Financial Profile Flashcards
(80 cards)
What are 3 broad categories of clients?
Personal Customers, Institutional Customers & Fudiciary Customers
What is an individual account?
An Account where a single person wishes to open an account for his or her benefit. To
open an account for an individual, no special paperwork is needed.
Individual Account Held TOD, Transfer on Death, Pay on
Death
Most states now allow an
individual account to be held “TOD” - Transfer on Death, also called Pay on Death
(“POD”). TOD registration allows the customer to maintain control over the account,
but upon death, the account assets transfer to the named beneficiary, bypassing the
estate and bypassing probate. No one can contest the transfer
Totten Trust, TOD Account at a Bank
note for the exam that banks have a similar type of account to “TOD” registration
called a “Totten trust.” This is not really a trust account, since any adult can open one
without a trust document. These are usually small bank accounts where a beneficiary
is named to receive the account balance at the depositor’s death. Often, the
beneficiary does not even know of the existence of the account. The depositor can
revoke the “Totten trust” at any time without penalty.
Joint Account
An account where more than one person, say a husband and wife, wish to open an
account, for their mutual benefit. Three options are available for joint account ownership:
Joint Tenants with Rights of Survivorship
Each party owns an “undivided interest” in the account. If one party dies, the
other person is the sole owner of the account. This ownership option is most
common for a husband and wife. Note that it can also be used by two people
who are unmarried living in a committed relationship, or other similar “familytype” relationships.
Tenants by Entireties
method of joint ownership that is only available to a married couple
(this is a test point) and which is only available in a limited number of states. Like
JTWROS, if one dies, the surviving spouse becomes the sole owner of the
property. The main difference between JTWROS and Tenants by Entireties is
what happens if one of the account owners is sued. Tenants by Entireties treats
the ownership of the account as one entity, and if one of the owners is sued and
a judgment is obtained, the assets in the account cannot be seized. In contrast,
with JTWROS, the joint tenants are not considered to be a single legal entity. If a
single spouse was sued and a judgement was obtained, the creditor could get
50% of the assets in the account - if the judgement was that large.
Tenants in Common
Each party specifies a percentage interest in the account. If a person dies, his
percentage interest is included in his estate. It can then be passed by will to any
named person. This ownership option is most common for business partners
Family Limited Partnership Account
Limited partnerships are business forms that allow for “flow-through” of gain and loss
to the partners - without the business itself being taxable. The family members are
the partners in the venture. These are used for estate tax planning purposes where
typically the parents are the general partners who contribute assets to a trust over
which they maintain control.The heirs (children) are the limited partners, who have no management role - they are
the passive investors. The parents use their “estate tax credit” so that no estate tax is
due when the assets are contributed to the trust; and the value of such assets
contributed to the trust is “discounted” since these assets are worth a lesser amount
when they are held via a limited partnership (partnership assets are “illiquid”). So the
parents might contribute a $700,000 house to the trust; but it goes into the trust at a
$600,000 value against the estate tax credit. This discount is one tax benefit; the next
benefit is that each parent then “gifts” $17,000 worth of their shares each year to
each child (up to $17,000 of gifts can be given in 2023 to a recipient without the donor
having to pay gift tax - note that this amount is adjusted for inflation annually). Thus,
over time, the asset in the trust becomes the property of the children without an
estate tax bill. To open such an account, a copy of the certificate of limited partnership (the
document filed with the State to create the legal partnership entity) must be obtained.
Institutional customers
Are broken down into two broad categories. The oldest form of
institutional ownership is either a sole proprietorship or a general partnership. These
business forms pre-dated the invention of the corporation (which happened around
the year 1600). With these older business forms, you simply go into business. The
State can ask to be notified that you are doing business there, but there is no Statecreation of the business itself. Both sole proprietorships and general partnerships are
the easiest businesses to form, but the owners take on unlimited liability. In contrast,
State-created business entities limit liability, which is their major benefit.
Sole Proprietorship Account “DBA” - Doing Business As
A sole proprietorship is a business owned by 1 individual. To establish such a
business does not require any filing in the State; the person simply starts
business operations. This is typical for small businesses, since no formal State
charter is required. If an individual sets up a business as a sole proprietor, the
legal name of the person’s business defaults to that individual’s name. If the sole
proprietor wishes to use a different business name, then the individual must file
a form in the State notifying the State of the legal name being used – the “DBA”
name - where DBA stands for “Doing Business As.”
Form 1040 and Schedule C Are Filed
Sole proprietorships do not pay corporate income tax, but all earnings are
subject to personal income tax. A Form 1040 tax return is filed by the individual.
