With the looming "fiscal cliff" at the end of 2012, a wide range of tax increases are scheduled to occur at the start of 2013. One of the most dramatic is the treatment of dividends, which will nearly triple from a current maximum rate of 15% to a top rate of 43.4% (or higher when accounting for high-income phaseouts). In the case of small business owners with closely-held C corporations, this presents a unique planning opportunity, because the client can actually control the timing of dividends, choosing to extract cash and profits from the business by the end of 2012 instead of waiting for 2013 and beyond. And given the magnitude of the scheduled tax increase, it may well make sense to do so. While some clients may at least adopt a wait-and-see approach until the election and potential end-of-year tax legislation, the reality is that it's prudent to at least begin planning now - because getting this "wrong" for a business with $1,000,000 of accumulated profits could cost the client a whopping $284,000 in lost taxes!Read More...
Although the tax laws have technically always required that, when investments are sold, the specific lots and their associated cost basis are identified to determine the amount of any gains or losses, in practice most clients have simply chosen after the fact - when the tax return is prepared - which shares were sold, selecting the lots that produce the most optimal tax result.
However, under new laws coming into effect, brokers and custodians will begin to automatically report transactions - including which lots were sold, the cost basis, the amount of gain/loss, and the date of acquisition and character of the loss - directly to the IRS, with sales locked in at the time the transaction settles. As a result, clients and their advisors must make proactive decisions regarding a proper method of accounting for portfolios, or run the risk that the "wrong" lots will be sold, with no way to remedy the situation after the fact!
And while the IRS does provide a default method of accounting that will apply, in reality most clients will find the default a sub-optimal solution. Which means the burden really shifts to clients and their advisors to put the optimal method in place... which first requires making the right decision about whether it's better to harvest gains or losses in the first place, depending on the client's situation!Read More...
To Roth or not to Roth. It is a question that planners and their clients commonly face, whether making the decision regarding an annual contribution, or about converting (or not) an existing retirement account.
Yet while the appeal for lifetime tax-free growth from a Roth may be appealing, the reality is that the Roth is not always the winning choice, and there are many myths and misunderstands about Roth accounts that make it difficult to know which is best.
The reality is that there are four (and only four!) fundamental factors that determine whether a Roth will or not will be more effective than a traditional pre-tax retirement account. Some factors are always in favor of the Roth account, but others can work against the Roth account; in fact, blindly choosing a Roth and ignoring the relevant factors can actually lead to wealth destruction! By knowing the four factors and avoiding the Roth myths, though, planners and clients can be assured of making an effective wealth-building decision.Read More...
Prior to the implementation of the so-called "second Bush tax cut" - the Jobs Growth and Tax Relief Reconciliation Act of 2003 - the long-term capital gains tax rate was 20%, which was reduced to 10% for those in the lowest tax bracket. With the 2003 tax legislation, the maximum long-term capital gains rate was reduced to 15%, with a tax rate of 5% for the bottom two tax brackets, and in 2008 the latter rate was reduced to 0%. Those 15% / 0% long-term capital gains rates remain in effect today, and are scheduled under the Tax Relief Act of 2010 to continue until the end of 2012. After that point, the current laws expire, and the long-term capital gains rate reverts to its prior 20% / 10% rates... with the addition of another 3.8% for high income clients under the new Medicare unearned income tax! Not only does the scheduled increase in long-term capital gains rates represent a rising potential tax burden for clients in the future, but it also creates a surprisingly counter-intuitive but beneficial tax planning strategy - instead of the traditional approach of harvesting capital losses, in 2012 it's time to harvest long-term capital gains!Read More...
On October 3, 2008, then-President Bush signed into law the Emergency Economic Stabilization Act of 2008. Although it was widely known as the "bailout" bill - it was the legislation that authorized the Treasury Secretary to use $700 billion under the Troubled Asset Relief Program (TARP) - the legislation also contained a number of measures to help bring in additional revenue to the Federal government.
