Karl W. Blovet & Associates

Here is a three-step process that will enable you to review your overall tax situation during the last few months of this year so you can minimize any potential threat of underpayment penalties that may arise.

Tax Tips #1: Avoiding underpayment penalties

You can be assessed for underpayment penalties if your total tax due is $1,000. or more when you file your tax return. However, there are ‘safe-harbors” that protect you against penalties even if the tax you owe is $1,000. or more:

  • If your withholdings and estimated payments are at least 90% of the current year’s tax liability, you will not be subject to any penalties, provided you pay the difference by April 15 of the subsequent year.
  • If your withholdings and estimated payments are at least equal to last year’s tax liability you will not be subject to any penalties, with one exception: If your adjusted gross income is in excess of $150,000., you must pay 112% of the prior year’s tax liability in order to qualify for the “safe harbor.” This “safe-harbor” can be very advantageous for people who are experiencing a dramatic increase in income from the prior year. Even if your tax liability is two to three times greater in the current year you will be protected from penalties. You must pay the remaining tax you owe by April 15 of the subsequent year. In essence, you are receiving a short-term interest free loan from the federal government.

Tax Tips #2: It pays to plan

Individuals and business owners are not always aware that as the year progresses, they are accumulating a significant tax liability. If you are incurring a tax liability not subject to withholding throughout the year, you must make quarterly estimated payments to avoid the penalties. For calendar year taxpayers, the quarterly payments are due on April 15, June 15, September 15, and January 15 of the subsequent year. Business owners who are incorporated face similar rules. For calendar year corporations, the payments are due on April 15, June 15, September 15, and December 15. For fiscal year corporations, the payments are due on the 15th day of the fourth month, sixth month, ninth month, and twelfth month.

Tax Tips #3: Use the withholding rules to your advantage

You can compensate for earlier underpayments during the current year by adjusting your withholdings for the last few months of the year. The IRS considers withheld payroll taxes as being paid equally throughout the year, in spite of when actually withheld. In the case where your additional withholdings occur during the last few months of the year, bringing your total withholdings within the “safe-harbor” provisions, you will be able to avoid the underpayment penalties.

Faced with a turbulent stock market and an economy in flux, we are increasingly worried about our finances. And though investors admit to financial planners’ expertise, few consult one. So says a survey the AICPA commissioned to better understand how we manage our money.

Harris Interactive, an Internet-based market research firm, conducted the survey, “Report on America’s Financial Health,” for the AICPA. Almost all respondents (91%) said they manage their finances themselves, doing their own research, and obtaining advice from family, friends, the Internet, or a broker. The survey revealed that almost three out four respondents (71%) have been thinking more about their finances in the last three years. But only 20% thought they were very prepared for retirement. Others were uncertain about their financial future, 81% were not sure their investments were earning as much as possible and 57% were not certain they knew how to minimize their taxes through proper planning.

The survey also revealed that even individuals who felt confident about their money management skills may have been off the mark. More than half of those who believed they were maximizing savings and earnings felt this way because they had personally researched their mutual funds, understood how much investment risk they should take, had a short-term savings plan or owned real estate. But almost 90% of the respondents lost money in the last six years because of quick decisions they made about financial matters without talking to a planner.

Why didn’t more of the investors consult one? Most sought out professional advice in special situations rather than as a matter of overall strategy. For example, respondents said they would contact a financial planner if they inherited money, wanted to plan for retirement, needed estate planning advice, wanted to rollover 401(k) or IRA funds or were confused by changing tax laws.

