The Beatles, Taxman - Chatham Financial

After spending the late 1950’s struggling to make ends meet in Hamburg, the Beatles engaged Brian Epstein in early 1962 to help realize their commercial potential, and within a few years they were earning rock star riches. So imagine George Harrison’s horror at finding out that Harold Wilson’s Labour government had passed a 95% supertax levied on the band’s earnings. No surprise, then, that the first song on the Beatles’ 1966 release Revolver had George choking out lyrics like: “Should five percent appear too small, be thankful I don’t take it all, ‘cos I’m the Taxman.” The Beatles broke up a few years later, but perhaps they ushered in a revolution of the taxation variety, for bands from the British Isles (U2 and the Rolling Stones, inter alia) have been setting up Irish corporate structures and Dutch pass-throughs to minimize their taxes ever since.

While we have never had to think about how to pay taxes on rock star riches, our family does need to file accurately with the IRS each year. For us, tax filing practices have fallen into three distinct eras:

1) We Can Work it Out: The first years of filing were fairly straight-forward; most of the lines on the 1040 were blank and the standard deduction applied. Even when we started itemizing deductions and adding dependents (including one born on December 31st at 9:32 pm in an extraordinary feat of tax efficiency delivered by my wonderful wife!), we generally felt comfortable that we could work it out without any assistance.

2) Help!: In 2007, our family moved to Krakow, Poland as part of the launch team for Chatham’s office there. From a tax perspective, we found ourselves needing somebody (not just anybody!). Since we had to comply with multiple tax codes in multiple languages, a correctly filed U.S. federal return grew from 9 pages to around 90! It quickly became apparent that it wouldn’t be possible to navigate the complex interplay of the American and Polish tax systems without outside tax experts to prepare our returns, so we engaged a company to complete our taxes directly for those years.

3) Come Together: In 2011, we got back to where we once belonged in the States. The tax code had grown substantially more complex, as had our life situation. It would be overly expensive relative to value to continue with our international tax experts, but impracticable to go back to hand calculations and paper tax forms. Consequently, we took a hybrid approach, purchasing tax software specifically tailored for our version of tax filing complexity, filling in key details ourselves, and relying on tax experts (included in our purchase price) for anything out of the ordinary.

In our experience, most companies analyze similar trade-offs when considering how to account accurately for financial derivative positions under ASC 815. Applying the same Beatles framework my family used for personal tax filing helps to clarify the alternatives:

We Can Work it Out: Many companies with whom we speak started out writing their hedge designation memos, creating their fair values, performing their effectiveness assessments, and calculating their journal entries. As those companies have grown, the operational risks associated with developing critical financial reporting data via Excel models have magnified, and some of the required calculations are too complicated for Excel (like credit valuation adjustments). As business exposures, derivative structures, and accounting regulations become increasingly complex, it can become more difficult and risky to work it out alone.

Help!: Faced with the above challenges associated with managing derivatives accounting alone, a number of firms turn to large software systems to take responsibility for derivatives accounting. The right accounting systems certainly reduce operational risks vis-à-vis spreadsheets, but many tend to be a black box without discernible steps from raw inputs to accounting assessments, journal entries, and disclosure outputs. Further, without expert hedge accountants available to provide support and technical advice, black-box accounting systems can make it challenging to understand outputs, identify issues, or handle nuanced hedging scenarios. However, the right accounting system combined with expert-level support professionals alleviates the administrative burden and risks of working it out alone.

Come Together: For many companies, neither relying on internally produced spreadsheets nor administering a program via a software platform fits their risk profile or accounting policy. As a result, they take a hybrid approach, fusing the reliability of a well-tested software system with the availability of expert accounting recommendations and advice. That way, the system can handle what it does best – accounting tracking, calculation, and disclosure creation – and the experts are always available to provide custom approaches to individualized challenges.

Chatham provides hundreds of companies with customized hedge accounting solutions that incorporate expert advisory with systems and technology. We’d love to discuss our approach to providing hedge accounting solutions with you, so give us a call 610.925.3120 or email us. and best wishes for April 15th! We hope you all get big refunds, but if you don’t, just remember that money can’t buy you love!