Roth IRAs: A Bad Idea?

I have a feeling this may turn out to be one of the most useful things I EVER post.David Collum is a professor at Cornell University and a wickedly funny financial pundit and sometime blogger. Perhaps more consistent and better than I on that count. ;) Each year since 2009 he has written an annual review of what he has found most important to him and his investing thesis. It's a great read. Google it.

Last year his think piece contained a discussion of Roth IRAs. He has an interesting take. In short, he believes they are a scam. I could re-characterize what he said but I found the whole argument so worthwhile that I am going to simply CUT AND PASTE IT and let you hear David and what he has to say, because by comparison to David I am a very poor writer. I did omit the numerous embedded citations though. Enjoy!

Roth IRA: A Bad Idea

Before leaving the world of pensions I’m gonna pick a fight with Roth IRAs. When the Roth IRA was first announced I had a unique—as in only-guy-on-the-planet unique—visceral response. The original IRA was very farsighted: Savers were allowed to compound wealth unfettered by taxes while the government deferred tax revenues to future generations. By contrast, the Roth IRA pulled tax revenues forward, leaving future generations to take a hike. Imagine the truly awesome demographic problems we would have if the Roth had been introduced in the 60s and the entire baby boom generation became entirely tax exempt. Was this an oversight? I don’t think so. The introduction of the Roth and the substantial revenues from regular-to-Roth rollovers coincided with the Clinton administration’s efforts to balance the on-balance-sheet Federal budget for the first time in decades. That is my minor gripe. To set up my really big gripe we must first dispel a widely held misconception and a common oversight.  In a regular IRA, the money is taxed at the end, whereas in a Roth IRA taxes are levied up front. If the two are taxed at the same rate—this is a critical provision—the outcome is identical. They are not just similar, it’s an identity. Break out your calculator if you must. There is no differential advantage offered by compounding in the Roth over the regular IRA. Simply put: Any advantage of the Roth IRA relative to a regular IRA necessarily stems from a lower tax rate while working than in retirement. Period/full stop.  The tax rates of the Roth and regular IRAs are fundamentally different: Roth IRA: Front-end loaded taxes paid at the marginal tax rate (highest tax bracket). Regular IRA: Back-end loaded taxes paid at the effective tax rate (integrated over all tax brackets). The distinction of marginal versus effective tax rate is critical and seems to be lacking from most analyses. One can calculate marginal and effective rates for any income online.  Let’s return to the top-5-percentile family—the 5 percenter. If they had used a regular IRA, they would be paying a 7% effective tax rate incurred on their $48,000 per year withdrawal in retirement. They paid an approximate 32% marginal tax rate—the tax rate at the top bracket—to shelter a few thousand per year in a Roth IRA. The numbers simply do not work. It is worse than that. Let us consider the lucky soul family—the extraordinarily rare couple—who actually accrued 25 annual salaries in their retirement account. For this family a 4% annual withdrawal will be equal to an annual salary while working, placing them in the same tax bracket (ignoring unknowable tax law changes). Even so, they paid 32% marginal tax on the Roth to avoid a 22% effective tax rate incurred by the regular IRA. The numbers still don’t work. I do not understand why the Roth is being sold so enthusiastically to the public. Now ponder all those folks who rolled over a lump sum from a regular to a Roth IRA. They not only paid the marginal tax rate on the rollover but caused the marginal rate to spike to a higher level! It’s hard to imagine that will prove to be a smart move. Congress is considering moving all pension funds to what is effectively Roth IRA rules as part of their Fiscal Cliff negotiations. You young guys are about to get hosed.

It didn't happen but Congress WAS entertaining that last idea. Is it coming? I don't know but it's a huge watch out. Anyway, a great take on Roth IRAs and a valuable counterpoint to all the financial planners and brokers who eagerly pushed their clients into the Roth orbit in The Great Roth Asset Collection of 2011/2012 that we discussed before.

