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TECHNICAL FREQUENTLY ASKED QUESTIONS

The information contained herein comes from a variety of sources: telephone inquiries to the Society’s technical hotline, the standing committees of the Society’s volunteer structure, the staff, members, and other interested parties.

FAQs are designed to provide general information and serve as a quick reference. They neither substitute for one’s own research and judgment nor constitute an opinion of the Society, of any of its committees or of its staff. References to appropriate standards-setting bodies and to authoritative literature is made whenever possible.

Members having a technical inquiry may call the NYSSCPA’s technical hotline at 212-719-8309.

Agri Business Committee

Q: For cash-method taxpayers, what are the IRS’s general rules for deductible prepaid expenses for livestock and farming operations?
A: Expenditures must be for a purchase rather than a deposit, and the prepayment must be made for a business purpose and not tax avoidance. The deduction will not result in a material distortion. Internal Revenue Code (IRC) Section 464(f) limits deductible prepaid farm supplies to 50 percent of deductible farm expenses for the year.

Q: For cash-method farming operations, what are the general rules for inventory?
A: Generally, the purchase price and other acquisition costs of the animals, and cost of seeds, plants, trees and vines with a preproductive period of more than two years must be capitalized, but the cost of raising animals and raising crops can be deducted when expensed. Special preproductive rules apply to timber and Christmas trees. When the farming operations are part of an integrated business not considered farming and requires inventories, the farming operations may be required to use inventories.[(IRC Regulation 1.466-1-(d)(1)].

Real Estate Committee

Q: What is the tax impact of a real estate partnership in which the partners have refinanced and are about to redistribute the money?
A: There is generally no tax due on debt-financed distributions. The liabilities associated with the refinancing give the partners additional basis to distribute. The partnership is subject to interest-tracing rules on these debt-financed distributions.

Depending on a number of factors, including the amount of the distributions and the operating expenses of the partnership, the characteristic of the partnership’s interest expense is subject to change. Normally, the interest expense would be treated as passive, like any real estate rental activity. However, if tracing is applicable, the individual partners receiving distributions must determine what kind of interest expense is related to the distribution based on what they do with the distribution. If the money is deposited into stocks and bonds, it would be investment interest. If used to invest in real estate, it would retain its passive character. If it is used to buy a boat, it would be personal interest, and therefore nondeductible.

Stock Brokerage Committee

Q: The Securities and Exchange Commission (SEC) has just approved my company as a registered broker-dealer. It’s close to the end of the fiscal year and I barely expect any revenues for the period. The expense of the audit at this time would be an undue burden to bear. Can our firm obtain a waiver from having an audit for this first, short period?
A: The SEC’s Rule 17a-(5) contains a paragraph stating that upon receiving a written request of any national securities exchange, registered national securities association, broker or dealer, or on its own motion, the SEC may grant an extension of time or an exemption from any of the requirements of the audit requirement either unconditionally or on specified terms and conditions.

To illustrate its position, the SEC issued a “no action letter” in December 2005 to address situations similar to the above. Exemptions outside the scope of the letter can be requested, but one can anticipate that it may be more difficult to obtain approval. Go to http://www.sec.gov/divisions/marketreg/mr-noaction/nysenasd121605.pdf to see a copy of the letter.

The Commodity Futures Trading Commission will consider written requests for waivers on a case-by-case basis. The CFTC has not adopted a written policy on the question for futures commission merchants (FCMs); relief for introducing brokers (IBs) is available in Rule 1.10(b)(2)(ii)(B). For FCMs and IBs who are already under the oversight of the SEC, it will consider relief in a manner consistent with that offered by the SEC wherever possible. Last, it should be noted that applicants for registration with the CFTC would usually have undergone an audit during their application process, before operations as a registered FCM or IB can begin.

Q: Who is required to register with the SEC?
A: Most brokers and dealers must register with the SEC and join a self-regulatory organization (SRO).

Q: Who is a broker?
A: The Securities Exchange Act of 1934 defines a broker broadly as any person engaged in the business of effecting transactions in securities for the account of others.

For example, each of the following individuals and businesses may need to register as a broker:

• investment advisors and financial consultants;
• foreign broker-dealers who cannot rely on Rule 15a-6 under the law;
• persons who operate or control electronic or other platforms to trade securities;
• persons who market real-estate investment interests, such as tenancy-in-common interests, that are securities;
• persons who act as placement agents for private placements of securities;
• persons who market or effect transactions in insurance products that are securities, such as variable annuities, or other investment products that are securities;
• persons who effect securities transactions for the account of others for a fee, even when those other people are friends or family members;
• persons who provide support services to registered broker-dealers; and
• persons who act as independent contractors, but are not “associated persons” of a broker-dealer.

Anyone who participates in the activities described below may need to register as a broker:

• finding investors or customers for, making referrals to, or splitting commissions with registered broker-dealers, investment companies (or mutual funds, including hedge funds) or other securities intermediaries;
• finding investors for issuers (entities issuing securities), even in a consultant capacity;
• engaging in, or finding investors for, venture capital or “angel” financings, including private placements;
• finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved).

Q: Who is a dealer?
A: The definition of a “dealer” does not include a trader. That is, a person who buys and sells securities for his or her own account, either individually or in a fiduciary capacity, but not as part of a regular business. Individuals who buy and sell securities for themselves generally are considered traders and not dealers.

Unlike a broker, who acts as an agent, a dealer acts as a principal. The law generally defines a “dealer” as any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.

Sometimes it’s easy to tell if someone is a dealer. For example, a firm that advertises publicly that it makes a market in securities is obviously a dealer. Other situations can be less clear. For instance, each of the following individuals and businesses may need to register as a dealer, depending on several factors:

• a person who holds himself out as being willing to buy and sell a particular security on a continuous basis;
• a person who runs a matched book of repurchase agreements; or
• a person who issues or originates securities that he also buys and sells.

Anyone who participates in the activities described below may need to register as a dealer:

• advertises or otherwise lets others know he is in the business of buying and selling securities;
• does business with the public ( retail or institutional);
• makes a market in, or quotes prices for purchases and sales of, one or more securities;
• participates in a “selling group” or otherwise underwrites securities;
• provides services to investors, such as handling money and securities, extending credit or giving investment advice;
• writes derivatives contracts that are securities.

Q: Should I register as a broker or a dealer?
A: Information on the broker-dealer registration process is provided in the SEC’s Guide to Broker-Dealer Registration on the SEC Web site (http://www.sec.gov/divisions/marketreg/bdguide.htm). Anyone who is still uncertain may contact the SEC’s Division of Market Regulation by calling 202-551-5777 or by e-mailing marketreg@sec.gov. (Be sure to include your telephone number.)

Note: Anyone acting as a broker or dealer must not engage in the securities business until properly registered. The SEC expects anyone already engaged in the business, but who has not yet registered, to cease all activity until properly registered.

Q: Who must register with the CFTC?
A: With certain exceptions, all persons and organizations that intend to do business as futures professionals must register under the Commodity Exchange Act (CEAct).