Guidance on New 2013 Tax Law

The following are highlights of the major provisions of the “American Taxpayer Relief Act,” which was negotiated and passed over the past few days (and nights!).

While the top federal income tax rates will increase only for those earning greater than $400-450,000, there are other measures that were previously enacted as part of the Health Care reform legislation that will cause nearly all working taxpayers to pay more Social Security taxes effective January 1, 2013.

Tax rates:

• Tax rates remain the same, except for taxable incomes above $450,000 for married taxpayers and $400,000 for single filers. A new top rate for taxable income above these levels is raised from the current 35% to 39.6%.
• Note that someone’s income can be well above $450,000 before the 39.6% rate is effective, as that rate is after itemized deductions, such as mortgage interest and charitable contributions. 
• For those with taxable incomes of less than $400-450,000, there will be no increase of current federal income tax rates.  
• As part of the health care reform passed in 2010, an additional Medicare tax of 3.8% will apply to unearned income (investment income, such as interest and dividends; capital gains and rental income), for married couples with income above $250,000 and single taxpayers above $200,000. This is already law, and is not part of the recent legislation.
• Also as part of the 2010 health care legislation, income from self-employment and wages will be subject to an additional FICA tax of 0.9% (employee portion only). This applies to the combined compensation of married couples in excess of $250,000 and single individuals in excess of $200,000.

Payroll Tax Cut not extended: There was NOT an extension of the Social Security payroll tax cut. This represents a tax increase for all workers as of January 1, 2013, from 4.2% to 6.2%.


Capital Gains and Dividend Tax Rates:

The capital gains and dividend income rate will increase from the current 15% to 20% (plus the above 3.8% tax rate increase from the health care reform act), only for taxpayers with incomes that fall into the 39.6% rate (as stated above). For married taxpayers, if your taxable income is less than $450,000, then the capital gains and dividend rates will remain at 15%.

AMT (Alternative Minimum Tax): The legislation provides a permanent fix by enacting AMT indexing for inflation. This has been an issue for years, and has frequently been temporarily extended. This provides needed clarity and corrects a measure that Congress usually fixed anyway.

Itemized Deductions and Personal Deductions:

There will be a phase out of these benefits, for incomes above $250,000 - $300,000, which is an indirect tax increase.

Estate taxes: The estate and gift tax exclusions were retained at $5 million, indexed for inflation. The top tax rate increases from 35% to 40%, effective January 1, 2013. This is a significant compromise by both sides, as it permanently (at least for now) increases the exemption amount, so most estates will not be affected by the estate tax, in exchange for a rate increase on those who are impacted. The portability “election” provision, which allows an unused exemption amount to be used by the surviving spouse, was made permanent.

Other items:

• Tax credits were extended for 5 years, such as college tuition, child and dependent care and the child credit.  
• Tax free distributions will be permitted for 2013 from IRAs to charitable organizations (one year extension, not permanent).

Impact on Investment Strategy: The increased tax rates on top income levels, in addition to the Medicare tax of 3.8% on investment income (such as capital gains), makes our firm’s investment strategy, which is very tax efficient, even more valuable.

If you would like to discuss any of these matters further, please contact our office.

Also, please feel free to forward this post, or a link to this post, to others who may find this information valuable.

Fiscal Cliff Negotiations: Our View Today

Important note:  This post is based on media reports from The Wall Street Journal and The New York Times, as of December 18, 2012. Fiscal cliff negotiations are very fluid, and until an actual deal is reached, and the fine print is released, a complete analysis is not possible.

The purpose of this post is to provide information and clarity, where possible, based on the information available as of this morning. It appears that concessions have been made by both sides, Democrats and Republicans, so basic concepts of a deal appear to be taking shape.