The Rising Tide of Taxes

An ongoing theme of this blog is the necessity of rising taxes in an economy structured in a manner such as ours. Whether it is Tax Freedom Day or Cost of Government Day, we see the historical trend toward later and later dates by and large to fund the operations of government in the U.S. Here's the announcement from the Americans for Tax Reform Foundation and the Center for Cost of Government:

In 2012, Cost of Government Day falls on July 15. Working people must toil 197 days out of the year just to meet all costs imposed by government. 2012 marks the fourth consecutive year COGD has fallen in July. From a different perspective, the cost of government makes up 54.0 percent of annual gross domestic product (GDP).

The most telling event in the latest "fiscal cliff" negotiations was both parties agreeing to end the payroll tax holiday (2%)at a moment in time where the economy was visibly weak. Wow. The government is simply desperate for income.

Note: Last year's date was favorably revised to July 18 from an August initial estimate. The 2012 date represents a three day improvement. Prior to 2008, the date had never fallen past June. The past 4 years have occurred mid-July. MPM

The Rising Tide: Taxation

This is not a political post per se but the theme of inexorably rising taxes has been a focus of this blog. For planning purposes.

We learn today that Cost of Government Day, a calendar date by which the average American is deemed to have paid for the cost of government falls on August 19th this year, the latest date ever recorded. The entire report of the Americans for Tax Reform Foundation is in the link above.

From the Report:

Cost of Government Day: Trends
Cost of Government Day (COGD) falls 8 days later in 2010 than last year’s revised date of August 11. In 2010, the average American will have to work an additional 51 days out of the year to pay off his or her share of the cost of government compared to 2000, when COGD was June 29.

In fact, between 1977 and 2008, COGD has never fallen later than July 20. 2010 marks only the second year that this has happened—2009 being the first. The difference between 2008 and 2009—from July 16 to August 11—was a full 26 days, spurred primarily by the Emergency Economic Stabilization Act (EESA) that created the Troubled Asset Relief Program (TARP) and the American Recovery and Reinvestment
Act of 2009 (ARRA).

A look at methodology is below:

The Cost of Government is determined by adding the figures for government spending (federal, state and local expenditures) and an estimate of the cost of government regulations (both on the federal
and state level). The total cost of government is then divided by an estimated Net National Product to determine the percentage of national income consumed by government. This percentage is applied to the 365.25 weighted calendar year to determine the date of Cost of Government Day.

More Tax Planning Dilemmas

"If the present Congress errs in too much talking, how can it be otherwise in a body to which the people send one hundred and fifty lawyers, whose trade it is to question everything, yield nothing, and talk by the hour?"-Thomas Jefferson

Congress was a WEE bit distracted last year focusing on health care and financial reform (ahem). What did it forget? Oh, only to renew the estate tax which expired at the end of 2009.

Is this important? Well, if someone died last year, the portion of their estate that's over $3.5 million would be subject to a 45% tax. If someone dies in 2010, no matter how large their estate is, it all passes on estate-tax-free. According to some, that could add up to some $26 billion in lost revenue. Legislators have proposed a number of bills to rectify the situation ranging from reinstating the tax for the rest of 2010 to making the estate tax retroactive to Jan. 1, 2010.

A free pass this year may sound good but what does it do for planning purposes? How do you do estate plans if you don't know what the exemption amount is going to be? How do you divide marital and family trusts? It also happens to be that generation-skipping taxes got caught up in the snafu. They disappeared as well. Some states have tried to fix the mess by enacting their own laws but what then happens if Congress comes in and tries a retroactive fix?

Talk to your estate planning attorney or advisor. What a mess.

The Rising Tide: State Tax Increases

The recession has hit states HARD. We now hear daily of layoff plans for state and municipal employees. Revenues have fallen dramatically. To counter this states have turned to tax increases to fund their deficits. A sampling of states that have raised taxes:

