Saturday, December 18, 2010

Highlights of the New Tax Law

Two-year extension of all current tax rates through 2012• Rates remain 10, 25, 28, 33, and 35 percent
• 2-year extension of reduced 0 or 15 percent rate for capital gains & dividends
• 2-year continued repeal of Personal Exemption Phase-out (PEP) & itemized deduction limitation (Pease)
Temporary modification of Estate, Gift and Generation-Skipping Transfer Tax for 2010, 2011, 2012 • Reunification of estate and gift taxes
• 35% top rate and $5 million exemption for estate, gift and GST
• Alternatively, taxpayer may choose modified carryover basis for 2010
• Unused exemption may be transferred to spouse
• Exemption amount indexed for inflation in 2012
AMT Patch for 2010 and 2011• Increases the exemption amounts for 2010 to $47,450 ($72,450 married filing jointly) and for 2011 to $48,450 ($74,450 married filing jointly). It also allows the nonrefundable personal credits against the AMT.
Extension of “tax extenders” for 2010 and 2011, including:• Tax-free distributions of up to $100,000 from individual retirement plans for charitable purposes
• Above-the-line deduction for qualified tuition and related expenses
• Expanded Coverdell Accounts and definition of education expenses
• American Opportunity Tax Credit for tuition expenses of up to $2,500
• Deduction of state and local general sales taxes
• 30-percent credit for energy-efficiency improvements to the home (IRC section 25C)
• Exclusion of qualified small business capital gains (IRC§1202)
Temporary Employee Payroll Tax Cut• Provides a payroll tax holiday during 2011 of two percentage points. Employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to $106,800.

Wednesday, December 15, 2010

Taxing Matters

It looks like Congress and the White House have agreed on a plan that will continue the current income tax rates, capital gains tax rate and dividends tax rate for two additional years (2011 and 2012). The framework agreed to also includes a patch for the Alternative Minimum Tax (AMT) that should (again) prevent its application to us middle-class taxpayers.

This is called “kicking the can down the road” which means we haven’t heard the last of these issues – like vampires, they will return from the dead at the next dawn – i.e., the 2012 election cycle. Undoubtedly, there will be some members of Congress who will rise to the level of hypocrisy we have come to know and love from our elected representatives on these issues. I tell ya, there is no position that any politician hasn’t taken that he or she won’t attempt to walk back when faced with losing their job and contemplating having to actually work for a living like the rest of us.

It is what it is, and it is my job to deal with the reality on the ground and bring you the best thinking and advice in advancing your goals.

The Alternative Minimum Tax (AMT)
Earlier in the year we were concerned that many middle class taxpayers would be subject to the Alternative Minimum Tax as the size of the previous years’ “patch” had been reduced for 2010. It looks like we’re going to escape this one, one more time.

Roth IRA Conversions
2010 is the first year that anyone can convert pre-tax retirement assets to post-tax retirement assets (Roth IRA) regardless of income level. Of course, such conversions require the payment of income taxes on converted assets at the taxpayer’s marginal rate. There has been some urgency on the part of the financial advice community as the income tax rates applicable to 2010 conversions were a known quantity, but the tax rates applicable to conversions after 2010 were not. With the agreement to continue the current rates for two more years, the urgency to beat the tax collector by converting pre-tax assets in 2010 has abated somewhat. That doesn’t mean that conversions in 2010 no longer make sense. I think many taxpayers will be best served with a series of annual conversions, timed and allocated in such a manner that the extra income is taxed within the taxpayer’s current marginal tax bracket. As they say, “individual situations can and will vary – consult your professional advisors before taking action”.

There is at least one remaining reason to effect a conversion in 2010: the “one-time only” ability to defer the taxation of the amount converted into the two tax years subsequent to 2010, namely, 2011 and 2012. Taxpayers converting assets in 2010 may elect to split the amount converted into two allocations: 50% to be added to their income for tax year 2011 and 50% to be added to their income for tax year 2012. With the (probable) continuation of the 2010 income tax rates and brackets, the taxes due on conversions in 2011 and 2012 are likely to be similar to conversions taxed in 2010 ASSUMING the taxpayer’s other income does not significantly increase. Those electing the deferral are taking the chance that their other income could be larger than they anticipate with current information, and thus pay a higher marginal rate on a 2010 conversion in future years. The tax rates are certain, the amount of taxable income is not, particularly if your income is given to fluctuation or in those situations where your employer finally gets around to recognizing your outstanding contribution and gives you that raise that you’ve been deserving for lo these many years.

For assets converted in 2010, it probably makes sense to tax the transaction in 2010, which is an available option.