Tax rates: 

• The White House has proposed permanently extending the Bush-era tax rates (current rates) on household income below $400,000. Above $400,000, they are proposing an increase from the current 35% to 39.6%.
• While they are using a $400,000 figure, they probably mean "taxable income" of $400,000. So, after deductions, someone could actually earn well above $400,000, before the 39.6% marginal rate becomes effective.
• For those with household or taxable incomes (to be clarified) of less than $400,000, it appears that there will be no increase from current federal income tax rates.
• It is possible this $400,000 level will increase, as part of negotiations, but likely not to decrease.
• As part of the health care reform passed in 2010, an additional Medicare tax of 3.8% will apply to unearned income (investment income, such as interest and dividends; capital gains and rental income), for married couples with income above $250,000. This is already law, and is not part of the current negotiations.
• Also as part of the 2010 health care legislation,  income from self-employment and wages will be subject to an additional tax of 0.9%.  This applies to compensation of married couples in excess of $250,000 and single individuals in excess of $200,000 annually. 

Capital Gains and Dividend Tax Rates:

There has not been any published information on changes to the capital gains or dividend tax rates, or where these stand in the current negotiations. I would expect that the capital gains rate will increase from the current 15%, to 20% (plus the above 3.8% tax rate increase from the health care reform act). I cannot forecast what change, if any, there will be to the dividend tax rate, other than the known increase due to health care reform tax, discussed above.

Change in calculation of inflation:  There is a proposal to adopt a new method of calculating inflation, which is expected to result in showing less inflation. The impact would be to reduce the growth of certain benefits, such as inflation adjustments to Social Security. There are other impacts of this inflation calculation change, such as slowing the rate that tax brackets rise each year, so taxpayers would pay more Federal income tax each year, than if this change had not been made.  I have not seen any details on how the new inflation factor would be calculated, or whether this would affect the inflation factor that is used in the investment return for TIPS (Treasury Inflation Protected Securities). This change is subtle, but a very important provision.

AMT (Alternative Minimum Tax):  The White House is proposing to permanently extend the AMT inflation adjustment provisions, which Congress has done every year or two, for many years, as the original law did not include any inflation adjustments. This would provide needed clarity and correct a measure that Congress usually fixes anyway.

Payroll Tax Cut: The Wall Street Journal, but not the Times, reported that the White House did not request an extension of the Social Security payroll tax cut. This would represent a tax increase as of January 1, from 4.2% to 6.2% of the social security tax that all workers pay. This is a change in position for the Democrats, as it would directly affect workers of all income levels.

Deductions:

There were no reports of any changes to itemized deductions. It is possible there will be some type of cap or limitation on total itemized deductions, such as 28% or 35% of one's adjusted gross income. It is possible that this change, if enacted, would only affect very high income levels.

Other items:

• The White House is requesting upfront infrastructure spending, as well as a temporary extension of expiring unemployment benefits. Other tax breaks may be extended permanently, such as research and development credits for businesses. 
• It is also expected that a permanent adjustment will be made to physicians' Medicare reimbursements. This is to correct a 1997 law, that has been corrected on an annual basis, to prevent massive reimbursement reductions.
• It is unclear whether there will be an increase in the age for Medicare eligibility, which is currently 65.  Republicans are proposing to increase this age to 67, to slow the growth of Medicare spending.
• There are no details on specific spending cuts, or when the actual tax reform changes will be drafted. We would expect some tax changes to be approved in the near term, with further revisions in 2013.

Estate taxes:  There has been no public information about how estate taxes will change going forward, based on these negotiations.

If you would like to discuss any of these matters further, please contact our office.

Sources:  The Wall Street Journal, http://online.wsj.com/article/SB10001424127887324407504578185362961624862.html?mod=WSJ_hpp_LEFTTopStories

The New York Times, http://www.nytimes.com/2012/12/18/us/politics/president-delivers-a-new-offer-on-the-fiscal-crisis-to-boehner.html?hp&_r=0&pagewanted=print

   

Election and Investment Planning

The election of 2012 is finally here. How will this affect your financial future? How will this affect your investment decisions?