* California added 0.25% to each income tax bracket, effective January 1, 2009 and ending December 31, 2010. The state also increased paycheck withholding rates by 10% for each tax bracket, effective November 1, 2009.
* Connecticut added a third income tax bracket of 6.5% on income over $500,000 for single filers and $1 million for joint filers, effective January 1, 2009. The state also delayed increases to personal exemptions and credits for three years and added a 10% corporate tax surcharge for 2009-2011.
* Delaware added a new top bracket of 6.95% on income over $60,000, an increase from the former 5.55% top rate, effective January 1, 2009. Business gross receipts tax rates were also increased across the board.
* Hawaii added three new tax brackets effective January 1, 2009. The new rates are 9% on income over $150,000; 10% on income over $175,000; and 11% on income over $200,000. The state has also delayed sending out all 2009 refund checks until July 1, 2010 to help cover budget deficits.
* New Jersey created three new brackets for 2009: 8% on income over $400,000; 10.25% on income over $500,000; and 10.75% on income over $1 million.
* New York added two additional tax rates: 7.85% on income over $200,000 ($300,000 for joint filers) and 8.97% on income over $500,000. This is effective January 1, 2009 and is slated to end December 31, 2011. Beginning April 7, 2009, people who have adjusted gross income over $1 million cannot claim itemized deductions, except for 50% of their Federal charitable contributions deduction.
* North Carolina imposed a tax surcharge of 2% on people with income over $60,000 ($100,000 for joint filers) and 3% on people with income over $150,000 ($250,000 for joint filers), effective January 1, 2009 and ending December 31, 2010. The state also created a new 3% tax surcharge for corporations.
* Oregon voters approved the addition of two new tax brackets effective January 1, 2009, and ending December 31, 2011: 10.8% on income over $125,000 and 11% on income over $250,000. After 2011, the former bracket will be reduced to 9.9% and the top bracket will be eliminated. Oregon also increased corporate income taxes this year.
* Wisconsin added a new top rate: 7.75% on income over $225,000 ($300,000 for joint filers).

Source: Tonya Moreno, "Significant State Tax Changes for 2009 and 2010"

The Rising Tide: New Health Care Taxes

We've been hammering this theme for months. Taxes are set to rise. It's a given. However, we weren't talking about taxes to pay for NEW programs but just paying for existing obligations. Then, in March, Congress passed the entirely new federal health care program. To help pay for the changes, the legislation contained two surprising new taxes: an extra 0.9% levy on wages for couples earning more than $250,000 ($200,000 for singles) and a new 3.8% tax on investment income on those same people (technically, people with "adjusted gross incomes" above those amounts).


As Laura Sanders of WSJOnline (www.wsjonline.com)writes:

Each tax signals a radical change in policy. For workers, the extra 0.9% levy puts a progressive element in what used to be a totally flat tax. The 3.8% tax on investment income also knocks down a longstanding wall by applying a "payroll" tax to unearned income. Until now, FICA taxes for Social Security and Medicare have applied only to wages, not investment income.

The article contains a question and answer of how the tax might work, given that the IRS hasn't had time to figure this out yet, and tax planning strategies for handling these new burdens, if you are affected. Well worth a read, the full story is here.

Check That Expiration Date!

As with bad cans of tuna, if you aren't aware of the danger of expired goods you could be in trouble. Here are some potential sources ofdifficulty for planners and their clients:

Tax Breaks that Expired at the End of 2009

* Deduction for classroom expenses for educators,
* Tuition and fees deduction for college,
* Additional standard deduction for property taxes,
* Additional standard deduction or itemized deduction for sales tax paid on a new vehicle,
* Itemized deduction for state and local sales taxes in lieu of state income taxes,
* Tax-free exclusion of the first $2,400 in unemployment benefits.
* Tax-free exclusion of IRA funds donated directly to charity,

Tax Breaks Expiring in 2010

The following provisions in the tax code will expire in the year 2010:

* Homebuyer tax credit for new or repeat home buyers expired on April 30, 2010. Military personnel can take advantage of this tax credit through April 2011.
* Tax credit for hybrid and alternative fuel vehicles expires for all makes and models at the end of 2010,
* Itemized deduction for mortgage insurance premiums,
* Qualified dividends taxed at capital gains rates,
* Reduced long term capital gains tax rates of 5% or 15% will revert to rates of 10% or 20%,
* All provisions part of the Economic Growth and Tax Relief Reconciliation Act of 2001. In particular, the current tax brackets of 10%, 15%, 25%, 28%, 33%, and 35% are scheduled to expire at the end of 2010. The marginal tax brackets will revert to their pre-2001 levels, which were five tax rates of 15%, 28%, 31%, 36%, and 39.6%.

