Wile E. Coyote and the Fiscal Cliff

 Have you ever had one of those dreams where you were just about ready to fall off a cliff … and thankfully you woke up just before looking like Wile E. Coyote?  Known as “The Coyote” to many who grew up watching “The Road Runner” and “Looney Tunes”, Wile E. Coyote fell off more than his share of cliffs in many an episode. 

Hopefully U.S. taxpayers will not end up like The Coyote as our nation faces a “fiscal cliff”.   While Chuck Jones created Wile E. Coyote, we have Ben Bernanke, Federal Reserve Chairman, credited with introducing the fiscal cliff metaphor.

The fiscal cliff essentially stands for the possible economic challenges coming should Congress fail to act on some important measures, most notably: 

• The expiration of the Bush Tax Cuts
• The expiration of the 2% reduction in payroll taxes
• Scheduled (forced) federal government spending cuts   

Add ‘em up and in the profound words of The Road Runner … beep beep.  Congress must act or the above measures are set to become law. If Congress doesn’t address the fiscal cliff successfully, economic growth as measured by gross domestic product in 2013 will be muted at best and contracted at worst.  

Without taking a political position or laying blame, Congress has unfortunately shown an inability to ACT in the past. Consider this your warning sign: Fiscal cliff ahead! You can keep running like The Coyote, or you can stop and pay attention to the sign. Proper advanced planning is critical in achieving your most important financial and life goals.  If you would like more information, email me and request a copy of our “Financial Planning in an Uncertain Tax Landscape” white paper from our partner Raymond James.  If you would like to schedule a time to discuss your specific planning needs, feel free to call or email to schedule a meeting. 

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The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.

Tax Records -- Trash It or Stash It?

Whether you’ve just finished your tax preparation regimen or you’re pushing the limits and still gathering your information, you’re likely facing a pile of papers on your home office desk (or perhaps the kitchen table).  If you haven’t already gone through the process of organizing your financial records in 2012, now is the time. 

In a previous post, I provided financial document retention guidelines that will be helpful in the tax-time clean-up process.  When cleaning up the tax mess, here’s what you should keep:

• Records of Income - shred your paystubs once you have your W-2; keep your W-2 with a copy of your tax return.
• Interest, Dividend and Capital Gain/Loss Records – keep until the appropriate 1099 is received.  Keep year-end statement for investment accounts to track progress, and purchase confirmations until the investment is sold.
• Charitable Donations and Deductible Expenses – Keep with your tax return.
• Real Estate-Related Papers – keep all records for 3 to 6 years after the property is sold and all taxes paid.  Although most real estate sales these days won’t have capital gain implications (current tax law allows up to a $250,000 gain for single filers and $500,000 for joint filers before there is income tax assessed on the gain), you may be able to use a loss on real estate for a tax advantage.
• Tax Returns – Keep them forever.

While it may seem that there are more records you need to keep than those you can shred, remember there are ways to lessen the burden on your space.  Personal scanners are inexpensive and can allow you to electronically file and store these important documents; just be sure to back up your files. Or, if your financial advisor has an electronic document management system, he or she may be willing to hold a copy of your records in your client file.

Whether it’s the New Year or Tax Time, or another time during the year that triggers your financial record keeping clean-up, use our easy-to-use record retention guidelines and make it an annual event! You might even consider printing out this blog and filing it away for easy reference when tax time rolls around again.

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.

Before You Tell Your CPA “You’re Fired!”

It’s that time of year again … when you gather up all of your tax documents, send them to your CPA or tax preparer and wait for the results.  Will you pay or will Uncle Sam be sending you a check?  For those that find themselves owing money on April 17, the first thought many times is, “Help – I need a new tax preparer!” Before you go firing anyone, check a few important lines on your tax return: 

• Line 43:  Did your taxable income increase over last year? 

• Line 44:  What is the total amount of tax owed for the year? 

• Line 72:  How much was withheld from your various income sources throughout the year? 

Remember, it is possible to pay less income tax than you did last year and yet OWE money to the IRS at tax filing time. How can that be?  Perhaps you simply had less withheld over the year.  

Here’s an example:

Joe and Sandy had to pay $2,000 more at tax time then they did last year.  However, the “extra” tax wasn’t really extra at all.  The total tax due for the year was about the same as last year.  The difference?  They had less tax withheld from their wages, pensions, or IRA distributions this year.  So, they owed the same amount for the year, but they paid (read: withheld) less throughout the year.  So, don’t go firing your tax preparer just yet! You may need to adjust your withholding via Form W-4 to avoid any surprises next April.

