Karl W. Blovet & Associates

Financial Planning

2017 Tax Planning

 

Chances for tax reform this year are growing dimmer and dimmer. But tax planning is still an ongoing process. Your situation can change during the course of a year and you should react accordingly. Marriage, divorce, the birth of a child, death, a change in job, or loss of a job, and retirement are just some of the life events that trigger a special urgency for tax planning. Your marital status is determined on December 31. If you are married on December 31, you are considered married the entire year. If you were divorced on December 31, you will be considered single for the entire year.

Individual income tax brackets for 2017

They are only slightly wider than for 2016 because of mild inflation during the 12 month period from September 2015 through August 2016 that is used to determine the adjustments. Tax rates did not change.

Itemized deduction limitations

The write offs are slashed by 3% of the excess of AGI over $261,500 for singles, $287,650 for heads of households, and $313,800 for marrieds. The total reduction cannot exceed 80% of itemizations. Certain deductions are exempt from this provision.

Personal exemptions

Personal exemptions remain at $4,050 for filers and their dependents. The amount is phased out by 2% for each $2,500 of AGI over the same thresholds used for the itemized deduction phase out.

The 20% top rate for dividends and long term capital gains starts at a higher amount

Singles with taxable income above $418,400, household heads above $444,550, and joint filers above $470,700.

The rules regarding IRA rollovers have changed

Beginning in 2015, taxpayers may only make one IRA-to-IRA transfer in any twelve month period. However, trustee-to-trustee transfers between IRAs are not subject to this limitation. Rollovers from traditional IRAs to Roth IRAs are not limited.

Minimize tax on Social Security benefits

When Social Security recipient’s modified adjusted gross income (MAGI) plus 50% of Social Security benefits exceed certain base amounts, the benefits can be taxable. The MAGI thresholds are $25,000 for singles and $32,000 for marrieds filing jointly. If your income will be close to these thresholds you should consider deferring income, if possible, to avoid tax on the benefits.

Roth conversions

If you have not yet made a Roth conversion, doing so prior to year-end 2017 might be an opportunity worth serious consideration. Variables include your present income tax bracket, how close you are to retirement, and your access to other funds both to pay the conversion tax and to delay distributions from your Roth account later.

Maximize retirement plan opportunities

In 2017 you can contribute up to $18,000 to your 401(k), 403(b), and 457 plans if you are under age 50. If you will be age 50 by year end 2017 you can add an additional $6,000. If you are already on track to max out your contribution for the year, you may also qualify for a contribution to a traditional IRA or Roth IRA. The maximum contribution is $5,500, plus another $1,000 if you are age 50 or older by year end. If you are no longer contributing to a retirement account and instead getting ready to transition from working to retirement, now is an opportune time to determine which assets and benefits you will be drawing from, including establishing the timing of your distributions and determining when to begin receiving Social Security benefits.

Alternative Minimum Tax (AMT)

For 2017 the exemption amount for couples increased to $84,500 and $54,300 for singles and heads of household. The phase-out zones for the exemptions start at $160,900 for couples and $120,700 for singles and household heads. The exemption amounts and phase-out levels have been permanently adjusted for inflation.

Capital gain rates

Your capital gain rate depends on your tax bracket and the character of the gain. Therefore, the rate can be 0%, 15%, 20%, 25%, or 28%. There may also be a 3.8% net investment income (NII) tax levied on top of those rates. Now is a good time to review the current status of your capital assets (not exclusively, but primarily investable assets that would be subject to taxation if sold at a gain). Time the recognition of capital gains and losses during the year to minimize your net capital gains tax and maximize deductible capital losses. Many investors still have excess capital losses from past stock market declines that they may “carry over” to offset capital gains that would otherwise be taxable.

 Payroll taxes

For calendar year 2017, the employee-share of OASDI tax is 6.2 percent up to the Social Security wage base of $127,200 and the Medicare tax is 1.45% with an unlimited wage base.

Also, beginning on January 1, 2013 there is a 0.9% Medicare surtax on earned income and remains in effect for 2017. The surtax applies to wages and self-employment income.  It applies to single filers and heads of household when total earnings exceed $200,000 and $250,000 for married filing jointly taxpayers.  For earnings over the thresh-hold, the effective Medicare tax will be 3.8%, the usual 2.9% tax rate, plus an extra 0.9%.  The surtax only applies to the employee’s share of tax, employers do not owe the tax.

Casualty losses

Taxpayers in many states have already experienced natural disasters in 2017. A casualty loss can result from the damage, destruction or loss to your property from any sudden, unexpected or unusual event, such as a hurricane, tornado, earthquake, wildfire, or flood. Casualty losses are generally deductible in the year the casualty occurred, less ten percent of your adjusted gross income and a $100 per casualty deductible.

However, if you have a casualty loss from a federally declared disaster, you can elect to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. The election gives taxpayers the opportunity to maximize their tax savings in the year in which the savings will be greatest.