These breaks are presently being debated in Congress. We've complained about the difficulty that advisers face in planning for their clients based on the late action on tax bills. Stay tuned.

Hurling Rocks at Goliath: Fighting the IRS

Think having your 401k get halved and then sitting out the rally because you switched to bonds (they're safer!) isn't bad enough? Well some people think worse CAN happen: you could get audited by the IRS. This article from the Wall Street Journal (www.wsj.com)talks about this issue.

With Washington searching for ways to cut the budget deficit, IRS officials face intense pressure to collect more revenue. The agency plans more audits, especially of taxpayers in high brackets or those who are self-employed and deal in large amounts of cash. The IRS also has turned up the heat in such areas as offshore tax evasion, including undisclosed foreign bank accounts.

If you become an IRS target, what should you do? For many people, the answer may seem simple: Surrender as quickly as possible, no matter how good a case you have.

Even if you are sure you are right and have all the records to prove it, fighting the IRS, one of the most powerful government bureaucracies on the planet, can be the ultimate nightmare. Seemingly routine struggles can drag on for years, leading to endless frustration and sleepless nights. Even those who eventually triumph may wonder if the fight was worth all the time, effort and expense.

But if you're ready for the challenge, there are many smart ways to fight back—and win. Start by keeping comprehensive, well-organized documents. Always scour the IRS's claims for mistakes. Don't get discouraged when dealing with tax officials. If you are convinced you are correct, consider pushing your case up the chain of command. Try the IRS appeals division. You may also get valuable help from the IRS's taxpayer advocate service. Or go to court.

At the same time, there are some classically dumb mistakes to avoid—everything from simply ignoring the IRS to arguing that it somehow is voluntary to pay federal income tax.

Here are some combat tips from lawyers, accountants and "enrolled agents," who are federally licensed tax experts authorized to represent taxpayers at all levels of the IRS.

Dumb moves

Hire the wrong tax preparer: Beware of someone who asks you to sign a blank tax return. Or whose fee is based on a percentage of how much you save in taxes. Or who promises to get you a significantly higher refund than anyone else can. People like these are likely to prepare outrageous returns that will land you in deep trouble with the IRS.

The Ostrich approach: One of the biggest mistakes is to bury your head in the sand and ignore IRS notices and letters, hoping the tax collectors eventually will lose interest and go away. "When dealing with the IRS, the best thing someone can do is to maintain regular communication," says Charles P. Rettig, a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez P.C., in Beverly Hills, Calif. "Whether during an audit or in the tax-collection process, ignoring the IRS is simply a bad idea."

Act professionally throughout the process and reply to IRS correspondence on time. The IRS is very serious about deadlines. Also, "keep a record of all communications and correspondence with the IRS, including proof of delivery, and keep your records organized," says Caroline D. Ciraolo, a tax lawyer at Rosenberg Martin Greenberg LLP in Baltimore.

Frivolity: Some people tell the IRS and judges that it somehow is voluntary to file a federal income-tax return and pay taxes. Or that their wages, tips and other income for personal services aren't taxable. Or that they are residents of a state but not of the United States. Or variations of these themes.

Don't even think of making any of those claims. Tax Court judges routinely label these as "frivolous" arguments, delaying tactics or both. More important, judges often impose stiff monetary penalties on those foolish enough to persist.

Bribery: This is even dumber—and far more dangerous—than frivolity. In a case last year, for instance, a Houston-area resident was sentenced to prison for two years for trying to bribe an IRS agent, according to a report by the Treasury Inspector General for Tax Administration. The U.S. Attorney's office in the southern district of Texas said the man offered the agent $2,500 to reduce his tax liability to around $500 from $49,000. In addition, the man "repeatedly offered the agent pizza from his restaurant as part of the deal."

Automatic surrender: Just because the IRS says you owe money doesn't mean that's correct. The agency makes mistakes—plenty of them, even in computing penalties and interest. "I have had several clients receive notices regarding unreported securities sales," says Stephen W. DeFilippis, the owner of West Suburban Income Tax Service in Wheaton, Ill., and an enrolled agent. "In these cases, the clients exchanged mutual funds one for another and didn't realize that's a taxable event." The IRS, he says, sent a notice "including the gross proceeds in income and assessing tax on the additional income."