Regardless, Roth conversions contain an escape clause, not unlike those contractual fine print items that allowed our noble bankers to escape punishment with their 7 and 8-figure bonuses intact. A Roth conversion can be reversed (“re-characterized” in IRS parlance) up until the filing date of the tax return for the year in question. For most of us, this is April 15, but the rule allows a reversal up to the filing date as extended, which means that reversals can be effected as late as mid-October (October 17, 2011 for 2010 returns). A reversal of the conversion puts the assets back in a pre-tax state as if the conversion had never taken place. So, if you do a conversion here in the remaining days of 2010, and then realize – before you file your 2010 return – that “things have changed” – you get a free do-over. This do-over is available every year in which a Roth conversion is effected. So for those doing a series of annual conversions, each separate conversion has a “free-look” period that expires on the filing date for the return for that tax year, including extensions. And you thought extensions were just for hair.

Roth Contributory IRAs
Aside from the Roth IRA Conversion issue, many taxpayers can make annual contributions to a Roth IRA. The allowance of such contributions is based on income. A chart is probably the best way to illustrate:

Oops - the chart didn't survive - contact me if you want the details or check IRS Pub590

Back Door Roth IRAs
If your income precludes you from making a contribution (see above) consider the Back Door Roth IRA. Anyone can fund a Traditional IRA regardless of income, but you probably will not be able to take a tax deduction for the contribution due to income limits or coverage by an employer plan such as a 401k, etc. There is no provision in the Roth conversion rules to prevent taxpayers from funding a Traditional IRA and then turning around the next day, week or month and converting the Traditional IRA to a Roth IRA. So it’s a two-step process, not unlike being coerced into a line dance at a cowboy-themed nightclub: 1) open a Traditional IRA and fund it (maximum $5,000 or $6,000), 2) open a Roth IRA Conversion account and convert the assets in the Traditional IRA into the Roth IRA. Depending on how the assets in the Traditional IRA have grown – or not - prior to the conversion, there will likely be little or no taxable income as the result of the conversion. A conversion even an Atheist can love.

Payroll Tax Holiday
The new agreement also includes a reduction in the EMPLOYEE contribution to Social Security (FICA) from the current 6.2% to 4.2% for one year - 2011. This step should have been taken the day after Mr. Obama’s Inauguration, but better late than never. FICA taxes are imposed on all earned income up to $106,800 with the maximum tax equaling $6,621.60 (the employer pays an equal amount). With this reduction, the maximum FICA tax will be $4,485.60, a savings of $2,136, or about 32%. I haven’t heard anything specific about the treatment for the Self-Employed, but presumably they will get the same reduction – that’s only fair. We’re all about being fair in America. Employers aren’t getting a break on their share, so expect to hear some breast-beating from the corporate and small business lobbies. Think about using this windfall to increase retirement plan contributions. Payroll taxes are made with after-tax dollars, so one could use this extra money for a Roth IRA contribution without increasing income taxes in 2011. If one were to use these funds to make a pre-tax retirement contribution, income taxes would be lower than otherwise.

I’m sure there will be more ideas that percolate up in the next few weeks and I’ll be sure and share my thoughts about them. As always, please contact me if anything here strikes your fancy [no statement made herein is to be construed as offering tax, legal, accounting or financial advice. Consult the appropriate professional for questions about your specific situation].

Tuesday, November 23, 2010

How Derivatives Markets Work -- A Lost Weekend Example

Heidi, a former member of Lunch Bunch, is the proprietor of a bar in Detroit . She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around about Heidi's "drink now, pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit .

By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively. A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral.

At the bank's corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS, ALKIBONDS and PUKEBONDS. These securities are then bundled and traded on global securitization markets. Naive investors don't really understand that the securities being sold to them as AAA "secured bonds" are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. He so informs Heidi.

Heidi then demands payment from her alcoholic patrons -- but, being unemployed alcoholics, they cannot pay back their drinking debts. Since, Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.

Overnight, DRINKBONDS, ALKIBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset values destroy the bank's liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.

The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the various BOND securities. They find they are now faced with having to write-off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations. Her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.

Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multi-billion dollar/no-strings attached cash infusion from their cronies in Government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Heidi's bar.

Now do you understand?

Monday, September 6, 2010

Cost of College in the US

Here's a chart I found on another blog comparing the percentage change in price of US Housing, US College Tuition and US CPI over the last 32 years. How long can such a disparity continue?

Wednesday, August 11, 2010

FHA offers refinance loans to underwater borrowers

By Pete MillerAugust 10th, 2010Posted in: Loans, Mortgage, Refinance

Refinance loans can be helpful to consumers in a variety of ways, which includes leading to lower interest rates on what they owe.Recently the Federal Housing Administration announced it is going to launch a program that could lead to refinance loans in a particular segment of the population.Consumers who are underwater on their mortgage may benefit by having a lower rate and having their principal reduced through the Short Refinance initiative."This is another tool to help overcome the negative equity problem facing many responsible homeowners who are looking to refinance into a safer, more secure mortgage product," FHA Commissioner David Stevens said.To qualify, homeowners must be current on their mortgage while also owing more on it than the property is worth. Furthermore, consumers have to meet FHA loan standards and their lender has to agree to write off 10 percent of their balance.Other efforts from the Obama administration to help troubled consumers keep their houses include the Home Affordable Modification Program, which can assist through lowering how much people have to pay every month on their mortgage.

