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83-2 Effect of Tax Law Changes on NASD Qualification Examinations

TO: All NASD Members and Interested Persons

ATTENTION: REGISTRATION AND TRAINING PERSONNEL

The passage of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA" or the "Act") has brought about changes in the tax law which will have an impact on the subject matter of the qualification examinations administered by the NASD. The chart at the end of this notice lists the areas affected by the Act and identifies by study outline section the examinations affected by the new tax laws. In addition, a brief explanation of these changes is included below.

All test questions in the item banks affected by the Act will be updated to reflect the new provisions beginning January 1, 1983.

SUBJECT AREAS AFFECTED BY TAX CHANGES

I. Individual Tax Rates

Alternative Minimum Tax - The add-on minimum tax is repealed. The alternative minimum tax is payable if it exceeds the regular income tax. The tax preference items which previously were included in the calculation of the add-on minimum tax, are now added to adjusted gross income. The alternative minimum tax rates are:

 

Adjusted Gross Income

Tax Rate %

Single Returns

Joint Returns

0

0 - $30,000

0 - $40,000

20

Over $30,000

Over $40,000

Tax Preference Items - Below are the tax preference items for the purpose of computing the alternative minimum tax under TEFRA:

  • Excess of the fair market value over the option price at exercise of incentive stock options;
  • Allowable depletion less the adjusted basis of the property at year-end;
  • Excess intangible drilling costs reduced by the net income from oil and gas properties;
  • All-saver's interest excluded from income;
  • $200/$100 dividend exclusion;
  • Excess of accelerated cost recovery deduction on leased property over the deduction allowable using the straight-line method and extended life;
  • Excess of accelerated cost recovery deduction on real property over the deduction allowable using 15 years and the straight-line method;
  • Accelerated depreciation on real property and leased personal property in excess of straight-line;
  • Excess of deductible mining exploration expenses, circulation expenses, and research and experimental expenses over amounts allowable if the expenses were capitalized and amortized over ten years; and,
  • Excess of the five-year write-off for certified pollution control facilities over the amount allowable if the facility had been written off under normal depreciation rules.

II. Depreciation and Tax Credits

Accelerated Cost Recovery System - The faster cost recovery percentages scheduled to become effective in 1985 are repealed under TEFRA.

Investment Tax Credit (ITC) - The basis of an asset will be reduced by 50% of the tax credit generated, including regular investment tax credit historic rehabilitation credit and energy credit. For other rehabilitation expenditures, basis will be reduced by the full amount of the credit. The reduced basis will be used to calculate the accelerated cost recovery deductions and gain or loss upon disposition of the property.

The reduction in basis can be avoided for the regular investment tax credit by electing, on a property by property basis, to reduce the ITC by two percentage points — reducing the 10% credit to 8% or the 6% credit to 4%. This election is NOT available for the energy credit or the historic rehabilitation credit. ITC may reduce up to 85% of the income tax liability in excess of $25,000.

III. Investments

Original Issue Discount - The method for determining the deduction for the original issue discount has been changed from a straight-line method to a method corresponding to the actual accrual of interest.

This new method reduces the amount of interest deductions and interest income in the early years of a bond's life. The amount of interest deductions and the corresponding interest income included by the bondholders increase each year over the life of the bond.

The new provisions extend the rules to taxable discount government obligations such as treasury bonds and notes as well as bonds issued by partnerships. Tax exempt bonds, U.S. Savings Bonds and treasury bills are excluded from these rules.

Registration of Debt Obligations - Under TEFRA, most debt obligations issued after December 31, 1982, will be required to be registered, including those issued by the United States and state and local governments. The primary exceptions to the Act include:

Obligations maturing in one year or less from date of issue; and,
Obligations sold outside the United States to non-U.S. persons.

These registration requirements for state and municipal obligations will become effective on July 1, 1983, at which time the interest income on otherwise tax-exempt obligations will no longer be exempt if the registration requirements are not met.

Issuers of debt obligations will not be allowed an interest deduction on obligations not meeting the registration requirements, may not reduce earnings and profits for such interest and are liable for an excise tax equal to one percent of the principal amount for each year from date of issue to maturity. A holder of a bond not in compliance with the registration requirements may not on disposition thereof deduct any losses or receive capital gain treatment.