But the IRS missed a vital point, he says: "The clients brought me these notices, and in each case the mutual-fund exchanges resulted in a loss. So instead of owing a large sum to the IRS, the clients got a refund."

This story shows how foolish it can be to pay what the IRS says you owe without "thoroughly investigating" the subject, says Mr. DeFilippis.

But if the amount in question is relatively small and the issue is confusing, some may conclude it isn't worth the time, trouble and expense of challenging the IRS and may decide to pay in order to make the problem disappear. It depends on the details of each case, including how confident you are of victory and how much time and expense you are willing to devote to the battle.

But often the smartest move is to get someone involved on your side: either an accountant or a tax attorney. The IRS makes mistakes. Loads of them. But the presentation and proof of those mistakes can be critical. And even when the IRS is proving obstinate, having that expert on your side can give you enough gumption to fight on. The IRS is no longer the automatic winner in appeals. As it used to be. And an appeal may be your only avenue of relief.

Consult your planning or tax professional if you have questions.

A Taxing Dilemma

You know in your heart that tax rates are going to rise. In fact you plan on it. You advise clients so and in your personal accounts you are positioned that way. They HAVE to, right? How else to fund the massive bailouts and stimulus programs.

But in the past, unlike this year, the IRS gave you some inkling by now of what it intended for the next year. Congress too. But they haven't and that is causing some stress among financial advisers.

As an example. advisers have been waiting to see what the tax rates on dividends will be for next year. This conundrum, and what investors want to know, were examined in a recent Wall Street Journal article:

Next year, what will the top tax rate on dividends be?

Investors like Clint Myers, an investment actuary in Georgetown, S.C., want to know. Some experts cite a 20% figure, while others say 39.6%, and still others talk about a tripling of the current 15% rate. "Lately I have seen figures citing almost any rate you can imagine," Mr. Myers says.

The short answer is that the 2011 nominal rate on dividends could be either 20% or 39.6%. Or something else—it is impossible to say given the legislative mood these days.

This is a big issue. Dividends provide approximately 40% of the total return to investors. How you tax them directly affects the allocations an adviser suggests for his/her clients. When will Congress act? We simply don't know but the present structure expires soon.

Next Jan. 1, a package of tax changes enacted under President George W. Bush expires. These provisions contained a historic change for dividends: For the first time, most were taxed at the same low rate as capital gains. Until then dividends had been grouped with interest, with both taxed at the higher rates levied on wages. In 2003 the nominal top rate on qualified dividends (usually, on stocks held longer than two months) dropped to 15%, where it has been ever since.

If Congress doesn't act, this reclassification will lapse at the end of 2010, and next year the top dividend rate would automatically revert to 39.6%.

The upshot is that next year the after-tax value of a 4% dividend yield on $100,000 of stock could be anything from $3,400 to less than $2,500 (before state taxes), and higher tax rates could lower the value of the underlying holding. Hardest hit, says Robert Gordon of Twenty-First Securities, could be utility stocks and fixed-rate preferreds with no way to adjust upward. He suggests a portfolio review to check for vulnerable spots.

Good advice.

Tax Day Approaches!

"The expenses of government, having for their object the interest of all, should be borne by everyone, and the more a man enjoys the advantages of society, the more he ought to hold himself honored in contributing to those expenses." -Anne Robert Jacques Turgot


I think Anne Robert Jacques Turgot needs to: a) seriously consider shortening that name, and b) have a gander at the modern tax system and reconsider her statement. Just my opinion.


Timely Reminders

As April 15th approaches, a few items to keep in mind. April 15th is the deadline for funding an individual retirement account, whether traditional or Roth. It's also the deadline for funding a health savings account for 2009. But what if you aren't certain if a Roth or Traditional IRA is right for you? Well, as long as you fund the IRA by April 15th and file an extension, the IRS will give you until October 15th to re-characterize the nature of your IRA contribution.

Some Relief

Choosing to file an extension provides you with additional time to file your actual 1040 and to fund a SEP-IRA. Note: You actually have to request an extension by sending Form 4868 to the IRS.

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.

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.

