Tag Archives: Taxes

A different tax saving strategy

Tax loss harvesting allows people to reduce their taxable income by selling securities that have gone down in value. Capital losses can be used to offset ordinary income or to offset realized capital gains.

But if an individual dies with a capital loss that they have not used, the person who inherits these securities may not be able to use these losses.  There is a way to use these capital losses if it’s done right.

For example, If Joe buys a stock for $200 and it declines to $100 and then gives it to daughter Sue, her cost basis is $100 (the value when he gifts the stock). If she then sells it for $100 she cannot claim a loss.

However, if Joe gave the stock to wife Mary who then sells it for $100 she can claim a loss of $100 (the original cost $200 – $100 = $100 loss).

This is a quirk written into the tax code -Section 1015(e) – specifically designed for gifting of depreciated assets to a spouse.

This example only works if the assets are gifted before death. If Fred dies with the depreciated stock the tax cost basis is its value as of the date of death.

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How tax brackets work

Being in the 24% tax bracket doesn’t mean you pay 24% on everything you make.

The progressive tax system means that people with higher taxable incomes are subject to higher tax rates, and people with lower taxable incomes are subject to lower tax rates.

The government decides how much tax you owe by dividing your taxable income into chunks — also known as tax brackets — and each chunk gets taxed at the corresponding rate. The beauty of this is that no matter which bracket you’re in, you won’t pay that rate on your entire income.

Being in the 24% tax bracket doesn’t mean you pay 24% on everything you make.

For example, let’s say you’re a single filer with $32,000 in taxable income. That puts you in the 12% tax bracket in 2018. But do you pay 12% on all $32,000? No. Actually, you pay only 10% on the first $9,525; you pay 12% on the rest.

These Tax Cuts and Jobs Act passed last year changed the tax brackets as well as the standard deduction.  The old 2017 tax bracket for this taxpayer was 15% meaning that he pays quite a bit less in 2018 than 2017.

If you are single and had $90,000 of taxable income, you’d pay 10% on that first $9,525, 12% on the chunk of income between $9,525 and $38,100, 22% on the income between $38,700 and $82,500 and 24% on the rest because, because some of your $90,000 of taxable income falls into the 24% tax bracket. The total bill would be about $15,890 — about 18% of your taxable income, even though you’re in the 24% bracket.  This is often referred to as your “effective rate”  as opposed to your “marginal rate.”

Under the new law, the “standard deduction” is going to make a big difference.  For a single filer, the deduction goes from $6,500 to $12,000.  For a married couple filing jointly the standard deduction goes from $13,000 to $24,000.  The increase in the standard deduction means that many people are no longer going to itemize.

 

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Can We Afford a Tax Cut?

 

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Our favorite economist, Brian Wesbury of First Trust says “yes.”:

Congress took a big step last week toward enacting some sort of tax cuts and tax reform.

That big step was the US Senate passing a budget resolution creating the room for ten years of tax cuts totaling $1.5 trillion with a simple majority vote. This procedure means there is no need to break a filibuster by getting to 60 votes.

So right about now is when self-styled “deficit hawks” will start to squawk. They will claim the federal government simply can’t afford to boost the federal debt, which already exceeds $20 trillion, with no end in sight.

Let’s put aside the issue that between 2009-12 many of these deficit hawks were supporting new spending, when annual federal deficits were $1 trillion plus. Let’s just take them at their word that they don’t think any policy that increases the deficit can be good for the economy.

One problem with their argument is that the $1.5 trillion is an increase in projected deficits over a span of ten years, not a definite increase in the debt. If tax reform focuses on cutting marginal tax rates, particularly on overtaxed corporate capital and personal incomes, and can thereby generate faster economic growth, the actual loss of revenue could be substantially less than $1.5 trillion or maybe nothing at all.

The estimate of a $1.5 trillion revenue loss is based on “static” scoring, which means the budget scorekeepers on Capitol Hill make the ridiculous assumption that changes in tax policy can’t affect the growth rate of the overall economy. Just a 1 percentage point increase in the average economic growth rate over the next ten years would reduce the deficit by $2.7 trillion, easily offsetting the supposed cost of the tax cut.

Another problem for the deficit hawks is that despite a record high federal debt, the servicing cost of the debt is still low relative to both the size of the economy and federal revenue.

Late last week, we got final numbers for Fiscal Year 2017 and net interest on the national debt was $263 billion – that’s just 1.4% of fiscal year GDP. To put that in perspective, that’s lower than it ever was from 1974 to 2002. The peak during that era was 3.2% of GDP in 1991. The lowest point since 1974 was 1.2% in 2015, not far from where we are today.