Payroll withholding

If you have significant income, or will have, not subject to withholding in 2017 you should increase your payroll withholding for the remainder of the year to ensure that it covers the required estimated payments in order to avoid underpayment penalties.

Gift/estate tax

The current estate tax is set at a maximum 40 percent rate and a $5.49 million exemption amount, indexed for inflation. Lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $14,000 for 2017 with $28,000 allowed to each donee by married couples. Making a gift in 2017 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.

Many changes went into effect on January 1, 2016 and certain key provisions were retained.

Tax planning is an ongoing process. Your situation can change during the course of a year and you should react accordingly.

Life changes

Marriage, divorce, the birth of a child, death, a change in job, or loss of a job, and retirement are just some of the life events that trigger a special urgency for tax planning. Your marital status is determined on December 31. If you are married on December 31, you are considered married the entire year. If you were divorced on December 31, you will be considered single for the entire year.

Individual income tax brackets for 2016

They are only slightly wider than for 2015 because of mild inflation during the 12 month period from September 2014 through August 2015 that is used to determine the adjustments.

Itemized deduction limitations

The write offs are slashed by 3% of the excess of AGI over $259,400 for singles, $285,350 for heads of households, and $311,300 for marrieds. The total reduction cannot exceed 80% of itemizations. Certain deductions are exempt from this provision.

Personal exemptions

Increases to $4,050 for filers and their dependents. The amount is phased out by 2% for each $2,500 of AGI over the same thresholds used for the itemized deduction phase out.

The 20% top rate for dividends and long term gains starts at a higher amount

Singles with taxable income above $415,050, household heads above $441,000, and joint filers above $466,950.

The rules regarding IRA rollovers have changed

Beginning in 2015, taxpayers may only make one IRA-to-IRA transfer in any twelve month period. However, trustee-to-trustee transfers between IRAs are not subject to this limitation. Rollovers from traditional IRAs to Roth IRAs are not limited.

Minimize tax on Social Security benefits

When Social Security recipient’s modified adjusted gross income (MAGI) plus 50% of Social Security benefits exceed certain base amounts, the benefits can be taxable. The MAGI thresholds are $25,000 for singles and $32,000 for marrieds filing jointly. If your income will be close to these thresholds you should consider deferring income, if possible, to avoid tax on the benefits.

Roth conversions

If you have not yet made a Roth conversion, doing so prior to year-end 2016 might be an opportunity worth serious consideration. Variables include your present income tax bracket, how close you are to retirement, and your access to other funds both to pay the conversion tax and to delay distributions from your Roth account later.

Health care reform

Many individuals and their dependents without qualifying health insurance will owe a tax in 2016. Several exceptions apply, particularly for lower income families. The penalty is the greater of $695 for each adult and $347.50 for each family member under age 18 (but not to exceed $2,085) or 2.5% of household income less the amount of the taxpayer’s tax filing threshold.

Maximize retirement plan opportunities

In 2016 you can contribute up to $18,000 to your 401(k), 403(b), and 457 plans if you are under age 50. If you will be age 50 by year end 2016 you can add an additional $6,000. If you are already on track to max out your contribution for the year, you may also qualify for a contribution to a traditional IRA or Roth IRA. The maximum contribution is $5,500, plus another $1,000 if you are age 50 or older by year end. If you are no longer contributing to a retirement account and instead getting ready to transition from working to retirement, now is an opportune time to determine which assets and benefits you will be drawing from, including establishing the timing of your distributions and determining when to begin receiving Social Security benefits.

Alternative Minimum Tax (AMT)

For 2016 the exemption amount for couples increased to $83,800 and $53,900 for singles and heads of household. The phase-out zones for the exemptions start at $159,700 for couples and $119,700 for singles and household heads. The exemption amounts and phase-out levels are permanently adjusted for inflation.

Capital gain rates

Your capital gain rate depends on your tax bracket and the character of the gain. Therefore, the rate can be 0%, 15%, 20%, 25%, or 28%. There may also be a 3.8% net investment income (NII) tax levied on top of those rates. Now is a good time to review the current status of your capital assets (not exclusively, but primarily investable assets that would be subject to taxation if sold at a gain). Time the recognition of capital gains and losses during the year to minimize your net capital gains tax and maximize deductible capital losses. Many investors still have excess capital losses from past stock market declines that they may “carry over” to offset capital gains that would otherwise be taxable.

Payroll taxes

For calendar year 2016, the employee-share of OASDI tax is 6.2 percent up to the Social Security wage base of $118,500 and the Medicare tax is 1.45% with an unlimited wage base.

Also, beginning on January 1, 2013 there is a 0.9% Medicare surtax on earned income and remains in effect for 2016. The surtax applies to wages and self-employment income.  It applies to single filers and heads of household when total earnings exceed $200,000 and $250,000 for married filing jointly taxpayers.  For earnings over the thresh-hold, the effective Medicare tax will be 3.8%, the usual 2.9% tax rate, plus an extra 0.9%.  The surtax only applies to the employee’s share of tax, employers do not owe the tax.