2010 Tax Planning

It's that time of the year! We all wait anxiously beside the mail box to see if the new year's tax forms have arrived. (Sarcasm warning.)

So when should your mail-person bring those welcome missives? Well, W-2 Forms reporting your wages and tax withholding normally arrive January through mid-February. Employers can either mail out or deliver the Form W-2 by January 31st. If you haven't received your W-2 by mid-February, I'd call and ask for a replacement.

Documents reporting bank interest, student loan interest, mortgage interest, dividends, and other types of income or deductions also get mailed out at end of January. One exception, however, is Form 1099-B, the reporting of proceeds from stocks, bonds or mutual funds that you sold. It isn't mailed out until February 16th. Last year brokers were sending out two Forms 1099-B, the first to meet the IRS-imposed deadline, and a corrected 1099-B about a month later. A declaration of the fact that it could be corrected was included in the first mailing, thereby necessitating a wait before you filed. Irritating but necessary.

For a 2010 Tax Calendar of important dates, see here.

Brighten Your Holiday Spirits with End of Year Tax Planning

If you didn't catch my earlier post on this when the topic was, well, a WEE BIT MORE TIMELY, it is here.

Speaking of timely, hopefully you are farther along in your gift shopping than I am.

Another Credit On Its Way: Cash for Appliances!

More stimulus is on its way from Washington:

In the coming months you may be eligible to receive rebates from your state or territory for the purchase of new ENERGY STAR-qualified appliances.

These rebates are being funded with $300 million from the American Recovery and Reinvestment Act of 2009. Under this program, eligible consumers can receive rebates to purchase new energy-efficient appliances when they replace used appliances.

......

Each state and U.S. territory was allowed to design its own rebate program, and all 56 have submitted plans to the U.S. Department of Energy (DOE).

The link to the Department of Energy's website announcing the program is here. A PDF of states with programs that have already been approved is here.

UPDATE (December 8, 2009):

And now "Cash for Caulkers"? Will this never end?

Reversing Last Year's Trade or Booking GAINS for Once

As part of my usual end of the year pontificating about tax strategies, I'm going to discuss capital losses and gains first. Why? Because the topsy-turvy nature of our capital markets from 2007-2008 to 2009 may give some opportunities for some unique strategies.

About this time last year I would have been advising you to offset capital gains with capital losses. In other words if you had sold profitable investments (lucky you!), I would have suggested you try to find some losing investments you could sell to minimize or eliminate your capital gains tax. In that environment it wasn't hard. However, a lot of investors now have significant losses in 2008 being carried over, and may have additional losses in 2009. Capital losses offset capital gains, and any excess losses are deductible up to $3,000 per year, which, given the degree of the carnage in the markets the past few years, may seem like a pittance to some. For example, if you suffered $100,000 of total capital losses in your portfolio but only $50,000 in capital gains, then your net capital loss is $50,000, but your total capital loss deduction for the tax year is merely $3,000. The remaining $47,000 in losses are carried over to next year. If this is you and, as a result of this you decided to stop investing and therefore never had another capital transaction, it would take you about 17 years(!) to fully utilize your carry-forwards.

What to do? Well, we might need to reverse the traditional advice and try to sell off investments with gains to offset losses.You could sell off profitable investments and repurchase them immediately. This books a capital gain for tax purposes, uses up some losses, and gives you a new cost basis position in the investment. You might be thinking, isn't this tactic prohibited by the wash sale rule? No, the wash sale rule only applies when you sell an investment at a loss and repurchase the same investment within thirty days. If you're selling an investment at a profit, the wash sale rule doesn't apply.

A little used tactic is to give appreciated stocks and other investments to someone with significant capital losses. Taxpayers can give up to $13,000 per year per person tax-free as part of the annual gift-tax exclusion. Under the scenario put forth above, a family member could give this individual stock or mutual funds or other investments that have appreciated in value with a cost basis of $13,000. The gains will be offset by the losses, and thus eliminating any capital gains tax.

One other note. You may want to think about the TIMING of the use of your losses. (I talked about this in my article on tax shifting.) President Obama has proposed increasing the tax rate on long-term capital gains to 20%. Perhaps you may want to keep carrying over some capital losses to offset future capital gains.