The same is true for interest relative to federal revenue, which was 7.9% in Fiscal Year 2017, lower than any year from 1974 to 2013. The high point during that era was 18.4% in 1991 and the recent low was 6.9% in 2015. Again, we’re still pretty close to the recent low.

Yes, interest rates should move up in the years to come, but it will take several years to rollover the debt at higher interest-rate levels. Even if interest rates went to 4% across the entire yield curve, the interest burden would remain below historical peak levels relative to GDP and tax revenue.

The US certainly has serious long-term fiscal challenges. The US government has over-promised future generations of retirees and should ratchet back these spending promises to encourage work, saving, and investment. Meanwhile, we need the US Treasury Department to issue longer-dated maturities like 50-year and 100-year debt to lock-in low interest rates for longer.

However, the absence of these changes should not be an obstacle to boosting economic growth by cutting tax rates and reforming the tax code. Plow Horse economic growth is certainly better than no growth at all, but turning the economy into a thoroughbred would make it easier to handle our long-term budget challenges, not harder.

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Required Minimum Distributions from Inherited IRAs

If you inherit an IRA and are not a spouse of the deceased you have two choices:

  1. You can cash it in and pay income taxes on the proceeds, or…
  2. You can defer the taxes on it and allow it to grow tax deferred.

An Inherited IRA (also known as a Beneficiary IRA) differs from a regular IRA and the two should not be combined.  A key difference between the two types of IRAs is how Required Minimum Distributions (RMDs) are calculated. Specifically, a different IRS table is used (the Single Life Table) to calculate the first year’s RMD from an Inherited IRA, and this initial calculation is used for the calculation of RMDs in subsequent years.

A second difference is that you are not required to take RMD distributions from a regular IRA until you turn 70 ½.  However, you are required to take an RMD from an Inherited IRA by the end of the year after you receive it.  This is true no matter the age of the deceased or the beneficiary’s age.

The amount of the RMD is based on value of the IRA at the end of the previous year and the age of the beneficiary.  The rules can get quite complicated and it’s usually a good idea to consult a professional to insure that you don’t run afoul of the IRS.  Penalties for not taking the RMD can be as high as 50%.

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Getting ready to file your taxes? Pay attention!

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As we head into tax season, many of you have received tax reports – commonly referred to as “1099s” – from your investment firm.

The IRS requires that 1099-MISC forms must be mailed by January 31st,  but issuers are not required to file copies of all 1099 Forms with the IRS until the end of February.

We frequently advise our clients to delay filing their taxes until March at the earliest.  That’s because the tax code is so complex that errors are inevitable.  As a result, investors often receive “corrected” 1099 forms after the February deadline has passed.  This may result in a change in the tax owed.  Those who use tax preparers or CPA firms may need to have their tax re-calculated, increasing the cost to the investor.

We note that Morgan Stanley has admitted to providing erroneous information to its clients.

Apparently Morgan Stanley’s reporting system sometimes generated an incorrect cost basis for its clients’ stock or bond positions, which threw off capital gains tax calculations following the sales of the securities, the paper reports. The errors affected a “significant number” of the firm’s 3.5 million wealth management clients for tax years 2011 through 2016, according to the paper. But around 90% of the under- or overpayments were less than $300 while more than half were less than $20, a Morgan Stanley spokesman tells the Journal.

It is always a good idea to check the accuracy of the statements you receive from your custodian.  There may be erroneous or missing information.  In many cases where securities were purchased years ago, the custodian does not have the cost basis of stocks or bonds that were sold.  In those cases the investor is responsible for providing that information.  If you do not provide that information, the IRS may assume that the cost basis is zero and tax you on the full amount of the proceeds of sale.

On a final note, many clients have asked us how long they need to keep records for tax purposes.  The primary IRS statute of limitations was three years. But there are many exceptions that give the IRS six years or longer. Several of those exceptions are more prevalent today, and one of them has gotten bigger.  The three years is doubled to six if you omitted more than 25% of your income. “Omitted” can mean to not report at all, or it can mean that the amount of income was under-reported by 25% or more.

If you have questions about your tax forms, or wonder where you can get assistance to determine the cost basis of securities bought or gifted long ago, give us a call.

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The New Trump Economy

We have been talking about the “Plow Horse Economy” for quite a while now.  Low interest rates designed to spur economic growth have been offset by other government policies that have acted as a “Plow” holding the economy back.

Market watchers have assumed that the November election would see a continuation of those policies.  The general prediction was for slow growth, falling corporate profits, a possible deflationary spiral, and flat yield curves.

What a difference a week makes.  The market shocked political prognosticators by standing those expectations on their heads.