Casualty losses

Taxpayers in many states have already experienced natural disasters in 2016. A casualty loss can result from the damage, destruction or loss to your property from any sudden, unexpected or unusual event, such as a hurricane, tornado, earthquake, wildfire, or flood. Casualty losses are generally deductible in the year the casualty occurred, less ten percent of your adjusted gross income and a $100 per casualty deductible.

However, if you have a casualty loss from a federally declared disaster, you can elect to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. The election gives taxpayers the opportunity to maximize their tax savings in the year in which the savings will be greatest.

Payroll withholding

If you have significant income, or will have, not subject to withholding in 2016 you should increase your payroll withholding for the remainder of the year to ensure that it covers the required estimated payments in order to avoid underpayment penalties.

 Gift/estate tax

The current estate tax is set at a maximum 40 percent rate and a $5.45 million exemption amount, indexed for inflation. Lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $14,000 for 2016 with $28,000 allowed to each donee by married couples. Making a gift in 2016 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.

 

Health care durable powers of attorney. Designates an agent to make health care decisions only after a physician determines that a person is incapacitated and unable to communicate decisions. All members of your family who have attained the age of majority should have signed and updated health care durable powers of attorney.

Durable powers of attorney for financial affairs. Designates an agent to be in charge of your financial affairs should you lose the ability to handle your affairs due to a disability or due to becoming incapacitated.

Wills. Spells out your desired beneficiaries and how your assets will be transferred (other than those assets that pass through trust, by contract, or by joint tenancy) upon your death. It also names an executor, who is someone that is responsible for administering and settling your estate. You may name a family member, a professional, or an institution to serve in this capacity. Wills need to be updated periodically in order to reflect any changed circumstances (move to a new state, major changes in income tax laws, change in health, etc.).

 

Living trust agreements. Provide greater flexibility and control than wills and may be useful to achieve specific longer term objectives. They are more complex and entail ongoing responsibilities. It is important to balance the potential benefits of a trust with the total cost.

 

Records inventory. Taking inventory of all your assets and related documents. In the case of a sudden death or incapacity, and having no records, it can take a family more than a year, along with high attorney fees, in order to reconstruct everything.

 

Periodic revisions of estate plans. You should revise your estate plan at least every five years, or more often, under certain circumstances (death, disability, divorce, marriage, birth, move to a new state, changes in tax law, etc.).

Tax planning for year-end 2014 should use both traditional year-end strategies as well as those that react to situations unique to this year. Particularly important at year-end 2014 is the impact of certain tax benefits that ended with 2013 and that may not be retroactively revived; and attention to new opportunities and pitfalls created during the past year through court cases and IRS rulings.

Income/Deduction Shifting

The traditional year-end strategy of income shifting applies to year-end 2014 but with an extra twist. Under traditional strategy, you time your income and deductions so that your taxable income is about even for 2014 and 2015 so your tax bracket does not spike in either 2014 or 2015. If you anticipate a higher tax bracket for 2015, you may want to accelerate income into 2014 and defer deductions into 2015. If you anticipate a leaner 2015, income might be delayed through deferred compensation arrangements, postponing year-end bonuses, maximizing deductible retirement contributions, and delaying year-end billings.

Minimize Tax on Social Security Benefits

When Social Security recipient’s modified adjusted gross income (MAGI) plus 50% of Social Security benefits exceed certain base amounts, the benefits can be taxable. The MAGI thresholds are $25,000 for singles and $32,000 for marrieds filing jointly. If your income is close to these thresholds you should consider deferring income, if possible, to avoid tax on the benefits.

Roth Conversions

If you initiated a Roth conversion earlier in 2014 and that Roth account has declined in value since then, you should consider a “Roth reconversion.” Reconverting your Roth IRA back to a traditional IRA before year-end will allow you to avoid paying income tax on an account balance at its higher value.

Finally, if you have not yet made a Roth conversion, doing so at year-end 2014 might be an opportunity worth serious consideration. Variables include your present income tax bracket, how close you are to retirement, and your access to other funds both to pay the conversion tax and to delay distributions from your Roth account later.

Health Care Reform

Many individuals and their dependents without qualifying health insurance will owe a tax in 2014. Several exceptions apply, particularly for lower income families.

Alternative Minimum Tax (AMT)

The exemption amount for couples increased to $82,100 and $52,800 for singles and heads of household. The phase-out zones for the exemptions start at $156,500 for couples and $117,300 for singles and household heads.

Capital Gains and Losses

Time the recognition of capital gains and losses at year-end to minimize your net capital gains tax and maximize deductible capital losses. Many investors still have excess capital losses from past stock market declines that they may now “carry over” to offset capital gains that would otherwise be taxable.

Payroll Taxes

For calendar year 2014, the employee-share of OASDI tax is 6.2 percent up to the Social Security wage base of $117,000 and the Medicare tax is 1.45% with an unlimited wage base.