For many, the election and the impending "fiscal cliff" have been influencing their financial decision making. For some, these issues have led to a lack of decision making, as they are waiting for these issues to be resolved, before moving forward with financial decisions. Some are even waiting to allocate funds to stock investments until they can "see" more clarity.

For our clients, we have been discussing these issues, but have certainly not allowed these issues to control our decision making or our actions. We adhere to the following motto: focus on what you can control and focus on things that matter, and especially when these two intercede.

How does this apply to the financial advice we have been giving to clients throughout 2012?

We have adhered to the financial plans that we have developed for our clients. For clients with stock allocations, that has been very beneficial during 2012. With many US and International broad stock averages up by approximately 10-15% for 2012, this is far superior to just holding cash, while waiting for these issues to be resolved.

We have actively pursued various strategies for our clients, to take advantage of the market volatility which has existed in 2012.

• For clients that purchased stock funds in early 2012, we did tax loss selling in the 2nd quarter of 2012, when the market declined. If we had not done this at that time, and waited until now, there may not be tax losses to harvest. Thus, these clients will have tax benefits, and still have unrealized gains. Our clients benefit from our monitoring of tax loss selling throughout the year, not just at year end.

We have met with clients during the year, and assisted them with their estate planning matters and charitable gifting (working closely with their attorneys). The future of estate tax rates is not known. However, with uncertainty comes opportunities that must be addressed and analyzed.

Once the outcome of the election is determined, one aspect of uncertainty will be removed. However, many issues will remain unresolved. Uncertainty will always exist, it is just the issues that change. As advisors, we guide our clients to handle these unknowns.

No one has an accurate crystal ball to know what the financial and tax impacts will be regarding the “fiscal cliff” issues, and how they will be resolved. Many “Wall Street experts” will make post-election predictions and recommendations, but do they really know? Will they be accurate?

Our investment strategy is not based on guesswork. By developing a globally diversified portfolio, we provide a solid and effective investment strategy. We know that structuring an investment portfolio that minimizes taxes and can reduce dividend distributions (if desired) will always be advantageous, and this is one of the strengths of our firm.

We know that decisions must be made. By assisting our clients with these decisions, we enable them to have the comfort and financial security they desire.

In these times of change, volatility and uncertainty, we can assist you with your important financial and wealth management decisions.

What is an investor to do?

The world is full of uncertainty. The US economy is struggling; not growing much, but not declining either. Job growth has been slow, but steady, particularly in the private sector. The European Union continues to face more significant challenges.

Interest rates are at all-times lows. The 10 year US Treasury bill yield has ranged from 1.45-1.60% recently, which is actually a negative "real" return. This means that after inflation and taxes, the net return is negative.

What is an investor to do?  

 

Many prominent stock and bond market "gurus" are decrying stocks, with comments similar to the "death of equities." Bill Gross, one of the world's largest bond fund managers, in his August, 2012 Investment Outlook, started his essay stating "the cult of equity is dying."

A few days ago, one of the largest hedge fund managers in the world, Louis Bacon, announced that he would be returning $2 billion to his investors (for which he was charging 3% annually, plus a 25% performance fee), citing his underperformance and inability to cope with worldwide market conditions.

There have been huge stock market redemptions from mutual funds over the past few years. Per Morningstar, since the beginning of 2009, investors have redeemed $200 billion from US stock market funds. During the same period, $700 billion has been added to bond funds. Usually, mass inflows or outflows of mutual funds tend to be leading indicators.....of the opposite direction of the markets.

These are all signs of stock market pessimism, which are actually positive, for long term investors.

We view the current environment as a long term opportunity, for many reasons. For our current clients, we have developed investment plans and are adhering to them. We do not think it would be advisable to react to current economic issues by making major, sudden portfolio changes. We agree with the philosophy of Warren Buffett, when he wrote that "we attempt to be fearful when others are greedy and greedy only when others are fearful." He is frequently a contrarian, and has been very successful doing so. As the stock market redemptions reflect, this has been a period when many others are fearful of stocks.