Wednesday, June 30, 2010

Investment Adviser Public Disclosure Enhancement

The US Securities and Exchange Commission (SEC) has expanded access to their public database for Registered Investment Advisers. You can now look up the records of any person registered as an Investment Adviser Representative (IAR) in addition to the records for Registered Investment Advisers (RIA). Investment Advisory Representatives (IAR) are the people who work in Registered Investment Advisory firms.

The distinction is important because many, if not most Registered Investment Advisers are companies (corporations, Limited Liability Companies, etc) whereas Investment Advisory Representatives (IARs) are always people. Previously the public did not have convenient, direct access to the registration records of individuals affiliated with Registered Investment Adviser firms.

One of the items on the checklist of anyone seeking to hire someone to provide investment advice should be a check of the individual’s registration records.

Registration records include:
· Full name, office address, phone number
· Names of prior firms the person was affiliated with including dates
· Whether the person has any regulatory disclosures i.e., black marks

Here is a link to the specific search page at the SEC website: SEC Investment Adviser Public Disclosure


Tuesday, June 15, 2010

Your 19th Nervous Breakdown

"Oh, who's to blame
That girl's just insane
Well nothin' I do don't seem to work
It only seems to make matters worse
Oh, please

You better stop and look around
Here it comes, here it comes
Here it comes, here it comes
Here comes your 19th nervous breakdown"
- 19th Nervous Breakdown – The Rolling Stones

Feeling a little queasy about stocks? Join the club. No one knows if they should zig or zag. Side with the bears or run with the bulls? Who knows?

You can probably shred your Risk Tolerance Questionnaire for the moment: I don’t know that you wouldn’t answer the questions the same today as you would’ve done before though, because a questionnaire is an intellectual exercise using “play money” if you will, whereas one’s true ability to tolerate risk in the moment is an emotional experience. [Notice the difference between "exercise" and "experience".] When markets are going down, we have a hard time imagining that they can or will ever go up. And when markets are going up, we have a hard time imagining that they can or will ever go down. There is far more pain in experiencing down markets than there is pleasure in experiencing up markets.

BUT - whoever said investing in the stock market was the only way to make money?

What you need to determine is YOUR Required Rate of Return. What % total return do you need to achieve to hit your retirement income targets? Is it 4%, 8%, 9.5%, 13% or __? If the conclusion is that you don’t need to achieve high returns in attempting to hit your target, then look for investment options that are likely to provide the return you need with a low expected deviation from that return. If a 4% return (for example) will get you there, then the stock market is probably not necessary.

Your Required Rate of Return is also dependent on inputs – account deposits and contributions (and these deposits and contributions do not have to go into tax-favored retirement accounts). The more you can add, the lower the return required to “get there” and vice versa. Think of the stock market as one tool in the toolbox – not the only tool in the toolbox. You can’t count on the stock market bailing you out with high returns in the future: the S&P 500 Index including dividends, had a negative return for the 10 year period ending Dec 31 2009.

Decide how much capital you are willing to risk, what level or levels of risk you are willing to accept, and put everything else in less risky positions such as bonds or an alternative like commercial real estate (which has different risk parameters than stock investing). You can buy real estate inside your IRA (with a plan document upgrade and the proper custodian) but there are trade-offs and limitations that make it less attractive than buying it outside a retirement account (in my opinion). For example, you don’t get to deduct depreciation. You also do not have to be the sole owner of commercial real estate – you can invest via a partnership or other investment vehicle.

Also, there is no rule that says all of your retirement capital has to be inside a retirement plan. The tax code encourages retirement plan contributions, but there is more than one way to skin the cat.

The stock market reflects human behavior, pricing the news of the day. Here’s the bottom line: what return do I need to achieve to meet my goals and what investments will capture that return? If the answer leads you to investments outside of the “easy channel” of the stock market, then that’s where you should go. There’s no rule that says you have to invest in stocks. If you find yourself running in a herd of lemmings, take a detour, find the road less traveled and change course.


Tuesday, March 30, 2010

Do You Know Your Money Personality?

Over and over
I tried to prove my love to you
Over and over
What more can I do
Over and over
My friends say I´m a fool
But over and over
I´ll be a fool for you

’cause you got personality,
Walk, personality
Talk, Personality
Smile, Personality
Charm, personality
Love, personality
- Personality (as sung by Lloyd Price)

OK, you have (a) personality – that essence of humanity that makes you, you. Got it? That’s what makes the world go ‘round. Did you know that you also have a Money Personality? Your Money Personality affects the way you deal – or don’t deal – with your money. There are several quizzes you can take to determine your Money Personality. Most people have elements of several different types but tend to have a dominant type. Knowing your Money Personality type can help you manage your way to financial success. Below is a Money Personality quiz we have used with clients, spend a few minutes to answer the questions and score yourself with the key at the end.

