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OVERVIEW

• Allocation of expense items applies both to spreading the economic burden of the expense and the allocation of the taxable deduction.
• If you allocate any expenses equally, amend your partnership agreement to reflect your policy in the matter.
• Decide as a group on your philosophy for your investment club. Are you an association of individuals who benefit equally from the administrative costs of your club, or are you a partnership, one entity, whose success or failure will be shared by members in proportion to unit holdings?
• Don't assess fees to fund expenses. But if you have been doing this, and are not going to change, don't allocate those expenses equally.

When talking about the allocation of expenses, it is important to remember that there are really two separate areas to discuss. First, how is the economic burden of the expense to be shared by the members? Second, how will this expense be allocated among members for tax purposes. In that connection, it is very important, if your club allocates expenses in any way other than proportionate to members' units, that your partnership agreement spell out how expenses are to be allocated for tax purposes.

Read that sentence again. I would wager that very few, if any, clubs that allocate expenses equally, spell it out in their partnership agreement, in spite of the fact that the IRS clearly states that, in the absence of such wording, expenses will be allocated in proportion to ownership.

It should also be noted that the ability to allocate expenses equally is a relatively new feature introduced to club accounting software programs. Before 2001, there was no option to do this. Clubs that wanted to allocate expenses equally did so by assessing a fee for the expense, and then immediately recording the expense. While this method did indeed allocate the economic burden for the expense equally, it did not allocate the tax deduction equally. Also, there was the additional problem that if you did not assess fees for exactly the same amount as the expense, an imbalance favoring the larger unit holders was introduced. Click here for an article on this subject.

When, in 2001, clubs were allowed options in allocating expenses. two schools of thought sprang up. One school said certain expenses of the club benefit each member equally, and thus should be allocated equally. Examples given were copying costs for reports, supplies, and even non-deductible expenses such as refreshments.

The other school said, not so. We formed an investment club because we felt the whole was greater than the sum of its parts. As a group, we can get much better information than we could get on our own. Therefore, any expenses involved in operating as a club, should be borne in ratio to ownership. Just as the larger unit holders benefit the most when stocks go up, so should they bear the greater portion of any expenses.

Since we are talking about investments, it was inevitable that there soon would be more than two schools of thought. So, a third school sprang up. Let's call it the hybrid school. This line of thinking went something like this. Some expenses benefit members in the same way as stock appreciation. An investment advice newsletter would be an example of this. So these expenses should be allocated in accordance with ownership. Other expenses benefit each member equally. Non-deductible refreshment expenses would fall into this category. So these expenses should be allocated equally.

Probably no issue has been more fiercely debated than the correct allocation of the annual dues to the NAIC. The amount of the NAIC fee is made up of two portions - one flat sum for each club, and a per member assessment. The fact that there is a per member assessment leads many clubs to the conclusion that that portion of the NAIC dues should be allocated equally. However, that issue becomes a little more cloudy when it is found that some club members are not figured in the per member assessment, since they are either life time members or are members of more than one club. If the per member portion does not include all members, it is hard to argue that the member portion of the dues should be allocated equally. A better solution for those that feel that the members should bear that portion is to have each member make out a check payable to NAIC and have the treasurer include those checks with the payment to NAIC for the club portion.

Clubs that feel that, as an investment club, all expenses should be borne by members in proportion to holdings, say that the NAIC dues are a part of doing business by the club and should be treated as any other expense.

Other articles on this website caution against clubs' making fee assessments to fund expenses.  Click here  for an article on this subject. However, in spite of this advice, it is recognized that a great number of clubs still do assess an annual fee to fund expenses. For clubs that do this, it is extremely important that they do not, repeat NOT, allocate these expenses equally. To do so, will create a double whammy for the smaller unit holders. Any time that a fee is assessed on all members, a portion of the value of the smaller unit holders is transferred to the larger unit holders. When this assessment is used for payment of equally allocated expenses this imbalance is escalated. Click here for more information.