See your trusted tax advisor or planning professional about any of this.

More Stimulus: The New Homebuyer Tax Credit

When George Washington threw the dollar across the Rappahannock River, he didn't realize he was establishing a precedent for government spending.

-Harold Coffin, "The San Francisco Examiner"


Quick Summary of the First-Time Homebuyer Credit

For 2008: up to $7,500, the credit is paid back over 15 years.

For Jan - Nov 2009: up to $8,000, the credit does not need to be paid back.

For Dec 2009 - April 2010: up to $8,000 for first-time buyers, the credit does not need to be paid back.

For Nov 7, 2009 - April 2010: up to $6,500 for "long-term residents" buying a new home, the credit does not need to be paid back.

Until April 30, 2011: homebuyer credit continues to be available for qualified members of the U.S. uniformed services.

Dollar Amounts of the Homebuyer Tax Credit

The tax credit is worth 10% of the purchase price of the home. For 2008, the maximum credit is $7,500 ($3,750 for married couples filing separate returns). The credit is also limited to the same $7,500 maximum for unmarried persons who purchase a residence together.

For 2009 and 2010, the maximum credit is $8,000 (or $4,000 for married couples filing separately).

Long-term residents purchasing a new home have a lower maximum credit of $6,500, or $3,250 for married couples filing separate returns.

Limit based on Maximum Purchase Price

No tax credit is allowed if the purchase price of the home exceeds $800,000. There's no phase-out or gradual reduction of the credit.

Qualifying as a First-Time Homebuyer

For the purpose of this tax credit, a first-time homebuyer is defined as someone who has not owned a primary residence in the three-year period ending on the date of purchasing the home. Married couples are considered first-time buyers if neither spouse has owned a residence in the previous three years.

Qualifying as a Long-Term Resident Homebuyer

People who already own a home can qualify for the tax credit if they buy another home. The qualify, individuals needs to have owned and lived in their residence for at least five consecutive years in the eight-year period that ends on the purchase date of the new property.

Limited Time Period for Purchasing a Residence

The credit has a very limited life-span. Individuals will need to purchase a residence after April 9, 2008, and before May 1, 2010. Qualified service-members must purchase a residence before May 1, 2011.

Income Phase-out Range

The credit is phased out for individuals with modified adjusted gross income between $75,000 and $95,000. For married couples filing a joint return, the phase out range is $150,000 to $170,000. Effective Nov 6, 2009, the phase out ranges start at $125,000, or $225,000 for married couples.

Modified AGI for the First-Time Homebuyer Credit

To determine if the tax credit is reduced or eliminated by the income phase-out range, individuals will need to determine their modified adjusted gross income.(Excerpted from About.com)

There's more. (Isn't there always?) The IRS announcement of the expanded credit can be found here.

Form 5405, the tax form to claim the first-time homebuyer credit can be found here.

For One Year Only (So Far)

When I first started this blog I didn't expect that I would talk so much about taxes. But the trend in taxes these days seems one directional: UP. It is becoming more and more important that each of us have a handle on how we are taxed and how we can reduce our tax burdens.

Today I just want to point out the new tax benefits for 2009. If you haven't been paying close attention, these appear to be one-time events related to government stimulus efforts for the financial crisis.

Unemployment Benefits are Partially Non-Taxable
The first $2,400 of unemployment benefits received in 2009 are tax-exempt. The remainder of the benefits are taxable. This temporary tax break has not been extended to 2010.

American Opportunity Credit for Undergraduates
A new tax credit for students attending the first four-years of college. The credit is worth up to $2,500, 40% of which is refundable (meaning it can increase your tax refund even if you have zero tax liability). This new credit is more generous than the Hope Credit (which it temporarily replaces for 2009 and 2010) and the Lifetime Learning Credit (which remains available for postgraduates).


Car Sales Tax Deduction for 2009 Only
People who buy a new car, motorcycle, truck or other vehicle can deduct the entire amount of sales tax paid (up to the first $49,500 of purchase price) either as an itemized deduction or as an addition to their standard deduction. (Source: About Taxes.com)

As an aside, here's an interesting chart about tax incidence that has been making the rounds on the Web. No political statement is intended by re-publication here. I just find it interesting. (I apologize for it being a little grainy. It is in the original article as well.) From mint.com:



As always, see your financial planner or trusted tax advisor regarding these.