You just received $5,000 and you can do whatever you want – what would you choose?
A. Find a way to play/enjoy it
B. Pay bills, then save the rest
C. Wonder what I want to do with it and decide to figure it out later
D. Use it for someone else or an organization or mission that deserves it
E. Buy something I really want

When it comes to dealing with money:
A. I don’t really want to be bothered with it
B. I enjoy keeping track of what I have
C. I use it to buy things
D. I find ways to give it back to the world
E. I use it to enjoy life, knowing I’ll earn more

When it comes to following a budget:
A. I don’t like budgets and tend to go on instinct each month
B. After paying bills, or sometimes before, I squeeze out money to help others and make contributions
C. I take time to look at expenses/income and watch it carefully
D. I use it to see how much money I need to earn to make sure life is fun
E. I think more money should be budgeted for shopping trips

When it comes to spending money:
A. I’ll spend it for someone I care about or give to my church or other charity
B. I don’t get much enjoyment from spending; in fact it does not feel good
C. I don’t usually know how much I have to spend, but still I may buy something
D. I buy something I want and I really get a kick from spending
E. I’ll often spend on things that include me and activities with other people

I deal with financial record keeping as follows:
A. I regularly keep records to ensure I have enough to play and live life well
B. I keep careful records
C. I keep them when I have to, but I usually don’t consult them to make decisions about spending
D. I keep records for the purpose of paying bills, tithing, giving to charities or people for whom I care
E. I would rather someone else keep the records, I only manage them when I have to

When it comes to saving money:
A. I am usually good at saving money
B. I often save but I like to live life in the present and value the use of money
C. I believe in saving, but usually leave it up to someone else to manage
D. I usually have little or no savings
E. I save when I can, but I often end up giving it to those who need it more than I do

This is my attitude toward credit cards or borrowing money:
A. I usually have credit card debt to pay off but I don’t know how much
B. I won’t borrow money or use credit card for myself but if someone else needs it, I often help them
C. I like credit cards and don’t feel bad about using them to buy things I want even if I can’t pay them off immediately
D. I often use credit cards but usually have enough to pay them off
E. I usually don’t buy things on credit or that creates debt

When I want a certain item but it’s not within my budget:
A. I look to see whether I can earn enough later to justify the expense. I’ll buy it if I think it will benefit me in business of influence others
B. If I really want it, I’ll buy it even if it isn’t in my budget
C. I don’t usually have a budget. When I do, I tend not to pay attention to it, I may or may not buy the item
D. I definitely do not purchase an item until I have planned for the item and have the money for it
E. I’ll consider how much it means to someone else. If it will really help them I’ll probably buy it

I worry about money:
A. When I think about my future and want to be sure I have enough for my later years
B. Only when I discover there are things I forgot about or didn’t know to pay and they are now overdue
C. When someone else is angry with me about my spending habits
D. When I don’t think I have enough to help others or contribute to my favorite mission
E. When I want to enjoy events and cannot afford to use the money for somewhat risky investments

When I think about providing for my future security:
A. I’d rather live in the moment and have what I want now
B. I leave the worrying and planning to others
C. I’d rather help others than worry about myself
D. I plan very carefully
E. I think about it but more often celebrate with others. I put some away for the future but am less concerned about that than living life to the fullest


A answers ___
B answers ___
C answers ___
D answers ___
E answers ___

Dominant money personality:

Mostly A answers: SPENDER. You love using money to bring you pleasure. And as a result, you have a hard time saving and delaying gratification for long-term goals.
Good trait: Generous with yourself and others. Know how to enjoy life in the moment.

Mostly B answers: HOARDER. You enjoy holding on to your money and find it difficult to spend on luxury items or for immediate pleasure.
Good trait: Good at budgeting, prioritizing and delaying gratification.

Mostly C answers: AVOIDER. You probably feel anxious or incompetent about dealing with money and therefore neglect everyday tasks like bill paying and balancing your check book.
Good trait: Don’t let money take up too much space in their lives and are often quite involved in other areas of their life in a constructive way.

Mostly D answers: CELEBRATORS. Having large amounts of money at your disposal to save, spend and invest makes you feel happy and secure. Amassers equate money with self-worth, so a lack of it can lead to depression.
Good trait: Understand the benefits of money in many different ways.

Mostly E answers: MONEY SAINT. You think money corrupts and feel guilty about having more than you need. A large raise of inheritance would make you anxious.
Good trait: Have a high degree of moral integrity and are committed to noble ideas.