEP IRA Eligibility
EMPLOYERS MUST MAKE CONTRIBUTIONS FOR ALL EMPLOYEES WHO ARE ELIGIBLE

Employees are eligible if they meet all these requirements:
-21 or older
-Worked for company for 3 out of the last 5 years
-Made at least $550 for the current tax year
Savings Incentives Match Plan for Employees (SIMPLE) Intro.
Simple allows eligible employees to make ELECTIVE SALARY DEFERRALS of their pre tax compensation into the plan

Is like the 401K but offers simpler and less expensive administration

In order to set up a SIMPLE, an employer MAY NOT also have another retirement plan set up.
SIMPLE is designed for
Small business
Requires 100 or fewer employees
Contribution for SIMPLE IRAs
Contributions are limited to Elective Salary Reductions made by the employee.

The max contribution is $11,500 (2009) and $2,500 catch up if you are 50 or older

EMPLOYERS MUST SET UP AND MAKE CONTRIBUTIONS TO ELIGIBLE EMPLOYEES:

they match the employee's contribution dollar for dollar UP TO 3% of the employee's compensation

Or a total of 2% of the employee's compensation if that employee chose not to contribute.
SIMPLE IRA ELIGIBILITY
Employees are eligible to participate if they MADE $5,000 OR MORE IN COMPENSATION FOR THE LAST TWO YEARS AND ARE EXPECTED TO MAKE AT LEAST $5,000 THIS YEAR
SIMPLE IRA rollover
Simples can be rolled over into other simples

Simples can rollover into other types of IRAs IF THE EMPLOYEE HAS PARTICIPATED IN THE SIMPLE FOR AT LEAST 2 YEARS
Distributions of a SIMPLE IRA
Just like a traditional except if an EARLY, unqualified distribution is made within the first two years of the individual owning the account, the tax penalty gets bumped up from 10% to 25%
A rollover IRA
A rollover IRA is a holding tank for IRA assets when someone has just left one IRA and will be rolling over into another.

The rollover IRA container is treated as a traditional IRA and serves the sole purpose of keeping the retirement assets from being commingled with other assets.
INTRODUCTION TO QUALIFIED PLANS

When you think qualified plans think...?
When you think qualified plans, think ERISA

Its a retirement plan provided by a private employer that meets Employee Retirement Income Security Act (ERISA)

401 K and profit sharing plans are examples of qualified plans

The employer is entitled to current tax deductions for plan contributions

Employees do not have to pay current taxes on their contributions (before tax dollars)

Earnings in the plan are deferred until distribution to the employee or his beneficiary

Taxes are paid only upon distribution. It is assumed that the taxpayer will be in a lower tax bracket by then because he will usually be in retirement
Qualified plans versus IRAs
IRAs are technically not "qualified plans"

When establishing a tax advantaged retirement plan, private employers can choose between a qualified plan base or an IRA base:
This choice usually comes down to contribution limits and administrative complexity.
- qualified plans typically have HIGHER CONTRIBUTION LIMITS and MORE COMPLEX ADMINISTRATION
What is Erisa?
Protect an employee's retirement assets in private sector companies.

Erisa act does not make it necessary that an employer offer a retirement plan, only that once a plan is created it be held to federal standards.
Rules that Erisa imposes
Disclosure - plans must regularly provide participants with important information about plan features and funding

Standards - Minimum standards are required for participation, vesting, and providing promised benefits.

Accountability - Fiduciary status

Remedies - legal action can be taken by participants against fiduciaries.

Guarantees - certain payments are guaranteed through the Pension Benefit Guarnaty Corporation
Define Fiduciary
A fiduciary is anyone who has the power to exercise discretionary authority or control over a plan's management or assets or who is paid a fee or any form of compensation for investment advisory services
Fiduciary responsibility and accountability is required.

Who does the fiduciary act on behalf of? What four qualities must they have?
Fidcucaries act soley in the interest of the plan participants and beneficiaries.

They must use care, skill, prudence, and dilligence. Failure to do so may result in liability for plan losses.
What one thing are fiduciaries not forced into doing but should do anyways?

(Test Question)
Diversify the plan investments!
Investment Policy Statements for Qualified Plans
An investment policy statement must be maintained for each qualified plan.