You should discuss any tax or legal matters with the appropriate professional.

Logic & Taxes Don’t Mix

A question I get a lot at income tax time is, “Can I deduct investment management fees?” While this should be a straight forward answer…we are talking about the tax code where nothing is simple.  As a law professor of mine once said, never put logic and income taxes in the same sentence.  Your tax preparer is the best person to consult with on this issue – but in the meantime, here are some guidelines:

The first place to start when trying to determine if an investment management fee is deductible or not is to determine the type of account (Taxable, Traditional IRA, Roth IRA, 401k, etc.).

Investment management fees paid in taxable accounts (such as single, joint or living trust accounts) are a tax deductible expense and reported as a miscellaneous itemized deduction on Schedule A of Form 1040.  That’s the easy part – but not the whole story. There is more to the story because not everyone can actually benefit from miscellaneous itemized deductions.  In order to benefit from your miscellaneous itemized deductions, in aggregate they must exceed 2% of your Adjusted Gross Income. As an example, if you have Adjusted Gross Income of $75,000, then the first $1,500 of miscellaneous itemized deductions are not deductible – only the balance can be deducted.  To further confuse the issue, if you are subject to the Alternative Minimum Tax some or all of these deductions could be disallowed as a tax preference.

For accounts such as Traditional IRA’s, ROTH IRA’s, and 401k’s, my interpretation of the tax code is that investment management fees paid by assets in the account are not deductible nor are they considered taxable income. In summary: not deductible (but you don’t pay income on the fee either). That said, some will argue that the fee is deductible, just as it is for taxable accounts discussed above. Lastly, some tax professionals will suggest that the fee is deductible if paid with money outside of the IRA. For example, some tax professionals will suggest that fees attributed to IRA type funds be paid via a separate check making them deductible.

As you can see, there are some gray areas on this topic.  What can you do?

• Be sure to share the fact that you paid investment management fees with your tax preparer
• Break the fees out by account type (taxable versus other types)

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The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS we are not qualified to render advice on tax or legal matters.

Why Age Matters with Michigan's New Pension Tax: Updated

Originally posted December 26, 2011

Michigan held out...they protected people collecting pensions for as long as possible. But the tax breaks are over, as Michigan follows suit with many other states in the nation by taxing pensions. It all begins January 1, 2012. Not all retirees with pension income are affected. However, if your pension income is subject to Michigan tax, under the new rules, you will need to withhold Michigan tax in the amount of 4.35%.

Here’s how the new law may affect you --

1.  IF YOU WERE BORN BEFORE 1946

No change in current law

• Social Security is exempt
• Senior citizen subtraction for interest, dividends and capital gains is unchanged
• Public pension is exempt
• For 2012 private pensions subtract up to $47,309 for single filers and $94,618 for joint filers.    

What will happen:  No Michigan tax is withheld from pension payments unless you request it. 

 2.   IF YOU WERE BORN BETWEEN 1946 AND 1952

Before the taxpayer reaches age 67

• Social Security is exempt
• Railroad and Military pensions are exempt
• Not eligible for the senior citizen subtraction for interest, dividends and capital gains.
• Public and private pension limited subtraction of $20,000 for single filers or $40,000 for joint filers. 

After the taxpayer reaches age 67 (**Will first occur in 2013**)

• Social Security is exempt
• Railroad and Military pensions are exempt (but see below)
• Not eligible for senior citizen subtraction for interest, dividends and capital gains
• Subtraction against all income of $20,000 for single filers and $40,000 for joint filers.
  • Not eligible for this income subtraction if choosing to claim a military or railroad pension exemption.

What will happen:  Michigan tax will be withheld from your January 2012 pension payment based on the number of exemptions you requested for your federal income tax. 

TAXPAYER EXAMPLE:

Tom and Nancy Jones are a married couple. Tom was born in 1947, is retired and collects social security and a pension.  Nancy was born in 1951, and is still working.

Tom’s Pension = $30,000

Tom’s Social Security = $20,000

Nancy’s wages = $40,000 

Will the Jones' be subject to pension tax in this scenario? 

Not under current tax law

• Pension subtraction = $30,000
• No withholding necessary on pension
• Social security is exempt   

3.  IF YOU WERE BORN AFTER 1952

Your pension will be subject to Michigan income tax until you reach age 67. 