Bank of America surveyed 177 fund managers in the week following the elections who say they’re putting cash to work this month at the fastest pace since August 2009.

The U.S. election result is “seen as unambiguously positive for nominal GDP,” writes Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett, in a note accompanying the monthly survey. 

The stock market has reached several new all-time highs, moving the DJIA to a record 18,924 on November 15th, up 3.6% in one week.

Interest rates on the benchmark 10-year US Treasury bond have risen from 1.83% on November 7th to 2.25% today (November 17th), a 23% increase.  Expectations for the yield curve to steepen — in other words, for the gap between short and long-term rates to widen — saw their biggest monthly jump on record.

 WealthManagement.com says that

Global growth and inflation expectations are also tracking the ascent of Trump. The net share of fund managers expecting a stronger economy nearly doubled from last month’s reading, while those surveyed are the most bullish on the prospect of a pick-up in inflation since June 2004.

Investors are now also more optimistic about profit growth than they have been in 15 months.

Whether this new-found optimism is justified is something that only time will tell.  In the meantime to US market is reacting well to Trump’s plans for tax cuts and infrastructure spending.  Spending on roads, bridges and other parts of the infrastructure has been part of Trump’s platform since he entered the race for President.  It’s the tax reform that could be the key to a new economic stimulus.

According to CNBC American corporations are holding $2.5 trillion dollars in cash overseas. That’s equal to 14% of the US gross domestic product.  If companies bring that back to the US it would be taxed at the current corporate tax rate of 35%.  The US has the highest corporate tax rate in the world.  The promise of lower corporate tax rates – Trump has spoken of 15% – could spur the repatriation of that cash to the US, giving a big boost to a slow growth US economy.

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Questioner asks: “Should I roll my SEP IRA into a regular IRA or a Roth IRA?”

There are two issues to consider in answering this question.

  1. If you roll a SEP IRA into a regular or rollover IRA, assuming you do it right, there are no taxes to pay and your money will continue to grow tax deferred until you begin taking withdrawals.  At that point you will pay income tax on the withdrawals.
  2. If you decide to roll it into a Roth IRA you will owe income tax on the amount rolled over.  However, the money will then grow tax free since there will be no taxes to pay when you begin taking withdrawals.

If you roll your SEP into a Roth, be sure to know ahead of time how much you will have to pay in taxes and try to avoid using some of the rollover money to pay the tax because it could trigger an early withdrawal penalty – if you are under 59 1/2 .

It’s up to you to decide which option works best for you.  If you are unsure, you may want to consult a financial planner who can model the two strategies and show you which one works better for you.

As always, check with a financial professional who specializes in retirement planning before making a move and check with your accountant or tax advisor to make sure that you know the tax consequences of your decision.

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Getting Financial Help

When people have financial questions, what do they look for?  According to a recent survey most people are looking for someone with experience.  We want to take advice from people who are familiar with the issues we face and know what to do about them.  We all know people with experience, but financial problems, like medical problems, are personal.  Most people we know would rather not go into detail about their personal finances with family or friends.  They are more comfortable sitting down with a financial professional to discuss their finances, their debts, their financial concerns, and their financial goals in both the short and long term. Professionals will provide advice without being judgmental and are required by their code of ethics to keep your information confidential.

Once people find someone who has a track record of giving good, professional advice, they want personalized advice and “holistic” planning.

No two people have exactly the same problems.  A good financial advisor listens attentively to learn the goals, the concerns and personal history of the people who come to him for advice.

People have specific issues and questions.  For example: a couple, aged 39, is seeking advice about their path to retirement.  They give their financial advisor a laundry list of their assets, their investments, their savings rate, their debts, and the ages of their children and ask if they should be doing something different or are they on the right path.  That’s a very specific question and the advisor’s response is going to be personalized for them.

The plan that the advisor comes up with is going to involve much more than money.  It’s going to take their personal characteristics into account.  This includes personal experience with investing, their risk tolerance, and their closely held beliefs and ethical values.  This is what is referred to as “holistic” planning; taking personal characteristics into consideration.

There is a fairly big difference in the advice sought by

  • “Millennials” (those born after 1980 and the first generation to come of age in the current century),
  • “Generation X” (the children of the Baby Boomers) and the
  • “Baby Boomers” (children of the soldiers returning from World War 2)

“Millenials” say that among their top three concerns are saving for a large expense such as a car or a wedding.  Too many are saddled by debt acquired to pay for higher education and are finding that their degrees are not necessarily an entry into high paying professional jobs.  Their next largest concerns are saving for their kids’ education and putting money aside for retirement.