Tips for Your Asset Allocation

There is no one-asset allocation formula suitable for all investors. You must evaluate your risk tolerance, time horizon, and rate of return requirements in order to determine how you should allocate your portfolio among the various investment categories. Consider the following:

  • The idea behind asset allocation is that different investment categories are affected differently by economic events and market factors. Some asset classes move in opposite directions (negatively correlated) while others move in the same direction (positively correlated). By investing in different types of assets, it is hoped that when one asset declines in value, other assets will increase in value.
  • Investments with higher return potential generally have higher risk and more volatility. While most investors want higher returns, they may be uncomfortable assuming higher risk levels. Asset allocation enables you to combine more aggressive investments with less aggressive ones. The combination can help reduce the overall risk in your portfolio.
  • Not only should you diversify across broad investment categories, such as equities, bonds, and money market funds, you should also diversify within the category of equities. For instance consider large-capitalization stocks, small-capitalization stocks, value stocks, growth stocks, and international stocks.
  • Determining your risk tolerance is one of the most important components of asset allocation. You are determining your emotional ability to stay with an investment when the returns are less than expected. The last two years should serve as a good framework for that assessment.
  • The longer your time horizon, the more aggressive you portfolio can be. Those with a time horizon of less than five years should not be invested heavily in equities. Look at bonds and money market funds for your short term needs. As your time horizon increases, you should have a higher percentage of equities in your portfolio.
  • Have reasonable return expectations. Basing your portfolio on a rate of return too high may cause you to increase the risk in your portfolio.
  • Rebalance your portfolio at least annually, if warranted. With time, your asset allocation percentages will change from your desired percentage as a result of varying rates of return for your different investments.
  • Be patient. The results of an investment program are best evaluated over a period of years, not days, weeks, or months.

For those of you who have procrastinated in the past about doing financial planning, Now is a “perfect time” to map out your strategy.

What follows is a brief outline of the areas you need to address:

1. Determine your spending habits.

  • Look at your expenditures from last year.
  • Break them out between necessities (food, utilities, transportation, mortgage payments, rent, etc.) and non-necessities (vacations, hobbies, entertainment, recreation etc.).
  • Make sure you have three to six months of cash available in case of an emergency, such as an unexpected job loss, in order to cover the necessity type of expenditures.
  • Also, set aside amounts for planned expenditures such as a vacation or the purchase of a new car.
  • Finally, determine if you can cut back on any of your expenses.

2. Determine your net worth.

  • Begin by adding up the value of your assets (house, car, boat, investments, 401(k), etc.).
  • Next, subtract the amount of your liabilities (mortgage balance, credit card debt, loans, etc.).
  • The result is your net worth.

3. Prepare a credit plan.

  • As a result of determining your net worth, you know the exact amount and nature of your debt.
  • Begin by checking your credit score report (www.myfico.com).
  • If you have too much credit card debt, create a realistic pay-down plan.
  • Find a credit card company that offers the most favorable terms on balance transfers, and use the new account to consolidate your debt balances, but consider any negative impact on your FICO score first.
  • Make sure that you stick with your pay-down plan.

4. Determine your philosophy relative to investing.

  • Write down your long term and short-term goals (why you are investing).
  • Determine you risk tolerance (what mix of investments will allow you to sleep at night).
  • Consider your tax situation and how often you want to rebalance your mix of investments.
  • Remember, investments are only a vehicle to help you attain your goals and objectives.

5. Do tax planning throughout the entire year.

  • Maintain good records. Keep receipts.
  • Analyze your current social security statement for accuracy.
  • Consider the tax implications of any major expenditure.
  • Review your prior year tax returns to become more familiar with the type of income and deductions you typically incur.
  • Educate yourself relative to the tax nuances for your income and deductions.

6. Make sure you have adequate insurance (property, health, life and disability).

  • Appropriate insurance coverage is critical to any financial plan. This is not area where you want to skimp.
  • Make a list of all coverages.
  • Determine your deductibles, over all limits, co-payments, premiums, etc.
  • This should be reviewed annually and discussed with your insurance agent.

7. And finally, resolve to save more.

According to the IRS, the average tax refund this year so far is around $2,000, about a 2% increase over last year. I often hear people asking one another “how much was your refund this year” and most people proudly respond by stating the dollar amount of their refund. I cringe when I hear this conversation. They don’t realize that they have provided our federal government with an interest free loan. The IRS will not do this for you! But, more importantly, they overpaid their income taxes by approximately $170 per month, primarily through excessive payroll withholding, or quarterly estimated payments, resulting in significantly less cash flow. These amounts should have been directed into some appropriate type of savings vehicle or paid down credit card debt.