Let the Tax-Shifting Begin!

"We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”

Winston Churchill

In a Bloomberg News story appearing November 5th, the dots are finally being connected between spending programs on one hand and the need for additional federal revenues on the other. See here.

The U.S. government is spending $787 billion to stimulate the economy, the deficit is $1.4 trillion and Congress is debating costly changes to health care. The taxpayers’ bill to pay for it isn’t far behind.

“Something is going to have to be done to raise revenue unless entitlement spending is cut,” said Gerald Prante, senior economist for the Washington-based Tax Foundation.

While the final resolution of the competing aims is being debated, what is under discussion has pundits opining that Federal tax rates may rise in 2011 to as high as 39.6 percent, up from 35 percent (for those earning more than $373,650). The House version of the health reform bill sets an additional 5.4 percent surtax on adjusted gross income for high- income individuals. Long-term capital gains rates may reach 28 percent, from 15 percent today, Prante said.

Tax advisers intend advising clients to take advantage of lower rates and expiring tax breaks on 2009 and 2010 returns, a tactic that could save millions for clients in the top brackets. Strategies range from investing in film production, deferring large-scale expenses into future years, investing in energy credits, to exercising non-qualified stock options.

“For many of our clients, particularly those who run their own businesses, there may be an opportunity to accelerate significant amounts of income -- even as much as $50 million to $100 million of taxable income,” said Mark Nash, a Dallas partner at New York-based PricewaterhouseCoopers Private Company Services, whose average client has assets of $150 million or more. The tax savings from moving income into 2009 or 2010 would be 4.6 percent of that amount, he said.

To me this just says "It's coming". The whole article is worth a read.

Year-End Tax Planning

Taxation *with* representation ain't so hot either. ~Gerald Barzan

Here's some basic tax strategies to consider implementing before the end of the year to keep your income taxes as low as possible.

Review the New Tax Credits and Deductions
There's some new tax credits and deductions available for 2009. First, if you purchased a new car or truck you can write off sales tax even if you didn't itemize as part of the new vehicle sales tax deduction. If you are a homebuyer, you should review if you are eligible for the $8,000 tax credit for first-time home buyers. Homeowners should also review whether it would be advantageous to take the additional standard deduction for property tax in lieu of itemizing.

Individuals who have two jobs and Social Security recipients who are working should review their eligibility for the Making Work Pay tax credit.

Boost Tax Deductible Expenses
Every year you should look at strategies for increasing your deductible expenses versus those that are not. Make an extra mortgage payment. The extra interest you pay will be added to this year's mortgage interest by your lender, boosting your itemized deductions. (But confirm with your lender that your payment will be credited as paid in the current year!)

Pay your property taxes.
If your property tax bill is due early next year, you might want to pay it now and take the deduction.

Donate to charity.

Pay Deductible Medical Expenses.
Pay doctor bills, insurance premiums, buy eyeglasses, or stock up on prescription medications. You can take a deduction for medical expenses exceeding 7.5% of your adjusted gross income.

Boost business expenses.

Business owners and independent contractors can buy office supplies, invest in new equipment, or pay bonuses to their employees. They should also review their retirement plans or decide about setting up a retirement plan. Many retirement plans need to be established by the end of the year if owners want to make tax-deductible contributions for the year. You will want to review what constitutes a legitimate business expense just to make sure it will be tax-deductible.


Manage Your Investments to Take Deductible Losses
Sell losing investments to offset capital gains. Investors can lower their capital gains taxes by selling securities that have lost money. Losses offset gains dollar for dollar, and losses in excess of your gains can be deducted, up to $3,000 per year.

Max out your retirement savings. Contributions to a retirement plan reduce your taxable income.

Tax Strategies Beyond Form 1040
Check your:

* Tax-free gifts for education through Section 529 plans
* Maximizing Your Flexible Spending Accounts
* Lowering Estate Taxes Through Gifts

Questions? See your tax attorney and/or your financial advisor!