Also, beginning on January 1, 2013 there is a 0.9% Medicare surtax on earned income. The surtax applies to wages and self-employment income. It applies to single filers and heads of household when total earnings exceed $200,000 and $250,000 for married filing jointly taxpayers. For earnings over the thresh-hold, the effective Medicare tax will be 3.8%, the usual 2.9% tax rate, plus an extra 0.9%. The surtax only applies to the employee’s share of tax, employers do not owe the tax.

Life Changes

Marriage, divorce, the birth of a child, death, a change in job, or loss of a job, and retirement are just some of the life events that trigger a special urgency for year-end tax planning. Your marital status is determined on December 31. If you are married on December 31, you are considered married the entire year. If you were divorced on December 31, you will be considered single for the entire year.

Tax Benefits That Ended in 2013

Tax benefits that expired on December 31, 2013 include but are not limited to:

the state and local sales tax deduction,
exclusion of up to $2 million of forgiven debt on a debtor’s primary home,
the ability of those 70 ½ and older to make distributions of up to $100,000 annually from their IRAs to a charity

Casualty Losses

Taxpayers in many states experienced natural disasters in 2014. A casualty loss can result from the damage, destruction or loss to your property from any sudden, unexpected or unusual event, such as a hurricane, tornado, earthquake, wildfire, or flood. Casualty losses are generally deductible in the year the casualty occurred, less ten percent of your adjusted gross income and a $100 per casualty deductible.

However, if you have a casualty loss from a federally declared disaster, you can elect to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. The election gives taxpayers the opportunity to maximize their tax savings in the year in which the savings will be greatest.

Payroll Withholding

If you have significant income not subject to withholding in 2014 you should increase your payroll withholding for the remainder of the year to ensure that it covers the required estimated payments in order to avoid underpayment penalties.

Gift/Estate Tax

The current estate tax is set at a maximum 40 percent rate and a $5.34 million exemption amount, indexed for inflation. Lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $14,000 for 2014 with $28,000 allowed to each donee by married couples. Making a gift at year-end 2014 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.

If you are creating a new business or unhappy with your current business structure, you need to consider the appropriate business entity. Whether to incorporate or form a limited liability company (LLC) is not always obvious. Under the Internal Revenue Code (IRC), a corporation is either a “C Corp” or an “S Corp.” An LLC is either a sole proprietorship (single member), a partnership (two or more members), a “C Corp,” or an “S Corp (if it meets all of the requirements and files a timely election).”

Tax issues to consider when choosing an entity: Sale of the business/liquidation. Tax rate exposure. Utilization of losses by the shareholders/members. Compensation/fringe benefit packages. Payroll tax liabilities and associated complexities. And state taxes.

Non-tax issues to consider: Limited liability protection for shareholders/members. The capital structure of the entity. Buy-sell agreements. The type of business/investment activity. And the applicable state law and other corporate legal formalities.

As indicated, there are many reasons to choose one structure over another. With that in mind, here is a brief description of these business entities

Sole Proprietorship

The simplest and least expensive structure. Works best if you are on your own, in a low risk business. No double taxation on profits, such as under a “C Corp.” Profits/losses reflected on Form Schedule C of the Form 1040. Unlimited liability for the owner and all income subject to the onerous “self-employment” tax.

Partnership

An unincorporated business that has two or more partners. There are two types: general and limited. In a general, partners share in management and are each 100% responsible for the partnership obligations. In a limited, there are general and limited partners. The general partners manage the business and are personally liable for obligations. The limited partners cannot participate in management, but share in the profits. Their liability is limited to the amount of their capital contributions. Profits are taxed only once, at the partners’ marginal tax rate.

C Corporation

They are taxed (federal and state) at the entity level and are subject to taxes on income generated by the business. Shareholders pay taxes (double taxation) on the profits distributed (dividends) to them. Liability is limited to the shareholder’s investment. They have an unlimited life and possess ease of transferability of ownership. Employment taxes can be minimized. Although, a reasonable salary must be paid.

S Corporation

Corporations with fewer than 100 shareholders can elect to be taxed under Subchapter S of the IRC. With some exceptions, the “S Corp” is not subject to federal tax at the entity level. Profits and losses flow through to the shareholders, to be reported on their tax returns at their marginal tax rates. Some states tax “S Corps” at the entity level. Employment taxes can be minimized for owners receiving a salary. Although, the amount of the salary must be reasonable compared to the profits being generated by the entity.

  1. Start now, not later.
  2. Set reasonable savings goals, and then live below your means. Being frugal is the cornerstone of wealth management.
  3. Know what to expect based on a long history of investor experiences. Look at average rates of return over long periods of time.
  4. Manage your risk – it can’t be avoided. There are two types: Volatility – actual returns vary compared to expected returns. Inflation – relates to losses in purchasing power.
  5. Diversify.
  6. Maintain a long-term perspective – the market rewards the patient investor.
  7. Do not attempt to time the market on what you or the experts expect the market to do.
  8. Know what your costs are – avoid loads, commissions, and expensive investment advice.
  9. Beware of the experts.
  10. Defer taxes unless unavoidable. Pay later than sooner.