Most people do not discuss the amount of their total tax liability (the amount of tax based on your taxable income before any payroll withholding or quarterly estimated payments) but discuss the amount of their refund or how much they owed. To a great degree, you control the size of your tax bill every April 15. Strategic tax planning throughout the year can decrease your tax liability. Also, if you consistently receive large tax refunds from year to year, decrease your withholding exemptions (ask your employer for Form W-4) or decrease quarterly estimated tax payments.

If you are self-employed, or are operating a side business in your spare time, you have special tax problems and tax opportunities.

Retirement Plans: You may be able to shelter all, or a portion, of your self-employment income even if you are covered by a plan through your employer.

Estimated Tax Payments: If you have self-employment taxable income you may have to make estimated tax payments throughout the year or incur an underpayment penalty. For 2007, one way of accomplishing this, would be to pay in 100% of your 2006 tax liability, or 110% of your 2006 tax liability if you had adjusted gross income in excess of $150,000. The other way is to pay in 90% of the 2007 tax liability.

Health Insurance Premiums: You may be able to deduct 100% of your premiums paid in 2007 as an adjustment to income on your Form 1040. The only limitations are (1) the amount can’t exceed your net earnings from your business, and (2) you can’t have been eligible to participate in a subsidized health plan of your employer or your spouse’s employer.

Home Office: If you use your home to conduct your business, a percentage of the ongoing expenses, including depreciation, may be deductible. The percentage is based on the square footage used for the office in relation to the entire home.

Employ your Children: This technique allows you to shift income to your lower-bracketed children and to get work done in the process. Earned income is not subject to the so-called “kiddie” tax. This only works if the work is legitimately performed and the amount of the compensation is reasonable.

Asset allocation is your target mix of stocks, bonds, and cash. Without periodic monitoring, your allocations may stray considerably from your target allocation.

For you to maintain your asset allocation and risk-control strategies, you should:

  • Check your asset class weightings semi-annually, or minimally annually.
  • Rebalance whenever any asset class has strayed more than 5% from your target allocation.
  • Time your rebalancing to coincide with a memorable date, such as a birthday or an anniversary.

It is best to rebalance tax-deferred accounts (401(k) or IRAs) first, since there are no tax consequences. Also, you should determine the amount of any related transaction costs.

By now you should have received your stockbroker’s Form 1099-B. This form is also sent to the IRS and indicates the dollar value of the stock you sold last year. We use this as the minimum amount that is reported on your Form 1040. Any amount less, may generate an IRS Notice. Depending on the broker, the information contained with the 1099-B may be all we need to prepare your tax return. Many brokers are now including not only the proceeds from the sale of stock, but also the basis (cost of your stock) in the stock sold. Unfortunately, they do not always include the basis. As a result, you need to provide us with the information. When you provide your basis, it makes our job easier and less expensive for you. Here are some rules in determining your basis:

  • With regard to mutual fund shares, the most common method in determining basis in your shares is the “average cost” method. This means you take the cost of all your shares purchased, including dividend reinvestments, and divide the total by the number of shares on the date of sale. The result is the average cost of shares (your basis). Alternatively, you can use the double-category method, whereby you total the cost of shares held more than one year and total the cost of shares held one year or less. You then figure the average cost per share for each group.
  • Under the specific identification method, you specify which shares have been sold. Your basis is what you paid for those shares when you acquired them. In order to use this method you must give written notification to the fund as to which shares you are selling
  • If you do not specify a method for calculating basis, the IRS assumes that you use the FIFO method, where the shares sold are the ones you have held the longest, which usually results in the largest capital gain.
  • With regard to individual stocks, you may also use the specific identification method and you also must give written notification to your broker to identify the shares that you are selling.
  • As with mutual fund shares, if you do not identify the shares sold, the IRS assumes that you use the FIFO method.

These are just a few of the complex rules with regard to purchasing and selling securities. If you have any questions, please call.

If you refinanced, or are considering refinancing, your home mortgage this year, you may be able to deduct some of the refinancing expenses on your tax return.