We work with our clients so they avoid making major financial mistakes, so they are better able to meet their financial and personal goals. We advocate broad, global diversification.

• US markets and many global stock markets are positive for 2012, though many people would not think so, based on media reports.
• We have avoided the huge losses that many have incurred by not buying IPO's in stocks such as Facebook or Groupon (including some very wealthy and prominent individuals and some of the largest stock market mutual funds).
• We have taken advantage of certain market volatilities, by rebalancing and tax loss selling many times already this year (and not just waiting to do this at year-end).

While we cannot predict how worldwide stock markets will perform, we know that we are providing advice for our clients that are in their best interests. We rely on academic and historical research, not unproven forecasts, or crystal balls, for our investing strategies and how we structure portfolios. We are confident that these strategies will continue to be successful over the long term.

Why Perspective and Time Matters

Our goal as a firm is to provide our clients with a greater sense of comfort and security. Each client defines this differently, but to most, this means having financial independence and adequate resources to be able to do the things in life that are most important to them.

Today, information and news moves ever faster, which causes society's perception and time frame to become much shorter. For an investor, this is not a good perspective. To be a successful investor, patience and a long time frame are very important. We discuss and stress this with our clients.

Last week, my son graduated from high school. For the fun of it, I looked up what the S & P 500 was when he was born, in late 1994. At that time, the S & P 500 was 469.

The day he graduated from high school, the S & P closed at 1,329.

Review those figures again:

October, 1994..................................469

June 2012......................................1,329

Many significant events occurred during these 17 years. There is never a period of time without uncertainty, or crisis of some form.  It is our role as financial advisors to work with our clients, to develop an appropriate financial portfolio, so that you and your family can benefit from the long term financial gains of owning stocks.

How long will you save, to fund your children or grandchildrens' education?  How long will you save for retirement?  How long will you live, during your retirement?

A long time.

Be patient. Have the proper time perspective.

Develop a globally diversified portfolio, and the time perspective to allow yourself to reach your financial goals. It will be worth it.



Note:   Other time periods may show different results, but the trend over long time periods are positive. The S & P 500 is an unmanaged index of US Large company stocks. Our firm generally structures stock portfolios to include globally diversified asset classes, which will include US and non-US stocks, of both large and small, growth and value companies.

A Valuable Conversation Worth Having

Extended families gather for many occasions. Celebrations. Holidays. Life cycle events. Family vacations. The discussions at these events and gatherings are generally the same: updates on kids and relatives, grandchildren, health, politics, sports, food, etc.

Between the generations of most families, however, the topic of money is rarely discussed. These types of discussions should be happening. Sometime. Anytime. And sooner rather than later.

We all have unique and different family backgrounds and situations. I did not get my education in money, investing and estate planning from my parents. We grew up as a lower-middle income family. I know that my mom struggled financially and worked very hard to support me and my three sisters. Investing was not a relevant topic. How I would pay for my college education, how much I had to work and save money for college education was a very relevant topic.

Fast forward 30+ years… and now I advise people professionally about their money. We have many discussions about their finances, their goals and how to deal with the volatility of the world and financial markets. These discussions are critical, and the educational aspect of these conversations makes our clients better and more successful investors.

I now want my firm to emphasize an additional type of conversation. This is a conversation between generations. These can be difficult discussions, which is why they are generally avoided. But if these discussions take place, tremendous value and important long term benefits can result. Clients can have these conversations (or “family meetings”), or we can assist in facilitating them.

Many couples deal with estate planning. Most view it like going to the dentist; painful, put it off, but they eventually get it done. Once an estate plan is completed, it usually becomes a set of documents that remain locked in a cabinet. One aspect of the discussion that I’m addressing is to make the estate plan real. Make it a living and breathing document and set of plans. Talk about your intents and wishes. Now, while you are healthy and able to have the discussion.

