Give Me a Break!

Taxes are going up. You can take that to the bank (or maybe you can't!). This and future administrations will need to pay for existing programs and deficits and new ones that are layered on. That is, of course, unless fiscal prudence comes back into vogue. Here's a tax break that every parent of a school aged child should know about and a way to take advantage of it even for high earners. Writer Bill Bischoff of SmartMoney gives us the refresher on the The American Opportunity credit for 2009.

If you earn a healthy income, then you probably don't qualify for the higher-education tax credits intended to help pay college-tuition bills. However, your college-age child just might.

Both the American Opportunity credit (maximum $2,500 for 2009) and the Lifetime Learning credit (maximum $2,000) help soften the cost of postsecondary education. The American Opportunity credit is available only for the first four years of college, while the Lifetime Learning credit can be used at any time and doesn't have a degree or workload requirement.

Unfortunately, you can't take both credits for the same student in the same year, and many parents earn too much to be eligible for either one. That's because in tax year 2009, the American Opportunity credit is phased out starting at an adjusted gross income, or AGI, of $160,000 for joint filers and $80,000 for unmarried individuals. At AGI levels of $180,000 and $90,000, respectively, the credit is completely phased out. The Lifetime Learning credit is phased out starting at AGI of $100,000 for joint filers and $50,000 for unmarried individuals.

At AGI levels of $120,000 and $60,000, respectively, you're completely ineligible.

As you might imagine, plenty of parents fall into the phased-out category. But even if you're among them, these valuable credits may not have to go to waste after all.

Here's how: Arrange things so your college-age child can claim one of these credits instead of you. To implement this strategy, you must forgo the dependency exemption deduction for your child ($3,650 for the 2009 tax year). Then the education tax credit becomes the property of your child, whose income is presumably well below the phase-out range.

The now-liberated education credit can cut your college-age child's tax bill by quite a bit. Remember, however, the credit is worthless to your child unless he or she has enough taxable income to actually owe the IRS. This income could be from summer jobs, work-study at school or income and gains from investments held in your child's name.

Also, keep in mind that this strategy makes the most sense when your AGI is quite high. Why? Because your dependency write-off for your college kid is itself partially phased out between an AGI of $250,200 and $372,700 for joint filers and between $208,500 and $331,000 for heads of households.

So giving up that dependency deduction on your 2009 tax return may not cost you all that much. (This strategy does not permit your child to claim an exemption on his or her return; the exemption belongs to you whether you choose to use it or not.)

As always, see your planning or tax professional for details and application.

Travelling

A good friend's parent has passed after a short illness. I shall be back later this week.

Households Paring Debt (Slightly)

The Fed’s Q4 2009 Flow of Funds statement is out. For those who aren't savvy to this report, it shows the balance sheet of the US, including households, companies and government. It reveals an improvement in the aggregate debt levels on an absolute basis but, shall we say, progress is slooow. Household debt (home mortgages and consumer credit) as a percentage of disposable income fell to 115% from 117% in Q3, vs 121% in ‘08, and versus the record high of 125% in 2007 and is back to the lowest level since 2004. However, it remains well above the level of 10 yrs ago (91%) and 1995 (83%).

It is my belief that we have to work back toward those 1995 levels in order to have the economy back on a sustainable path. Leverage does not produce wealth.

The Quest for Yield: Master Limited Partnerships

Some financial planners are using master limited partnerships, or MLPs, to diversify retirees' portfolios, provide dividend income and try to hedge against inflation. No free lunch though. There are risks involved.

MLPs are typically limited partnerships that are publicly traded on a U.S. securities exchange. (I wouldn't touch the non-publicly traded ones.) Standard & Poor's has a report you can read explaining the market for them. You can read it online at www2.standardandpoors.com/spf/pdf/index/MLP_Primer_Nov2008.pdf.

Many MLPs are in the pipeline business. In essence, you get paid for the volume going through the pipe, so the cost of the gas doesn't affect you. Others have commodity price risk embedded in their models. I'd stay away from those.

The attraction to MPLs are their high yields. You can still find MLPs with yields of 8% or so. During the downturn these yields got REALLY rich.

When held in taxable accounts, MLPs provide some attractive tax advantages. Because of its structure, an MLP gets to pass its depreciation of assets and expenses through to investors, who may be able to use the pass-through expenses to reduce or eliminate the tax on the income received from that particular investment.

But you would lose that tax advantage by holding MLPs in a tax-deferred individual retirement account, and you have to pay ordinary income tax on any distributions you eventually take.

And if an MLP investment generates what is known as "unrelated business taxable income," which is likely, the IRA has to file a separate tax return and pay any tax involved from assets in the account.


How to fix this? First, you may want to consider converting your traditional IRA to a Roth so that you don't have to pay income tax on future earnings (subject to Roth holding rules). However, your account could still be subject to unrelated-business income tax.

Or you could make future investments in "closed-end" funds that invest in a number of publicly traded MLPs. Such funds aren't subject to the unrelated-business income tax, but still could benefit from potential returns. However, the returns from these funds tend to be slightly less as they absorb all the tax consequences.

All in all, an intriguing avenue for yield hungry investors. See your advisor for details.

Life Changes, Withholding and Your W-4

When you are through changing, you are through. -Bruce Barton


As you know if you are a regular reader, my family has moved due to a recent job change by my wife. Goodbye Northeast. Hello (again) Midwest. This has brought huge changes to our lives. She travels much more. Mark is seeing a LOT of the kids and little of the outdoors and, since we have a much bigger house thanks to the happy coincidence of geography, we are making a local furniture store very happy.

When you make significant changes like this you need to step back and see how they effect your financial planning. Some changes are obvious; some more subtle. One obvious effect is that state taxes are different. New state, new returns to file. More subtle: State laws govern wills and trusts. Better have a quick chat with my estate planning attorney to see if we need to do anything.

With the new job has come a new paycheck. How should we think about IT for planning purposes? Well, if you work for an employer that automatically withholds taxes from each paycheck, then you have the ability to adjust how much is withheld by adjusting the exemptions on IRS Form W-4. This is a thinking process you should undertake for many significant changes such as:


* Having a child
* Getting married or divorced
* Buying or selling a home
* Number of "claimable" dependents changes
* Changes in retirement
* Changes in college savings contributions
* Change in employment


So look at last year's return. Did you receive a sizable tax refund last year? You just gave an interest-free loan to Uncle Sam. Or did you owe the IRS money? You didn’t withhold enough and you may even owe (arrgh!) a penalty. Your goal should be to strike a balance so that you receive little or no refund.

The W-4 form has instructions and a worksheet that can walk you through the exemptions, but, frankly, that can be a bit intimidating. You can find those here. Unbelievably, the IRS has a very useful tool that can help you estimate what you should claim on your W-4 so that you don’t have to guess: IRS Withholding Calculator. I've tried it and it's pretty darn useful!

Finally, the W-4 will take care of your federal tax withholding, but you should check with your employer or your HR department to see if any changes need to be made to your state withholding.