WealthManagement Magazine

Industry Frets Over Tax Case

In a tax case involving an unnamed brokerage firm, the IRS national office held that upfront bonuses paid to broker recruits were 100% taxable to the reps in the first year. The finding was made in a technical advisory memorandum (TAM) issued by the IRS in June and released in October. The TAM focused on how a firm can deduct such payments. However, the IRS also said upfront payments were taxable

In a tax case involving an unnamed brokerage firm, the IRS national office held that upfront bonuses paid to broker recruits were 100% taxable to the reps in the first year.

The finding was made in a technical advisory memorandum (TAM) issued by the IRS in June and released in October. The TAM focused on how a firm can deduct such payments. However, the IRS also said upfront payments were taxable income, rather than loan proceeds, so they were taxable when received.

The ruling has the industry worried.

Normally, brokers pay taxes on bonuses as the loan amount is forgiven in installments. If the IRS reading in this particular case were expanded to the entire industry, firms might be forced to pay more for recruits and pay higher tax bills.

As a result, the industry is evaluating how to redo incentive deals to avoid the potential hit (see The Problem Deal, below).

In this case, the IRS ruled that the firms loans were not really loans since repayment was conditioned only on recruits remaining with the firm. Therefore, the IRS held that the bonus was current compensation, taxable in the year paid.

At the same time, the IRS ruled that the employer couldnt deduct the entire bonus in the first year. The firm had to amortize its deduction over the life of the loan.

As this TAM makes clear, it accelerates income [to the IRS], but not the deductions; its a win-win for the IRS, absolutely, says Howard Barnet, a partner in the New York law firm of Carter Ledyard & Milburn.

A TAM is case-specific, says Judy Alden, director of PriceWaterhouseCoopers Washington, D.C., national tax services division and a former IRS official. Therefore, only the one firm is affected. (The TAM says the brokerage involved is not publicly traded.)

All firms need to take heed of the TAM, says a brokerage official who asked not to be named. It indicates the thinking of the national IRS office. According to another industry source who requested anonymity, a second firm (as yet unknown) has encountered the same problem with the IRS.

Meanwhile, the industry is lying low on the issue. No one wants to escalate this, the industry source says.

Sidebar: The Problem Deal

The upfront loan deal that raised the IRS' ire involved a typical arrangement whereby the firm's reps got money upfront, signed a five-year note for the cash, then received annual bonuses which exactly offset the loan payments.

The problem, says Judy Alden, director of PriceWaterhouseCoopers' Washington, D.C., national tax services division, is that the note and bonus payments were married.

Howard Barnet, a partner in the New York law firm of Carter Ledyard & Milburn, says another problem is that the firm forgave the balance of the loan if the broker died or was disabled.

At the very least, you don't want to put it in those terms, to say forgiven, Barnet says. Firms should make separate arrangements for death or disability payments.

The IRS' ruling is contained in TAM No. 200040004, http://ftp.fedworld.gov/pub/irs-wd/0040004.pdf .

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