Amongst those provisions was the establishment of a new requirement for financial intermediaries to track and report cost basis on securities transactions to the IRS on an updated Form 1099-B, to better ensure that taxpayers properly their gains and losses on investments and pay taxes as appropriate, and the new rules took effect for stocks that were purchased in 2011. Over the long run, the new rules will make it easier for clients to track the cost basis for most of their investments, simplifying reporting and preparing returns during tax season.
However, in the near term, the introduction of cost basis reporting brings new complexities and challenges to manage. To help support taxpayers through this process, the IRS has revamped Schedule D, and introduced the new Form 8949 - which may have to be done three times for many individuals! - for reporting capital gains and losses for the 2011 tax year.
While the tax code offers a deduction for investment management fees paid by an investor, it is a less than ideal tax deduction. Characterized as a miscellaneous itemized deduction subject to the 2%-of-AGI floor, in practice it is not deductible unless the taxpayer both itemizes deductions in the first place, and has enough miscellaneous itemized deductions in total to exceed the required threshold. In addition, all such miscellaneous itemized deductions are disallowed for AMT purposes - especially problematic since the AMT is somewhat more likely to affect those with sufficient income and assets to be paying such fees in the first place.
To avoid this tax result, some clients and their accountants have been going an alternate route: capitalizing the investment management fee into the cost basis of the assets being managed, which at least provides some tax benefit, by increasing the cost basis and reducing future capital gains (or increasing the losses). Unfortunately, though, the IRS has already responded to the strategy: Just Don't Do It.Read More...
When it comes to my personal taxes, I am a chronic late filer. In my own defense, it is usually because some partnership or another could not get me my K-1’s by the deadline, so I go ahead and file the extension. Or maybe it’s because the pain of actually seeing my tax bill is too great and I find a way to defer that decidedly unpleasurable experience to a later date. This year I had a large tax liability associated with capital gains in my managed accounts, and since 100% of my money is invested in the Pinnacle DMG portfolio, I couldn’t help but think of other Pinnacle clients in the same boat. Since cutting a check to the IRS has the remarkable ability to focus my thinking about tax planning, I thought I would share a few of the thoughts that crossed my mind at the time.Read More...
Although we often think of the IRA as simply another account, the tax law generally regards it as a quasi-entity that is separate from the individual who owns it. Both the individual and the IRA have their own separate tax rules that apply; intermingling money is not allowed (due to contribution limits), and even paying each others' costs can get a client into some hot water. Accordingly, clients must be very careful when they use their own "outside" dollars to pay any form of expenses that are associated with the IRA itself. Fortunately, in a recent private letter ruling, the IRS did (re-)affirm that an IRA's wrap fee expenses are an acceptable cost to pay on behalf of an IRA with outside dollars, while not running afoul of the IRA rules and limitations.
Under the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (or the "Tax Relief Act" for short!) signed into law by President Obama on December 17th, taxpayers over age 70 1/2 may once again make up to $100,000 per year of so-called "qualified charitable distributions" out of their IRAs and directly to a charity, for the 2010 and 2011 tax years. Doing so allows the entire amount of the distribution to be excluded from income, effectively ensuring that those IRA dollars are never taxed, while also satisfying charitable goals.
Unfortunately, the problem is that this is actually a remarkably INefficient way to make significant charitable gifts, compared to other alternatives available under the tax law!
The Small Business Jobs Act of 2010, passed earlier this year on September 27th, opened up the possibility of completing an in-plan Roth conversion rollover from a 401(k) or 403(b) to a Roth 401(k) or Roth 403(b). However, the rules are not quite as simple and flexible as typical Roth conversions, due to the fact that the account is still first and foremost a qualified employer retirement plan. Fortunately, the IRS has issued guidance to help individuals understand the details of the new rules - which is fortunate, because there are some significant differences that could otherwise catch clients (and their planners) unaware!
