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Tuesday, February 18, 2003

Hidden Costs of Tax Reform

by: Sean Hanna, Editor in Chief

If President Bush's gets his way on the tax treatment of dividends, the fund industry may face higher costs. Tracking and reporting dividends as required by the proposed tax reform would add major administrative, accounting, and technology problems, according to reports. The firms facing the largest immediate costs would be back office firms, including Bisys, PFPC and DST.

Those recordkeepers and administrators would be facing major reprogramming of their systems in order to comply with the new tax code. Undoubtedly, they would pass most or all of those costs on to fund firms.

Part of the problem is the complexity of the President's proposal. Only dividends paid from earnings would be tax exempt. Dividends paid by companies without earnings qualified under the proposal would not be exempt. A further wrinkle would be "deemed dividends". Those dividends represent retained earnings that are not paid by shareholders but do serve to raise the cost basis for shares for capital gains purposes.

All of those dividends, deemed dividends and revised cost basises would have to be tracked by funds. Today, though, no fund accounting system is set up to do this. The ICI is aware of these problems and has put the issue on the agenda for its upcomming meeting of the tax committee.

Besides the obvious costs, a second and just as large a problem will be the speed with which a solution has to be implemented. Having to implement a speedy solution would both raise the costs of programming fixes and raise the possibility of costly errors.

Today, the liklihood of Bush's plan surviving its way through Congress is unknown. The White House hopes to have the bill passed through by Congress' Summer recess. There is a chance, though, that the bill would not be passed until the end of the year and that it is significantly changed. There is also the possibility, of course, that the dividend proposal is dropped all together. Perhaps it is wise to leave some room in your budget just in case.  

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