Coupon Stripping - Bondholders have used "coupon stripping" to create losses or accelerate income by selling separately bond coupons while retaining the principal. Under TEFRA the seller must:

(1) allocate the basis of the investment between the rights retained and disposed of based on their relative fair market value; and,
(2) include in income any interest accrued to the date of sale. The accrued income is added to basis in making the basis allocations.

The items retained by the bondholder — the stripped bond or coupon — will be treated as original issue discount bonds issued by a corporation on the date of disposition and subject to the periodic original issue discount rules. The purchasers of a stripped bond or a detached coupon essentially acquire an original issue discount bond and must periodically include in income the original issue discount from the date of purchase to the maturity date of the bond or redemption date of the coupon.

Tax exempt bonds are affected by TEFRA to the extent that:

(1) basis must be allocated if a tax exempt bond is stripped; and,
(2) on subsequent sale or maturity of principal, gain, to the extent of the fair market value at the time of stripping of coupons not received, will be taxed as ordinary income.

IV. Small Business

Subchapter S Corporations - The number of shareholders has been increased to 35 and the differences in stock voting rights will not create separate classes of stock.

A corporation can elect Subchapter S status during the first 75 days of a tax year. If the following requirements are not met, the election is not effective until the following year:

(1) the corporation and shareholders must have been eligible during the entire period of the tax year prior to the election; and,
(2) all persons who held stock in the corporation at any time during the period of the year prior to the election must consent to the election.

Under TEFRA, the 80% foreign source income limitation is repealed and for corporations without accumulated earnings and profits for their years as a regular corporation, the 20% passive income limitation is repealed.

Subchapter S corporations with accumulated earnings from pre-Subchapter S years will be taxed on passive income in excess of 25% of gross receipts. However, the election will be terminated only if the 25% limit is exceeded for three consecutive years.

V. Retirement Plans

Partial IRA Rollovers - A distribution from an IRA may be partially rolled over within 60 days of receipt. The amount rolled over will not be currently taxed, but any amount retained will be taxed in the year received.

Deferred Annuities - Under the IRS Code, deferred annuities generally allow an annuitant to defer taxation of the accumulated earnings until the annuity payments begin. In order to discourage the use of deferred annuities as a short-term investment, the taxation rules are changed under TEFRA for contracts entered into after August 13, 1982. For post August 13, 1982, contracts, partial withdrawals before the annuity starting date will be considered payment of accumulated earnings and will only be treated as a non-taxable distribution out of principal after all accumulated earnings are withdrawn. Loans received by the annuitant are treated as withdrawals. Withdrawals of accumulated earnings from post August 13, 1982, contracts may be subject to a 5% penalty tax, unless certain stipulated conditions are met.

* * * * *

Questions regarding this notice should be directed to Carole Hartzog at (202) 728-8141.

Sincerely,

Frank J. McAuliffe
Vice President
Qualifications and Examinations Department

Examinations Affected by the Tax Equity and Fiscal Responsibility Act of 1982
(Numerical References Within Test Series Identify Study Outline Sections Affected by the "Act")

Areas Changed

Test Series Affected

 

2

6

7

8

22

24

26

I. Individual Tax Rates

             

A. Alternative Minimum Tax

       

3.3.4

   

B. Tax Preference Items

       

3.3.4

   

II. Depreciation and Tax Credits

             

A.. Accelerated Cost Recovery System

       

3.2.2

   

B. Investment Tax Credit

       

3.2.5

   

III. Investments

             

A. Original Issue Discount

   

14.11.2

       

B. Registration of Debt Obligation

3.1,3.2,
3.3

 

1.1.3

       

C. Coupon Stripping

3.1

 

1.1.3 1.2

       

IV. Small Business

       

1.2.1

   

A. Subchapter S Corporations

             

V. Retirement Plans

             

A. Partial IRA Rollovers

5.7

3.3.1

3.3

2.3.2

 

3.1.6

2.3.2

B. Deferred Annuities

 

3.1.8

3.1.10

2.3.2

   

2.3.2

* * * *

TEST SERIES KEY

Series Number

Examination Title

2

SECO/NASD NonMember General Securities Examination

6

Investment Company Products/Variable Contracts Representative Examination

7

General Securities Representative Examination

8

General Securities Sales Supervisor Examination

22

Direct Participation Programs Representative Examination

24

General Securities Principal Examination

26

Investment Company Products/Variable Contracts


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