Market conditions are compelling investors to reassess their investment strategies. Investors again value investments that emphasize capital preservation. Fortunately, there are viable alternatives when seeking safety. Because safety means lower returns, you must maintain a strict policy of minimizing investment costs. Investments with a higher degree of safety can be found in bonds and annuities. The following discussion is not intended to recommend one investment over another, but to highlight the necessity to fully analyze any investment from an integrated tax, risk, return, and cost perspective.

Debt-Based Products

Bonds can offer a higher degree of principal protection than equity securities, but they are not as readily tradable. Due to liquidity factors, obtaining reasonable pricing requires considerable effort on an investor’s part. However, this effort is well rewarded because a bond’s fixed return component means that higher fees have a significant negative impact on returns. Options range from actively “pricing out” a bond issue, buying an initial bond issuance, or purchasing a low-cost bond fund. Bonds typically have a lower return potential than equities due to enhanced safety, although one can purchase junk bonds for higher returns, but with greater risk.

Treasury Securities

Treasury securities are backed by the full faith and credit of the U.S. government. They are considered the safest investment available. The major drawback is that yields on these securities have fallen to historic lows. The prior budget surplus has reduced the offering of these securities, but they still can be purchased directly from the U.S. government (www.treasurydirect.gov/). Directly purchasing from the government is a distinct advantage in that you can obtain a market-based price without having to negotiate with a third party on pricing and/or to incur trading commissions. The Treasury now only issues notes that mature in 10 years or less (the 30-year bond is no longer issued). Treasury interest is free from state income taxation.

Treasury Inflation Protected Securities

Treasury inflation protected securities (TIPS) are a relatively new investment option whereby an investor is protected against inflation. These bonds pay a lower fixed rate, but the principal value is adjusted upward to offset inflation (based on the Consumer Price Index). In the current low interest rate environment, this feature is highly appealing if interest rates start to increase. A major drawback is that the principal adjustment is taxable as credited, but not paid until maturity. The use of a tax-deferred or tax-free account (such as a Roth IRA) would make this tax problem irrelevant.

Agency Securities

Agency securities are debt instruments issued by a governmental entity that is part of the U.S. government. Because they are typically not backed by the full faith and credit of the U.S. government (only indirectly backed), they generally pay a slightly higher rate of interest than Treasury securities.

Ginnie Maes

Ginnie Maes securities represent pools of mortgages that are backed by the full faith and credit of the U.S. government. You can purchase a Ginnie Mae directly ($25,000 minimum), but the use of a low-cost Ginnie Mae mutual fund is probably a better approach. Funds can offer greater diversification in underlying pools and professional management. The major risk is that principal is typically paid back when interest rates fall, and therefore, Ginnie Maes would tend to lose value.

Municipal Bonds

Municipal bonds have the tax advantage that their interest payments are free from the regular federal tax. However, the alternative minimum tax (AMT) can be applicable if they are “private activity bonds issued after August 7, 1986.” The AMT is affecting more taxpayers with the imposed 2001 scheduled tax rate decreases. Private activity bonds tend to offer higher yields due to this distinct tax disadvantage. Another disadvantage is that state income taxation of municipal bond interest occurs if it is not issued from the state in which the taxpayer resides. The interplay of the federal regular income tax, alternative minimum tax and state income taxation necessitates a high degree of tax planning to maximize after-tax returns.

Corporate Bonds

Corporate bonds generally offer the highest yields but without the safety level of government-backed bonds. Additionally, they are taxable on the federal and state levels. You can obtain corporate bond pricing data from the National Association of Securities Dealers, Inc. (NASD) for approximately “500 investment-grade corporate bonds” at www.nasdbondinfo.com/asp/home.asp. One alternative is to invest in preferred and convertible preferred shares instead of corporate bonds.

Other Debt-Based Products

Other debt-based products are bank-based certificates of deposits (CDs), saving accounts, money market accounts and savings bonds. Savings bonds (HH, EE or inflation indexed) in certain circumstances are ideal investment vehicles. For the highest yielding money market funds and bank accounts, you can find yields at www.imoneynet.com and www.bankrate.com. However, a higher yield, as always, can indicate additional risks. A bank investment has the advantage of being federally insured up to $100,000. Money market funds are not insured, and losses, while infrequent, do occur.

Annuities

Annuities have income tax advantages, but they typically are loaded with excessive fees. A $50,000 annuity can generate brokerage fees of up to $4,000, which virtually negates the tax advantage. Proceeds in excess of the investment are taxable as ordinary income upon withdrawal. Also, amounts withdrawn before age 59 ½ are subject to a 10-percent early withdrawal penalty. Additional complicating factors are surrender fees and annual operating fees. It is essential that you seek independent assessment prior to purchase; we can assist you in this area.