-A test to determine if an investment is proper for any plan is THE AMOUNT OF RISK involved in the investment

-COVERED CALL WRITING and INDEX OPTIONS CAN be done IF THE INVESTMENT POLICY STATEMENT SPECIFICALLY SAYS SO
Qualifed Plan

Fiduciary Prohibitions
A fiduciary shall not deal with the assets of the plan in his own interest or for his own account

A fiduciary shall not act in any transaction involving the plan on behalf of a party whose interests are ADVERSE to the interests of the plan, its participants or its beneficiaries.

A fiduciary shall not receive any compensation from any party dealing in connection with a transaction involving the the assets of the plan.
Qualified Plan

A fiduciary shall not cause the plan to engage in a transaction if he knows or SHOULD know that such transaction constitutes a direct or indirect
--I believe "party in interest" means the employer or one of the suppliers the employer uses, or any other entity that has a tie to the employer because then the money is also helping the employer and not just for the participants and their beneficiaries.

The sale, exchange, or leasing of property between the plan and a party in interest

lending of $ or other extension of credit between a pension plan and a party in interest

Furnishing of goods, services, or facilities between a pension plan and a party in interest

Transfer to, or use by or for the benefit of, a party in interest, of any assets of the pension plan

Acquisition, on behalf of the plan, of any emplyer security or employer real property unless ERISA requirements are met.
Two Categories of Qualified Plans - what are they?
Defined Benefit (DB) &
Defined Contribution (DC)

DB and DC Dumpster Baby and Deanna Cotton. Deanna is having a dumpster baby
Qualified Plans: Defined Benefit
Under a Defined Benefit plan:

The BENEFIT is predetermined by a formula that factors age, years of service, and compensation.

HIGH SALARIED WORKERS BENEFIT MOST FROM THIS TYPE OF PLAN.

Benefits are taxed as Ordinary Income.

An actuary must be used to regulary review contribution amounts by the employer to make sure the contributions will meet the payout requirements.
Qualified Plans: Defined Contribution Plans
A defined contribution plan is based upon employee and employer contributions. Both can make contributions.

An employer may also choose to make matching contributions and profit sharing contributions based on a predetermined formula.

The retirement benefit can not be calculated ahead of time as it is based on contributions and the performance of investments in the in the account.
Qualified Plans: Defined Contribution Plans: 401 K Plan
-Voluntarily established by employers

- A portion of the employee's salary is deferred into a personal 401 K account

- Many employers match contributions up to a certain percentage of compensation

- These programs also have profit sharing attached to them

-AKA CODA (Cash or Deferred Arrangment Plans)
-AKA Cash Accumulation Plans
-AKA Capital Accumulation Plans

-Contributions and earnings grow tax deferred

- Rollovers CAN NOT be made directly to a ROTH IRA

-PRE TAX ANNUAL CONTRIBUTION LIMITS ARE SET. 2009/10 is

$16,500 &
$ 5,500 catch up for 50+
Qualified Plans: Defined Contribution Plans: 401 K Plan

Distributions / Rollovers
Distributions may begin the year you turn 59½, they must begin by April 1 following the calendar year you turn 70½.

Early withdrawals are subject to 10% tax

Late withdrawals are subject to 50% penalty on the insufficient (not great enough) distributions.

Distributions to tax holders are taxable AS ORDINARY INCOME.

-Exception: When someone is still working at age 70½ and does not own 5% or more of the company he is not subject to the 50% tax

Rollovers must be completed in 60 days and can be rolled over into another qualified plan or a traditional IRA.
Qualified Plans: Defined Contribution Plans: 401 K Plan

Roth 401 K's
Modifications may be made to 401 K's to include Roth provisions and thus have the money go in after tax and come out tax free
Qualified Plans: Defined Contribution Plans: Profit-Sharing Plan
A plan where the company shares its profits with its employees

-DEDUCTIBLE ALLOWANCES MAY NOT BE CARRIED OVER TO THE NEXT YEAR - MUST BE CLEARED EVERY YEAR!

-Designed to give an incentive to employees to produce

-Employer voluntarily chooses to contribute and set the size of the contributions

-The contribution is dependent on company profits

-All funds in the plan are tax sheltered
Qualified Plans: Other Plans:

Keogh (HR-10) Plans - in General
Keogh Plans are for self-employed individuals. They can be set up as defined contribution or defined benefit

More complicated than SEP but allow higher contributions
Qualified Plans: Other Plans:

Keogh (HR-10) Plans - Eligibility
Eligible parties include Recipients of income from the self-employment and their full time employees who:

Work at least 100 hrs
Have worked at least 1 year
Are 21 or older
Qualified Plans: Other Plans:

Keogh (HR-10) Plans - Contributions
For a Keogh Defined Contribution Plan: Pretax max is 100% of earned income or $49,000 whichever is less

For a Keogh Defined Benefit Plan: Pretax max is 100% of earned income or $195,000

Contributions and earnings are tax-deferred while in the plan
Qualified Plans: Other Plans:

Keogh (HR-10) Plans -
Distributions
Same as Traditional IRAs
Main types of real estate DPP's:
Residential property
Commercial property
Industrial property
Government assisted housing
Condominium securities (TIME ....SHARES)
Raw land

Raw land can not be depreciated. The main reason to purchase raw land is to sell it later for a capital gain.
Deduction available to investors of DPP's include.... but not.....?
Depreciation deductions & interest on mortgages

BUT NOT PRINCIPAL PAYMENTS OF MORTGAGES
Main advantages of real estate programs
Potential for capital appreciation
Tax Deferral
Pass through of income and expenses (single taxation)
Limited liability
Before investing in real estate DPP's consider:
Forecasts of regional economic conditions

Changes in interest rates

Changes in tax law

QUALIFICATIONS OF GENERAL PARTNER
What's sale and leaseback?
Sale and leaseback is when the original owner of a building has exhausted all of the depreciation on the building. He will then sell it and lease it from the new owner.

The new owner gets to start the depreciation from scratch. The original owner (who is now leasing) gets to deduct lease payments.
Thing to remember about "triple net leases"
Each tenant is responsible for paying:

Property tax
Insurance
Operating & Maintenance expenses

The new owner is responsible for paying debt service (principal and interest) on the property.
Condominium units are considered to securities when they are sold to investors to rent them.
In order to qualify for as an investment for tax purposes, they must not be considered a residence.

A condo IS CONSIDERED A RESIDENCE IF it is used for more than 14 days by the same people.

A UNIT DEED is a document that specifies the areas which are shared by other owners and which areas over which the condo owner has exclusive use.
How do you calculate cash flow on a real estate DPP?
Revenue - all deductions

EXCEPT DEPRECIATION
What is the ideal situation for a limited partner investing in a real estate DPP?
Generating an overall loss, but positive cash flow
403(b) TSA (Tax Sheltered Annuities)
Plan is designed for NON PROFIT organizations
-includes public schools, hospitals, religious organizations, etc.
Contribution info 403(b) TSA
Annual contributions may include elective salary reduction by employee, non-elective contributions by employer, and additional after tax contributions made by the employee

100% of compensation or $49,000 (lesser of two) / $5,500 catch up contribution
Distributions for 403(b) TSA
Same as traditional IRA except distributions are taxed as ordinary income WITH A COST BASIS OF ZERO.
Non- Qualified Deferred Compensation
An agreement between an individual and their employer.
Designed for highly compensated athletes and executives.

Not subject to Erisa - plan may discriminate to who it allows in.

Part of compensation is deferred until retirement (not paid out by employer until retirement)

Basically a promise to pay. If they go broke the player won't be paid his retirement money------>. PLAN ASSETS CAN BE SUBJECT TO THE COMPANY'S CREDITORS
Payroll Deduction Plans
Non qualified plans - after tax deductions to fund insurance, healthcare, etc.
Rollover into a Roth
Rollovers into a Roth are allowed if the person's AGI is less than 100,000 dollars.

Income tax would have to be paid on distributions before the money is rolled over into the Roth

Rollover from a Roth into a qualified plan is NOT permitted.

Qualified to Roth is permitted now.
Coverdell
Maximum annual contribution is $2000 per beneficiary until 18. to educational IRA, tax favored trust, or custodial accounts.

Coverdell can be used for any level of education.
Contributions are not tax deductible but distributions are tax free -- KINDA ROTHY

MOST APPROPRIATE FOR LOW AND MIDDLE CLASS CONTRIBUTORS
529 plans
Prepaid Tuition
allows ANYONE to contribute for a child - relative, family friend ANYONE

Buy units (or periods, credit hours) at today's prices to be used in the future

NO INVESTMENT RISK
529 plans
College savings plan
Also can be made by relatives, friends, ANYONE

Based upon investments in an account - investment risk

Growth and distribution is tax free. Contribution is based upon gift laws of 13,000 per year, 65,000 for 5 years..... 26,000/130,000 for married couple
529 plans in general
Can change the beneficiary as long as the new beneficiary is in the same family as the old. In the same family means just about any relation.. In-law, cousin, aunt, step-brother...

Can change to a different 529 once a year.