To report the income and loss from the business, a Schedule C (Profit or Loss
from a Business) form is attached to that individual’s Form 1040. Sole proprietors
have unlimited liability for all business debts, which makes this form of operation
not too attractive. No special paperwork is needed for this type of account.
General Partnership Account
A general partnership is formed when two or more persons form a business
enterprise under the terms of a general partnership agreement. Some States ask
that the agreement be filed, others do not. The agreement names each general
partner and his or her percentage share of income and loss in the venture. The
partnership itself is not taxable - each partner’s share of income and loss is
included on that partner’s personal tax return. Thus, there is no “double taxation”
that is inherent in “C Corporations” (covered following). However, each general
partner bears unlimited liability for all business debts, making this form of
operation unattractive. A copy of the partnership agreement filed with the State
is needed to open this type of account.
The corporation was invented how?
with the formation of the Dutch East India Company in
the early 1600s. The intent of this “new” business form was to limit liability of owners.
To get limited liability, the corporation is created in a State under that State’s
incorporation laws. Another State-created business form is a limited partnership,
which also limits liability of owners. Limited partnerships are State-created entities.
Finally, the newest type of State-created entity is an LLC (a Limited Liability Company)
that has characteristics of both corporations and partnerships.
Limited Partnership Account, Passive Investors, DPP - Direct Participation
Program
A limited partnership is formed when 2 or more persons form a business
enterprise where at least 1 person is a general partner and 1 person is a limited
partner (there must be at least 1 of each). The general partner is the manager of
the venture and bears unlimited liability. The limited partner(s) is (are) the
passive investors, whose loss is limited to their investment in the partnership.
The partnership itself is not taxable - each partner’s share of income and loss is
included on that partner’s personal tax return. Thus, there is no “double taxation”
that is inherent in “C Corporations” (covered following). Because these allow “direct participation” in income and loss, these are commonly referred to as
“DPPs” - Direct Participation Programs. A copy of the certificate of limited
partnership, which is the State-creation document, is needed to open such an
account
C Corporation Account
A C corporation is a type of company that, under the IRS code, is a taxable
entity. The corporation computes net income (or net loss) and must pay
corporate income tax on any net income. If the corporation pays a cash dividend
to shareholders out of “after-tax” income, the shareholders must include the
dividend amount on their personal tax returns, and pay personal income tax on
the distribution. Thus, C corporation cash dividends are said to be “double
taxed.” Though the tax status of C corporations is less beneficial, in return,
shareholders have limited liability - the most that they can lose is their
investment.
To form a C Corporation, a certificate of incorporation must be filed in the State.
Under the terms of that State’s corporate charter, the corporation is bound to the
laws of that State. A copy of the corporate charter is needed to open such an
account
S Corporation Account
A corporation that has 100 or less shareholders can elect “S” corporation status
for tax purposes. S corporations are not taxable entities - all items of income and
loss flow-through onto the shareholders’ personal tax returns (similar to
partnership taxation). Thus, smaller companies and family owned companies,
can take advantage of limited liability and avoid the “double taxation” inherent in
C Corporations. A copy of the corporate charter is needed to open such an
account.
Limited Liability Company Account
A relatively new type of business form, “LLCs” are neither a corporation nor a
partnership. They are formed as business entities that give the “flow through
benefit” associated with S Corporations (or partnerships) without the
shareholder limitation imposed on S corporations (maximum of 100
shareholders). In addition, LLC “members” (the owners are neither shareholders
nor partners) can take a management role without being considered to be
general partners in a venture (who would assume unlimited liability).
Thus LLCs have the benefits of flow-through taxation and limited liability. To
form an LLC, a certificate of organization, which is the State-creation document,
must be filed in the State. A copy of this document is needed to open an LLC
account.
Fiduciary customers are:
Trust Account, Settlor, Trustee, Beneficiary
Trust Account
In a trust, a trustee is appointed to manage the assets for a beneficiary under the
terms set forth in the Trust Agreement. The terminology associated with trusts is
“legalistic,” but must be known for the exam:
Settlor
The settlor is the individual who establishes the trust, donates the assets to the
trust, sets the objectives of the trust, names the beneficiary(ies) of the trust and
names the trustee.
Trustee
A fiduciary that manages the assets of the trust in the best interests of the
beneficiary(ies).
Beneficiary
The individual(s) named in the trust document for whom the assets are being
managed. The trust document may, or may not, bequeath the assets to the
beneficiary(ies) on the death of the settlor.
Legal List
The trust is a legal entity formed in the State, with the trustee being a fiduciary over
the account. Fiduciaries are often limited by each State in the types of investments
that can be made. State law requires that fiduciaries either follow the “prudent man”
rule or restrict investments to a “legal list” provided by the State.
