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Accepting Inconvenience For Safety

Nobody likes going through airport security, but nobody wants the security measures to disappear, either.

That’s pretty much how I feel about a new round of government regulations that affect investment advisers and tax return preparers. The new rules will make my life more difficult, and they may contain some contradictions and gaps that will cause headaches for people in my line of work. On the other hand, if the regulations keep a few charlatans from abusing clients’ trust, this would outweigh whatever annoyance they may cause my colleagues and me.

The first important set of changes that will affect our company comes from the Securities and Exchange Commission. Last month the SEC adopted a number of rules to protect investors who place assets in their adviser’s hands. Nearly all of the assets we manage at Palisades Hudson Asset Management, L.P., are actually held by third-party custodians, such as Charles Schwab & Co. However, in some cases we are still considered to have custody, typically because I serve as trustee for certain client accounts.

Over the past year, the SEC has brought a series of enforcement cases against advisers who made improper use of their access to clients’ assets. Some, most spectacularly Bernard Madoff, covered up their misdeeds by providing clients with false account statements that reported assets that did not exist and transactions that never occurred. To protect against this sort of fraud, under the new rules, advisers with custody of client assets will be required to have an independent public accountant conduct a surprise examination at least once a year to verify that client assets have not gone missing. The new rules also will require advisers with custody to obtain a written report, prepared by an outside accountant, describing the controls in place to protect client funds.

Separately, the Internal Revenue Service is preparing to implement a new set of regulatory standards for tax return preparers. At Palisades Hudson Financial Group LLC, all the tax returns we prepare are reviewed by a client service manager, and all of our client service managers are Certified Public Accountants or Enrolled Agents, or hold the Certified Financial Planner® credential. Most of our managers hold more than one of those designations. However, under present laws, anyone can set up shop and offer return preparation services, regardless of competence or professional knowledge.

With the new standards, most individuals who sign a federal tax return as a paid preparer will be required to register with the IRS. All preparers will be required to demonstrate a minimum level of competence and to complete certain continuing education requirements. Those who already meet licensing standards in order to practice as CPAs, Enrolled Agents, or attorneys will be exempted from additional requirements.

The IRS will have to answer some thorny questions when it writes the detailed regulations explaining these requirements. For example, because our firm typically handles complex returns with a lot of data and often-esoteric issues, many of our returns are drafted by one person, reviewed by another, and then reviewed again and signed by a third. The IRS will have to create guidelines clarifying exactly who in that process needs to register.

The IRS action comes after several states have moved to regulate return preparers. Oregon and California already require return preparers to register with the state and meet certain requirements. Maryland and New York have both passed legislation requiring registration and will begin regulating paid preparers in the near future. Other states will probably follow.

Many firms, including ours, prepare returns for multiple states. Some of our clients file returns in 10 or more states because they are partners in companies that do business in all of those jurisdictions. It is not practical for these taxpayers to hire a separate state-registered preparer in each state. It also is unrealistic to expect individual preparers to comply with varying registration and continuing education requirements across, potentially, dozens of jurisdictions. Any of the professionals in our offices might be involved in preparing returns for 20 or 25 different states in a given tax season.

Since most state income tax rules follow a fairly standard framework (usually based on federal law), and since many of the details are baked into the software that is used almost universally by professional preparers, there is little reason to impose such multi-state burdens. That does not mean the states will not try, however, especially if the registration fees promise to bring in some much-needed revenue.

The states will most likely eventually figure out some sort of system that works in conjunction with the emerging federal rules, or the courts will define the limits of state powers to impose registration on out-of-state tax preparers. In the meantime, firms such as ours that prepare returns for many different states might rely on these states’ exemptions for licensed professionals. Sorting out the states’ varying requirements will be time-consuming, but we will just have to do it anyway.

Time will tell whether these new regulations will bring any real benefits. But, just as we tolerate those aviation security measures, we will have to put up with some inconvenience in the name of financial safety.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, The High Achiever’s Guide To Wealth. His contributions include Chapter 1, “Anyone Can Achieve Wealth,” and Chapter 19, “Assisting Aging Parents.” Larry was also among the authors of the firm’s previous book Looking Ahead: Life, Family, Wealth and Business After 55.

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