Fixed Annuities

Fixed annuities offer a high degree of payout certainty (as long as the underlying company is financially viable). However, they are typically expensive to purchase, resulting in lower overall return potential. Web sites such as www.immediateannuity.com and www.brkdirect.com can be used to obtain competing rates of return. Caution is necessary in verifying an insurance company’s financial credit worthiness. Moody’s reported that American International Group, MetLife, Aegon and Prudential Financial each had over $1 billion in credit “exposure” from bond investments in Worldcom, Enron, Qwest, Williams, TYCO, Dynegy, Global Crossing, Adelphia Communications, Kmart and Xerox. In total, life insurers “held about $23 billion” in these companies, most of which were considered “financially stable” until recent events. State guaranty plans offer only limited protection.

Variable Annuities

Variable annuities are essentially mutual funds with tax deferral. They offer a limited insurance element to qualify under the tax law. There are low expense annuity options available, but “many variable annuities carry substantial fees, as high as 4% annually.”

Dividend Paying Stocks

Dividend paying stocks are now looking much more attractive. Companies, such as Disney, even converted from the standard quarterly distribution to an annual distribution. Dividend yields had dropped to one percent, but are now above two percent. Although, there is no guarantee that any company will pay dividends.

Real Estate Investment Trusts

Real estate investment trusts (REITs) speculate in real estate properties. They typically have a high dividend yield because, in order to qualify for favorable tax treatment, they must distribute 90 percent of their income back to the shareholders. REITs have had a remarkable performance in the current market conditions, but as history shows, the best performing asset classes do not maintain their status indefinitely. REITs can be equity or mortgage based or a combination of both. Mortgage-based REITs subject investors to additional credit risks and were often considered part of the prior problem with this asset class. REITS can be issued on a variety of rental properties.

Guarantee Funds

Guarantee funds are sold on their ability to guarantee investors at least the return of their initial investment (principal). The funds have high fee structures, are limited in the assets in which they can invest and typically offer a principal guarantee only after several years. As the market falls, they are forced to sell more of their equity holdings and place the proceeds into bond-based products. In essence, you obtain an expensive balanced fund (containing both debt and equity) that will move more towards bond-based funds when the markets fall. As the funds invest in more bonds, their yearly tax effect will increase, and therefore, they are not “tax friendly.” Sales charges over five percent are not uncommon, and these funds have an average annual expense ratio of 1.5 percent.

Tax-Integrated Investing

Besides offering an independent assessment of investment alternatives, we can assure that the tax impact of different investments is fully and correctly integrated in financial planning. Investors and/or their advisors all too often ignore the following:

1. Tax-exempt interest considerations

  • How does the AMT affect the situation?
  • Is interest on municipal bonds taxed at the state level?

2. Treasury securities

  • Ability to defer income taxation to the next tax year
  • Advantageous avoidance of state income taxation
  • Ability to match maturity of a Treasury security with the tax obligation

3. Use of tax-deferred accounts to invest in unfriendly tax investments (interest paying, TIPS, etc.)

4. Utilization of the new capital gains rates of 18 percent and 8 percent

5. Proper use of tax losses

6. Consideration of transfer taxes and stepped-up basis issues

Conclusion

The current market downturn has forced investors to reassess their financial plans. Emphasis needs to be placed on investments with better return characteristics, as opposed to recommending a particular investment product. We believe that clients require unbiased information, not a sales pitch. Due to the fact that most brokers work on a commission basis, a direct conflict of interest exists between brokers and their clients. We can ensure that you are fully aware of the tax, risk, return, and cost factors of investing.

Tax planning for year-end 2011 should use both traditional year-end strategies as well as those that react to situations unique to this year. Particularly important at year-end 2011 is the impact of certain tax benefits scheduled to end with 2011; a look ahead at possible significant changes in the tax laws starting in 2013; and attention to new opportunities and pitfalls created during the past year through court cases and IRS rulings.

Income/deduction shifting

The traditional year-end strategy of income shifting applies to year-end 2011 but with an extra twist. Under traditional strategy, you time your income and deductions so that your taxable income is about even for 2011 and 2012 so your tax bracket does not spike in either 2011 or 2012. If you anticipate a higher tax bracket for 2012, you may want to accelerate income into 2011 and defer deductions into 2012. If you anticipate a leaner 2012, income might be delayed through deferred compensation arrangements, postponing year-end bonuses, maximizing deductible retirement contributions, and delaying year-end billings.

The twist for year-end 2011 is the uncertain future for tax rates after 2012. We believe that higher-income taxpayers will be asked to pay more, either through higher tax rates or more limited deductions. That may suggest a strategy in which income is not deferred but is recognized now at lower tax rates still available in 2011 and 2012.

Roth conversions

If you converted an individual retirement account (IRA) to a Roth IRA in 2010, you were given an option: recognize all income in 2010 or defer that income, half into 2011 and half into 2012. If you elected to defer that income into 2011 and 2012, do not forget to figure that income into your year-end planning for 2011.

