Pennsylvania Investment Observer

Complexity

by Daniel J. Nestlerode

I got a call from a client who lives in the mid-west asking about his 1099R reports he had received from the trustee for his IRA accounts. The particular client has moved funds from a regular tax deductible IRA account to a Roth IRA every year. When he completes his taxes, with the assistance of his accountants (in this case enrolled agents), he then recharacterized some money from his Roth IRA back to his regular IRA to avoid paying any federal income taxes. Aside from the investing of the money, we constantly play a game of moving money to his Roth IRA because it is completely non taxed under the current rules. It is detailed and difficult to keep track of each of these movements of shares and cash, back and forth every year. But it is a necessary evil if he is going to maximize his returns and minimize his federal income taxes.

Our clearing firm, First Southwest Company, applied for and got an extension on providing our clients with the proper 1099 forms. Usually out at the end of January, First Southwest asked for and received an extension until March 2nd to provide this data to all its clients. I am not sure about the problem that led to the extension, but if I had to guess I would say that it has to do with the characterization of dividends as either qualifying or non-qualifying for the lowest tax rate of 15%. Under the Bush tax cuts, the rules got a tad more complicated and apparently the data providers are having problems complying with the rules and regulations. Some where in here I hear a Homer Simpson retort.

A few days ago, I read the results of a law suit filed against the Securities and Exchange Commission (SEC), the safeguard agency that is supposed to keep our investment markets credible. It seems that the SEC, in their fervor to protect the investor, was making rules on the fly and hadn't bothered to make the necessary rule changes before they decided to penalize the brokerage community. The federal administrative law judge in this case thoroughly chastised the SEC for not following the rules and exonerated the brokerage firm and broker in question. This raises a red flag for all brokerage firms about rules interpretations from the agency that is supposed to know its business.

In the world today, the ground rules are becoming more complicated and complex. The application of these rules and regulations is leading to breakdowns in the system of taxation and regulation. More importantly, the breakdowns are increasing the costs of doing business with very little or no return to the client. I recall the Tower of Babble parable and, after forty years in the investment business, I am wondering if this just might becoming a system running headlong into losing its workability. I am reminded that the IRS has over 900 definitions of profits. And their definitions are not coordinated with any other part of government. In a system of government that relies on voluntary compliance with the rules and regulations, it is no wonder that the "underground economy" is growing faster than the overall economy. People are just opting out of the complex and intruding regulatory and taxing system that few, if any understand let alone comply with.

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