So-called “points” may be deductible as mortgage interest. Points paid to obtain an original mortgage on the acquisition of your personal residence are fully deductible in the year paid. Points incurred to refinance a home mortgage must be amortized over the life of the mortgage. If you used the loan proceeds to pay for improvements on your residence, and if you meet certain other requirements, the points incurred will be fully deductible in the year paid. If you are refinancing the mortgage on your personal residence for a second time, the unamortized portion of the points paid on the first refinancing will be fully deductible.

IRS Definition of Points

Points, in order to qualify as deducible interest, must be considered compensation to the lender solely for the use or forbearance of money. Points cannot be a form of service charge or payment for specific services. They must be calculated as a percentage of the loan amount, paid by you directly, and may not be derived from loan proceeds.

Related Expenses

Other related expenses, such as appraisal fees, notary fees, note preparation costs, etc., cannot be deducted.

A study of 17,000 stock mutual fund share classes by Standard & Poor’s, determined that fund expenses are a critical factor in fund performance.

The study found that over a ten-year period, stock funds with lower than average expense ratios performed better than funds with higher than average expense ratios in all investment style categories except one. The exception was the mid-cap blend category.

It is important for you to keep fund expenses in the forefront of your analysis when selecting funds for your portfolio.

Significance of tax planning

Tax planning will often result in substantial tax savings. If you use a calendar year for preparing and filing your tax return, your opportunity for tax planning will end on December 31. Therefore, with some exceptions, when you do prepare your tax return two to three months after the end of the year, it is generally too late to do anything.

Tax planning involves the timing and method by which your income is reported and your deductions and credits are claimed. In general, you should defer income into a subsequent year and accelerate deductions into the current year. You also need to consider if the income can be taxed when you are in a year with a lower marginal tax rate (marginal tax rate = highest rate that is applied in the tax computation for a particular taxpayer) and the deductions claimed in a year when you are at a higher marginal tax rate. For example, if you expect to be at a lower marginal rate , you should defer the receipt of income and accelerate deductions.

Three cardinal rules for tax planning:

  • Defer tax whenever possible
  • Recognize income when your marginal rate is low
  • Pay deductible expenses when your marginal rate is high

Planning around your marginal tax rate

Controlling your marginal rate of tax rests in your ability to time your income and deductible expenses. Some other factors that may change your marginal rate of tax from year to year follow.

Filing status

There are four schedules of tax rates that apply to individuals. Two apply to married persons and two to single persons. For married persons, the choices are “married filing jointly” and “married filing separately.” On occasion, a married couple may be able to reduce their overall tax liability by filing separate returns. If separate returns are filed, each spouse reports his or her income and deductions on separate returns. Moreover, for tax purposes, your marital status is determined on the last day of the year.

Single people generally select “single” filing status. If a single person lives with and provides support for a dependent he or she may file as “head-of-household.” These rates are more favorable than the rates that apply for “single” status.

Income level

Your level of income will determine your marginal tax rate. Therefore, significant changes in income from year to year may present planning opportunities. A marriage or divorce can have a major impact on your level of income, as do job changes, retirement, inheritances, illness, and sale of investments.

Tax preference and adjustment items

So called “preference items” and “adjustment items” (some examples include: certain tax exempt interest income, incentive stock options, and certain itemized deductions) are relevant with regard to the Alternative Minimum Tax (AMT). The AMT is in place to make sure that you pay at least a minimum level of tax. Consequently, if your deductions are significant and/or you have taken advantage of too many other tax opportunities, some or all of the “preference items” and “adjustment items” may be disallowed or adjusted for purposes of the AMT calculation. The important thing for you to know at this time is that if you have significant deductions or preference/adjustment items, you may be subject to the AMT. If you are subject to this tax, you may be at a higher marginal rate than you anticipate. Because of this possibility, planning for the AMT is very important.


Tax planning is now much more than just deferring income and accelerating deductible expenses towards year-end. Major Tax Acts over recent years guaranteed lower tax liabilities for almost everyone. But with so many changes being phased in and out over the next several years, you will need a scorecard to keep it straight. Also, with many more options now available, tax-planning strategies should be considered year-round and not only towards year-end.