If you initiated a Roth conversion earlier in 2011 and that Roth account has declined in value since then, you should consider a “Roth reconversion.” Reconverting your Roth IRA back to a regular IRA before year-end will allow you to avoid paying income tax on an account balance at its higher value.

Finally, if you have not yet made a Roth conversion, doing so at year-end 2011 might be an opportunity worth serious consideration. Variables include your present income tax bracket, how close you are to retirement, and your access to other funds both to pay the conversion tax and to delay distributions from your Roth account later.

Alternative Minimum Tax (AMT)

Because the AMT was not indexed for inflation, and for other reasons, the AMT today encroaches on many moderate-income taxpayers, especially two-income married couples. With most of your income and deductions for 2011 more predictable as year-end approaches, now is a good time to compute whether you will be subject to the AMT for 2011 or 2012.

Capital gains and losses

Time the recognition of capital gains and losses at year-end to minimize your net capital gains tax and maximize deductible capital losses. Many investors have excess capital losses from recent stock market declines that they may now “carry over” to offset capital gains that would otherwise be taxable.

Also of concern is whether the maximum tax rate for capital gains will rise from 15 percent to 20 percent or higher after year-end 2012 because of the scheduled expiration of the Bush-era tax cuts. Since long-term capital gains are only available on stocks and other capital assets held for more than one year, a capital asset must be bought on or before December 30, 2011 in order to be sold in 2012 and guarantee qualifying under the lower capital gains rates.

Finally, if you would like capital gains taxes at a zero percent rate, consider investing in “Section 1202” small business stock before year end. The 2010 Tax Relief Act allows the exclusion of 100 percent of the gain from the sale or exchange of qualified small business stock acquired by an individual after September 27, 2010, and before January 1, 2012, and held for more than five years. The window of opportunity to invest in stock that will yield 100 percent tax-free gain closes on December 31, 2011.

Payroll taxes

Wage earners and self-employed individuals will experience a tax increase in 2012 unless Congress extends the current employee-side payroll tax cut. For calendar year 2011, the employee-share of OASDI taxes is reduced from 6.2 percent to 4.2 percent up to the Social Security wage base of $106,800 (self-employed individuals receive a comparable benefit). President Obama has proposed to extend and enhance the payroll tax cut. The fate of the payroll tax cut will likely not be decided by Congress until late 2011.

Life changes

Marriage, divorce, the birth of a child, death, a change in job, or loss of a job, and retirement are just some of the life events that trigger a special urgency for year-end tax planning. After December 31, 2011, it will be too late to alter most of your bottom-line tax liability for 2011.

Medical expenses

Effective January 1, 2011, the Patient Protection and Affordable Care Act (PPACA) provides that over-the-counter medications and drugs can no longer be reimbursed from a health flexible spending arrangement (health FSA) unless a prescription is obtained. The rule also applies to health reimbursement arrangements (HRAs), health savings accounts (HSAs), and Archer medical savings accounts (Archer MSAs), an important consideration for employees who are required to make a decision prior to year-end 2011 on how much to fund their accounts in 2012.

Tax extenders

A number of tax extenders are scheduled to expire after December 31, 2011. They include:

  • the state and local sales tax deduction,
  • the higher education tuition deduction, and
  • the teacher’s classroom expense deduction.

Seniors age 70 1/2 and older should also consider making a charitable contribution directly from their IRAs up to $100,000 and paying no tax on the distribution. This tax break, especially advantageous to those who do not itemize deductions, is scheduled to end for distributions made in tax years beginning after December 31, 2011.

Casualty losses

Taxpayers in many states experienced natural disasters in 2011. A casualty loss can result from the damage, destruction or loss to your property from any sudden, unexpected or unusual event, such as a hurricane, tornado, earthquake, wildfire, or flood. Casualty losses are generally deductible in the year the casualty occurred, less ten percent of your adjusted gross income and a $100 per casualty deductible.

However, if you have a casualty loss from a federally declared disaster, you can elect to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. The election gives taxpayers the opportunity to maximize their tax savings in the year in which the savings will be greatest.

Energy tax incentives

If you are considering replacing your roof, HVAC system, or windows and doors, doing so using energy-efficient materials before January 1, 2012 may generate tax savings. Through the end of 2011, a number of residential energy-efficiency improvements qualify for a tax credit. These include qualified windows and doors, insulation products, HVAC systems, and roofing. The “lifetime”credit amount for 2011, however, is $500 and no more than $200 of the credit amount can be attributed to exterior windows and skylights.

Gift/estate tax

The current estate tax through 2012 is set at a maximum 35 percent rate and a $5 million exemption amount. We are of the opinion that after 2012 Congress will lower the exclusion to $3.5 million and raise the top rate to 45 percent. In light of this possibility, lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $13,000 for 2011 (and, again, for 2012), with $26,000 allowed to each donee by married couples. Making a gift at year-end 2011 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.

