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Volume 2, Issue 1, dated March 31, 2001 (pdf)

• That old college cheer

• A (very) brief guide to equity

• New rules for using your retirement money

• Freelancers fight back

That old college cheer

The cost of sending your child to college or university is going up - in most cases, at a pace faster than inflation. According to The College Board, tuition costs increased on average at a rate of 5% last year.

The current average annual cost of a four year undergraduate education hovers at around $20,000 per year for private universities and $10,000 for public universities. Locally, Temple’s tuition for the year comes in at approximately $7,000 per year for residents and $12,000 per year for non-residents. Drexel’s tuition is $20,000 per year, depending on your program, and the University of Pennsylvania costs $25,000 per year.

Taking into consideration these averages, and yearly increases of about 5%, tuition costs for a newborn today to attend a public university will cost more than $100,000. Tuition costs for the same child to attend a private university could reach $250,000.

In response to growing concerns about the affordability of college, section 529 of the Internal Revenue Code, “Qualified State Tuition Programs” was enacted in 1996. It was subsequently revised as part of the Taxpayer Relief Act in 1997.

Section 529 outlines a tax-deferred savings program for qualified higher education expenses. Qualified higher education expenses include tuition, fees, books, supplies, equipment and room and board in some instances. Eligible institutions may include community colleges, undergraduate colleges, and certain graduate programs including law school, medical school and business schools, so long as the institutions qualify as an “eligible education institution” under the Code.

There are two types of plans under section 529. One plan is a “prepaid tuition” plan which allows prepayment of tuition at state-sponsored colleges or universities at discounted rates (i.e. pay at today’s rates for tomorrow’s education). This plan is generally considered the least attractive of the two because of the difficulty in determining whether a child might choose to attend a state-sponsored school. There have, however, been rumblings in Congress over extending this plan to private colleges and universities.

A much more popular plan under section 529 is the educational savings account plan. In brief, the educational savings account plan is administered by individual states, following criteria set out in section 529 of the Code. The program allows taxpayers to contribute to a qualified state tuition account for a designated individual (typically a child or grandchild). A separate account must be established for each child.

The primary advantage of the plan is that the earnings in the account are federal income tax-deferred to the donor and are taxed at the beneficiary’s tax rate upon withdrawal (generally a lower rate because of the age of the beneficiary); many states also exempt earnings from state income tax, including Pennsylvania and New Jersey. Additionally, the beneficiary/student may be eligible for the HOPE scholarship credit and the lifetime learning credit.

There are potential estate tax benefits for the donor as well. Contributions to a tuition account are considered a completed present-interest gift even though the beneficiary may not use the contributions for several years and the donor has the right to take back the funds (subject to a penalty as discussed below). If the donor elects on the federal form 709 to have the gift spread out over five years, he or she can make large gifts in one year.

There are some drawbacks to the program, as well. Taxpayers have no control over the investments, although some states do offer a choice of investment plans. Funds are, however, typically managed by a reputable investment company. There is a penalty upon withdrawal if the funds are not used for educational expenses. If the money is not used for educational expenses because the beneficiary dies, becomes disabled or receives a scholarship, no penalty is assessed. However, if the beneficiary dies prior to withdrawing the funds, the value of the account will be included in his or her estate.

Currently, forty-five states, including Pennsylvania, New Jersey, and Delaware, have qualified state tuition programs in place. State plans vary and you are not necessarily restricted to a plan in the state of your residency, though certain states have more favorable plans for residents than non-residents. You may wish to “shop around” to locate the most favorable state for investment strategies, residence requirements and state tax benefits.

There are many other options available to pay for college, including educational IRAs and savings bonds. For more information on a specific plan, residency requirements or restrictions, contact this office.

For more information on this topic contact Kelly Phillips Erb at taxgirl@erblaw.com

A (very) brief guide to equity and private placements

Many small companies have discovered the wonders of equity, of giving away small scraps of paper and receiving money in return. Indeed, over the past few years, many companies have been doing so with great abandon. Unfortunately, under federal and state securities laws these activities are very strictly regulated. Ah, securities law, you say, surely the purview of large companies like AT&T and Microsoft? Not exactly.

Generally, sales of securities must be registered with the Securities Exchange Comission (SEC) and state officials unless the sale fall under an exemption. The definition of a “sale” and a “security” is broad, very broad, and many companies which have freely given away shares of their corporation, partnership or any other equity interest in exchange for money, work, or even free Chinese food may be in technical violation of the securities laws. Even options, warrants, and some promissory notes can be considered a sale of securities. As a result, business owners must be careful about providing equity in exchange for investment or securities without the proper documentation. To make things more complicated, state securities laws may differ significantly from federal law.

Securities laws are intended to protect investors, so exemptions to the registration of securities are limited. There are four primary considerations when determining whether a sale of securities is exempt: (1) how savvy are the prospective shareholders, (2) how much information is available to the investors, (3) who will be receiving the shares, and (4) how much money is the company looking to raise.

There are a number of different factors used to determine the “savviness” of an investor, or, in securities law speak, whether the investor is “accredited” or not. Generally speaking, accredited investors include banks; business development companies; business trusts and certain other trusts with assets in excess of $5,000,000; directors, executives, or general partners of the issuer of the securities in question; individuals with a net worth of more than $1 million dollars; individuals with an annual income exceeding $200,000 or whose combined income (husband and wife) exceeds $300,000 for the past three years; or any corporation or partnership whose owners are all accredited investors.

In some cases, investments may be made by investors who are not accredited, provided they understand and are capable of evaluating the risks involved and have enough information to judge whether or not to take those risks (i.e., provided they are “sophisticated” in such matters, to use the proper terminology). Other exemptions are available for securities offerings which will be limited only to residents of the state in which the offering is made, and for employees and some consultants.