“Generation X” is primarily focused on saving for retirement.  They are married, own their own home and may have children in college.  Concerns two and three are tax reduction and paying for their children’s education.

“Baby Boomers” have finally reached retirement age.  More than a quarter million turn 65 each month.  As a group they are a large and wealthy generation, but a vast number have not saved enough for a comfortable retirement.  Many are forced to continue to work to supplement Social Security income.  Their number one concern is the cost of health care.  Concerns two and three are protecting their assets and having enough income for retirement.  The three concerns for Baby Boomers are inter-connected.  For many Boomers, Medicare helps them with the costs associated with most medical issues.  However, as people live longer, there comes a time when they are unable to care for themselves and live independently.  Long-term-care insurance was once believed to be the answer but insurance companies found that costs were much greater than anticipated.  The result is that many insurers have stopped offering the policies and those remaining have hiked premiums beyond the ability of many to pay.  The cost of long term care is so high that many Boomers are afraid that their savings will soon be exhausted if they are forced into assisted living facilities or nursing homes.

Each generation has its own problems and at a time when the world has gotten much more complicated.  Getting experienced, personalized and holistic financial advice is more important than ever.

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Keeping the Family Together With a Private Foundation

A private foundation has many advantages for the high net worth (HNW) individual. Along with the tax benefits, the foundation also provides a way of keeping families together.

Private foundations sound like they are only appropriate for the ultra-rich; but that’s not the case.  There are over 90,000 private foundations in the U.S. and 98% are under $50 million.  In fact you can start a private foundation with as little as $250,000 according to Foundation Source.

Of course the immediate advantage of a private foundation is the tax benefit you get from funding it.  It sets you apart in the world of philanthropy and allows you to leave a legacy that can outlive you.  It also provides protection from unsolicited requests for donations; you can always tell people that it’s a wonderful cause but you’ll have to check with your board.

But one of the major benefits of a family foundation is that it can act in many ways like a family business.  It can create the glue to keeps a dispersed family together working toward a common purpose.  It creates a way of instilling family values and transmitting those to a younger generation.

A large proportion of family foundations have two or more generations on the board.  Most are set up as family affairs with membership limited to immediate members of the family.

Contact us for more information.

 

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Changes in tax law create problems for trusts – what to do now.

In our previous discussion of this issue we reviewed why so many estate plans included an A/B (or “spousal” and “family”) trust as a key provision of the plan.  It was a way of avoiding high estate taxes on modest sized estates.  However, when the tax laws were changed to increase the amount exempt from estate tax to $5.45 million per person (the current amount) it exposed some problems with these plans for people whose estates are under the exemption amount.

These are:

  • Inconvenience
  • Administrative costs
  • Capital gains taxes

Inconvenience:

Setting up two trusts requires establishing separate banking and investment accounts to hold the assets of each trust.

The surviving spouse may be allowed to use the income and assets in the “family” trust for health, education, maintenance and support but has to be careful that the heirs to the trust do not dispute the manner in which these assets are managed or dispersed. In the case of a blended family, this could cause problems.

Administrative costs:

Determining which assets go into the “family” and the “spousal” trust often requires the assistance of an attorney, a CPA or a financial advisor.

The income in the “family” trust requires a separate tax return and the tax rates on the two trusts are different.

This means that the surviving spouse may need expensive professional help for the rest of his or her life.

Capital gains taxes:

This can be the biggest issue of all.  When someone dies, the assets owned by the decedent have a step-up in cost basis.  This means is that if someone bought stock ABC many years ago for $1 per share and dies when the stock is worth $100, the new tax cost basis on ABC is $100.  If the heirs sell it for $100 there is no capital gains tax.   If it’s left to the spouse the spouse receives the stepped-up cost basis.  At the death of the spouse, the heirs receive a second stepped up cost basis.

Only assets left to the surviving spouse or to a “spousal” trust receive a stepped up cost basis at the survivor’s death.  Because the assets in the “family” trust never become the assets of the surviving spouse for tax purposes there is no second step-up in cost basis when the survivor dies.

For example, if ABC is put in the “family” trust with a stepped up cost basis of $100 and the stock is worth $200 per share when the surviving spouse dies, the heirs have to pay a capital gains tax of $100 ($200 – $100 = $100) when they sell.  If it had been left to the surviving spouse, the capital gain tax would have been avoided.

If the estate plan documents were prepared when the exemption was much lower, the result could be an actual increase in cost and increase in taxes rather than a tax saving.  It may be time to meet with your attorney and bring your estate plan up to date.

In our next essay we will briefly look at ways to increase the amount that can be left estate tax free to over $10 million.

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