On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“Act”). In addition, in early 2011, Illinois legislation was passed increasing the individual and corporate income tax rates. The new federal and state legislation will have a dramatic impact on how you prepare your 2010 and 2011 income tax returns. Listed below is a brief summary of portions of the legislation.

Individuals

The reduced Individual income tax rates (10, 15, 25, 28, 33, and 35 percent) have been extended through 2012.

Personal income tax in Illinois has been raised to 5%, effective January 1st of this year.  This increase is up from 3%, and will remain in effect until 2015, when the Illinois individual income tax is scheduled to decrease to 3.75% and remain at that rate through the year 2024, when it is scheduled to decrease to 3.25%.  These Illinois rates apply to individuals, estates, and trusts.

Capital Gains Tax Rates and Dividend Tax Rates remain unchanged.  Individuals in the 10% and 15% tax brackets will have a zero percent capital gains and qualified dividend tax rate, while other individuals with long term capital gains and qualified dividends will be taxed at a maximum 15% tax rate.  These rates will remain in effect through December 31, 2012.

Alternative Minimum Tax (“AMT”) exemptions are temporarily increased (patch) for 2010 and 2011.  For 2010, the individual exemption amount has been increased from $46,700 to $47,450, and the married filing jointly exemption has been increased from $70,950 to $72,450.  For 2011, the individual exemption amount is $48,450 and for married individuals filing jointly the exemption amount is $74,450.  These higher exemption amounts are designed to prevent some middle income earners from being subject to the AMT.

Social Security Tax Rates will be temporarily reduced by 2%.  For 2011, only the employee portion of social security taxes will be 4.2%, instead of the previous 6.2% rate.  This is paid in on the first $106,800.00 of compensation.  The employer portion of social security tax remains at 6.2%.  According to the IRS, this reduction will not affect an employee’s future Social Security benefits.

Tax Credits under the Act include enhancements to the child tax credit, earned income credit, adoption tax credit, and dependent care credit.  These credits will continue through 2012.  The credit for individuals who make energy efficient home improvements has been extended through 2011.

Individual Tax Deductions have been extended for 2010 and 2011.  Some of these include deductions for student loan interest, classroom expenses for teachers, and a state and local sales tax deduction.

Charitable Contributions and IRA Distributions: Taxpayers age 70 ½ or older can take a tax free distribution up to $100,000, when made from an IRA and paid directly to a qualified charitable organization.  This incentive continues through 2011.

Making Work Pay: The “Making Work Pay” credit, which was part of the 2009 Recovery Act, expired on December 31, 2010 and was not renewed.  The credit was worth $400 to taxpayers making $75,000 or less ($800 to married couples earning under $150,000).

Businesses

Self-Employment Tax is reduced from 12.4% to 10.4% in 2011.  Self-employed individuals will pay 10.4% on the net self-employment income up to $106,800.

Illinois State Corporate Income Taxes have been increased from 4.8% to 7%.  This increase will remain in effect until 2015, when the Illinois corporate tax rate will go back to 4.8%.

Bonus depreciation has been extended and doubled from 50 percent to 100 percent for qualified property placed in service before January 1, 2012.

Sec. 179 expensing has been extended through December 31, 2012.

Estate Tax

The federal estate tax has been reinstated through December 31, 2012. The maximum rate is 35 percent with $5 million exclusion amount. The legislation allows “portability” between spouses of the estate tax exclusion amount. For years beginning January 1, 2013, the exclusion amount and rate are scheduled to be $1 million and 55 percent respectively.

The Illinois estate tax has been reinstated, with an exclusion amount of $2 million, and a graduated rate scale ranging from 7.2 percent to 16 percent.

This year in particular, year end tax planning is full of uncertainties. This makes it even more difficult than previous years. If you believe that tax rates will not rise in 2011, including the 15% top rate on qualified dividends and long term capital gains, here is what most taxpayers should consider doing:

Accelerate deductions from 2011 to 2010 and defer income into early 2011 (do not jeopardize collection of the income), unless you expect to be at a higher marginal tax rate in 2011.

If you qualify to itemize deductions shift state and local income taxes into 2010. Pay your estimated tax payment s due in January, 2011 in December, 2010. This is not a strategy if you expect to be subject to the dreaded “alternative minimum tax” in 2010. Accelerate charitable contributions into 2010. If possible, make the donations using appreciated investments held more than one year. Do not donate investments that have declined in value. Pay your January, 2011 mortgage payment in December of 2010.

If you plan to do a Roth IRA conversion, converting in 2010 allows you to spread the resulting tax over 2011 and 2012. If you wait until 2011 to convert, the two year spread is not available.

Harvest capital losses, matching losses with capital gains to produce a net loss of $3,000. If you have a capital loss carry forward (from 2009 and earlier years), harvest capital gains if it fits your overall investment strategy in order to take advantage of the tax benefit.