Depending upon the amount to be invested, certain information must be made available to the investor prior to the sale. This includes both financial and non-financial information. The information must be prepared and audited to certain standards, which become more exacting as the amount of money sought increases. There are antifraud provisions which prohibit inaccurate or fraudulent statements, and which require that all material facts must be disclosed.

The target audience and the number of investors must also be considered when looking at the exemptions available to an issuing company. General solicitation or advertising in mass media are generally prohibited, and, in some cases, the number of unaccredited investors may not exceed 35. As noted above, issuance of stock to key employees may be exempt under the securities regulations.

Finally, certain exemptions are limited to a maximum of $5 million in investment, whereas other exemptions may be used for unlimited investment provided the other requirements are met. Within those limitations, the requirements may vary significantly depending upon whether the amount to be raised is less than $1 million, between $1 million and $5 million, or more than $5 million.

Penalties for failure to follow securities regulations can be severe, and can include civil to even criminal penalties. In addition, investors may be able to sue for return of the invested money or damages.

Hopefully, this gives some of you an idea of some of the things to look for when considering a sale, trade, or other issuance of equity in your company. Hopefully, too, you will consider whether a transaction which you are considering may constitute a “sale” under US securities laws. Obviously, this article provides little more than food for thought, and any transaction involving unregistered securities should be reviewed by an attorney or other qualified professional.

For more information on this topic contact Chris Erb at jcerb@erblaw.com

New rules for using your retirement money

For many retirees, calculating the minimum required distributions (“MRD”) from qualified retirement plans is but one step below advanced calculus. The number of tables and divisors further complicate an already complex formula. It is, however, important to figure the number correctly because if you are age 70 1/2 or older and participate in a qualified retirement plan (or if you are the designated beneficiary of such a plan), you may be subject to tax if you take less than the MRD for the year.

This complicated math is finally beginning to change. The IRS has issued new rules that simplify how MRDs from qualified retirement plans will be figured for the year beginning January 1, 2002. If that seems too far away, don’t fret. For much of the year 2001, the MRD can be figured using the new rules or the old rules.

If your required beginning date (“RBD”) is April 1, 2001, either because you reached age 70 1/2 or retired from your job in the year 2000, and you are taking your MRD for 2000 by April 1, 2001, you must use the old rules. However, you may use the new rules for figuring the MRD that must be made by the end of 2001.

Distributions during your lifetime. Under the new rules, MRDs during your lifetime are based on a distribution period that is determined using a single table and your age. The distribution period is not affected by your beneficiary’s age unless your sole beneficiary is your spouse who is more than ten years younger than you; in that event, you must use a different table.

To figure your MRD for 2001, divide your account balance at the end of 2000 by the distribution period from the “Table for Determining Applicable Divisor for Minimum Distribution Incidental Benefit” using the “applicable divisor” listed next to your age as of your birthday in 2001. If your spouse is more than ten years younger than you, you must use the “Joint and Last Survivor Expectancy” table.

These rules also apply for figuring the MRD for 2001 if you die in 2001 after your RBD.

Distributions after your death. Designations of beneficiary for retirement plans are an important aspect of estate planning. And now they are easy to calculate! Under the new rules, if the designated beneficiary is an individual, such as your spouse or child, the MRDs for years after the year of death are based on a distribution period determined by your beneficiary’s life expectancy, whether or not you die prior to your RBD.

If your designated beneficiary is your spouse, the distribution period is the divisor listed in the “Single Life Expectancy” table next to your spouse’s age. If you die prior to the year in which you would have attained age 70 1/2, distributions to your spouse need not begin until the year in which you would have attained age 70 1/2.

If your designated beneficiary is a child or other individual, the distribution period is the divisor listed next to the beneficiary’s age as of his or her birthday in the year following the year of your death, reduced by one for each elapsed year following your death.

If your designated beneficiary is an estate or a trust, the MRD depends on whether or not your death occurs before your RBD.

If you die on or after your RBD, the account balance at the end of the year 2000 is divided by the distribution period from the “Single Life Expectancy” table. The distribution period is the divisor listed next to your age as of your birthday in the year of death reduced by one for each elapsed year since the year of your death.

If you die before the RBD, the five year rule continues to apply. Under this rule, the entire account must be distributed by the end of the fifth year following the year of your death. No distribution is required for a year before the fifth year.

For more information on this topic contact Kelly Phillips Erb at taxgirl@erblaw.com

Freelancers fight back

The advent of the internet and other computer-based compilations of magazines and other copyrighted material has resulted in a number of interested copyright cases of late. In one case, a renowned photographer sued National Geographic for including four of his photographs in the CD compilation of National Geographic magazine without his permission. The photos originally appeared in the magazines, but no separate agreement was made with regard to subsequent compilations. The photographer won, and National Geographic will be forced to either remove the photographs or, as the judge in the case suggested should be the case, pay royalties for the privilege of including them.

Another important case on this subject will appear before the Supreme Court shortly. The Tasini case involves a writer who is suing the New York Times and other providers of archived periodicals for including his writings in those online databases without payment. The publishers won the first round, Mr. Tasini the second, and now it will be up to the Supreme Court to decide whether writers or publishers have the right to determine which articles appear in online databases and other compilations.

On one hand, freelance writers claim that their rights to be compensatted are being trampled on. On the other, publishers and historians are concerned that researchers and others will not have access to articles and other publications of interest on the web and in databases. One proposed solution would have publishers pay into a fund for secondary publication, which would disburse the payments to freelancers accordingly.

It remains to be seen whether these cases settle, or whether they will stand on appeal, but there is no question that the future of online and offline archival of publications depends on the outcome of Tasini and related cases.

For more information on this topic contact Chris Erb at jcerb@erblaw.com