I’m suggesting that parents and grandparents sit down with their next generation, or generations, and talk about their “family” finances. For example, my extended family is going on vacation later in June. My siblings and my parents will be together for a week. We should set aside some time to have a discussion of what will happen when each of them passes away. What is their intent? How will we handle things?

We have actually had this discussion, but it was many years ago. It should happen again. But most families have never had a multi-generational discussion. The topics can vary, depending on the financial assets (small, large or very wealthy), and the ages of the different generations.

At family events, the telling of family stories is how family histories are remembered. The discussion of money, both positive and negative, can be important as well. Parents and grandparents can share their financial and investment lessons, both good and bad, with their next generations. This would be very valuable.



Note: I would like to thank Nathan Dungan, for the valuable session he led on this topic at a seminar I attended in May, as well as Susan Weiner (@susanweiner), who wrote an excellent blog post encouraging financial advisors to write in a more personal manner, which inspired this post. Thanks to both of you.

Graduation, my son and his impact

My second son, Scott, is graduating from high school next week. While I am obviously very proud of him and his many accomplishments, I have also thought about his impact on me and my firm (and thus, my current and future clients).

Parents teach their children. Children also teach their parents. Scott has taught me many things, and we have learned some things together.

Five years ago, no one would have thought of me as a techie or an early adopter of technology. That is very different today. Thank you Scott, for pushing and encouraging me.

At Scott's insistence, I was one of the first to get an iPhone, when they were initially introduced. That enabled me to "consume" information in a new and better manner. As a voracious reader of business and news, I could then begin to read the NY Times and Wall Street Journal, whenever and wherever I wanted. Years later, I got an iPad. Now, Instapaper and Good Reader are indispensable apps.

Scott encouraged me to use Twitter years ago. I am not a follower of celebrities. I have used Twitter primarily as a learning tool, to connect with thought leaders in various fields and professions, and well as to meet and establish relationships with people I otherwise would have never met. I have made great business and personal connections, and some very close friends. Also, through "following" these people, I read articles and blog posts they refer and “link” to. This has been invaluable for my personal growth and learning, and it has benefited my firm in numerous intangible ways.

Through Twitter, I connected with individuals, like @michealport and @bobburg. As a result, in 2011, I attended a 3 day seminar with Michael Port. Within weeks of this seminar, my firm implemented a Client Relationship Management (CRM) program. This helps us maintain better information about current and future clients. This is generally an area of weakness in most professional services firm, which we have resolved.

Earlier this spring, I attended a conference sponsored by Bob Burg, another great friend and source of inspiration I met on Twitter. I wrote about this conference in a previous post, dated April 24, 2012, http://www.wassermanwealth.blogspot.com/2012_04_01_archive.html . At this event, I met a number of national speakers, who I now follow and continue to learn from.

Scott and I have also developed a wonderful relationship with @jasonwomack, a thought leader in personal development and time management. Jason Womack is one of the most positive, inspiring people anyone could meet (and I strongly recommend you meet him!). Scott has provided Jason with technology assistance for the past few years. While doing this, Scott has learned business and life lessons that few adults ever learn and absorb, let alone a 17 year old. Scott and I have enjoyed many great and important discussions, initiated by Jason's podcasts, blog posts and book.

It is important to note that Scott's relationship with Jason started because Scott was willing to help Jason with a tech question, via Twitter, late one Sunday evening. As Bob Burg would say, Scott is a "Go Giver." Others would say you are a "mensch."

Scott, you are very talented and have pursued your technology passion. Along the way, you have helped so many others in your school and community. I look forward to seeing where this passion leads you, as well as your continuing to encourage me to try, and adopt, new technology. Because of you, our family is stronger, I have developed great business and personal relationships, and my clients and my firm have benefited. Thank you!