Before the taxpayer reaches age 67

• Social Security is exempt
• Railroad and military pensions are exempt
• Not eligible for the senior citizen subtraction for interest, dividends and capital gains
• Not eligible for public or private pension subtraction

After taxpayer reaches age 67 (**Will first occur in 2020)

• Not eligible for senior citizen subtraction for interest, dividends and capital gains
• Not eligible for public or private pension subtraction
• Income exemption election:
  • ELECT exemption against all income of $20,000 for single filers or $40,000 for joint filers
    • No exemption for Social Security, military or railroad retirement
    • No personal exemptions

**OR**

•   ELECT to exempt Social Security, military and railroad pension.  May claim personal exemptions.

What will happen:  Michigan tax will be withheld from your January 2012 pension payment based on the number of exemptions you requested for your federal income tax. 

As always, our advice is to work with your professional advisors if you have any questions about the tax law changes and your pension income. Laurie.Renchik@Centerfinplan.com or Julie.Hall@Centerfinplan.com

Note:  Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors with RJFS, we are not qualified to render advice on tax matters.  You should discuss tax matters with the appropriate professional.

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Source:  www.michigan.gov

Why Age Matters with Michigan's New Pension Tax

Michigan held out...they protected people collecting pensions for as long as possible. But the tax breaks are over, as Michigan follows suit with many other states in the nation by taxing pensions. It all begins January 1, 2012. Not all retirees with pension income are affected. However, if your pension income is subject to Michigan tax, under the new rules, you will need to withhold Michigan tax in the amount of 4.35%.

Here’s how the new law may affect you --

1.  IF YOU WERE BORN BEFORE 1946

The new State of Michigan income tax doesn’t apply to your pension.

What will happen:  No Michigan tax is withheld from pension payments unless you request it. 

2.   IF YOU WERE BORN BETWEEN 1946 AND 1952

Some of your pension income may be subject to Michigan income tax. 

• Up to $20,000 in pension income for single filers
• Up to $40,000 in pension income for joint filers

Once you turn 67, the subtraction allowance applies to all forms of income 

What will happen:  Michigan tax will be withheld from your January 2012 pension payment based on the number of exemptions you requested for your federal income tax. 

TAXPAYER EXAMPLE:

Tom and Nancy Jones are a married couple.  Tom was born in 1947, is retired and collects social security and a pension.  Nancy was born in 1951, and is still working.

Tom’s Pension = $30,000

Tom’s Social Security = $20,000

Nancy’s wages = $40,000 

Will the Jones' be subject to pension tax in this scenario? 

Not under current tax law. 

• Pension subtraction = $30,000
• No withholding necessary on pension
• Social security is exempt.   

3.  IF YOU WERE BORN AFTER 1952

Your pension will be subject to Michigan income tax until you reach age 67.  After you reach age 67, if the total income of all people in your household is less than $75,000 for single filers or $150,000 for joint filers, you can subtract the following pension amounts from taxable income on your Michigan income tax forms:

• Up to $20,000 in pension income for single filers
• Up to $40,000 in pension income for joint filers 

What will happen:  Michigan tax will be withheld from your January 2012 pension payment based on the number of exemptions you requested for your federal income tax. 

As always, work with your professional advisors if you have any questions about the tax law changes and your pension income.  

Note:  Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors with RJFS, we are not qualified to render advice on tax matters.  You should discuss tax matters with the appropriate professional.

Source:  www.michigan.gov

Pay Now or Pay Later?

As if you didn’t have enough to do around the holiday, add this to your list … start thinking about contributing to your retirement plan, if you haven’t already. You have until April 15^th to make a contribution for 2011, but first you need to figure out what kind of IRA to fund … a traditional or a Roth. Do you take the tax hit now with a Roth or do you pay later with a traditional IRA? First things first -- consider that most people will have somewhat less annual income later in life, when they are done working.  If working years are typically our high income years, then why choose a Roth or convert savings to a Roth when we are working? Why pay a higher tax on retirement dollars now than you will later? 

It may come as a surprise, but there are some situations when it makes sense to go ahead and bite the tax bullet now. If you happen to have a special situation where your income is considerably lower now (or during a working year), then consider a Roth or Roth conversion. Maybe you have excessive business expenses or losses that can be deducted in a year, or perhaps you've had a very low income year due to the slow economy or due to a job loss. Maybe you or your spouse went back to school or stayed home with a baby and the household income has been cut in half … all are good reasons to go with a Roth. 

There is another important consideration. If you believe that the tax brackets and/or tax system will be changed on us, your decision could be much different depending on your expectation. For example, if you feel that tax rates on your retirement dollars will be increased substantially between now and retirement, you might want to hedge your bets and implement a larger Roth allocation into your overall tax strategy. Even if it means you pay some unwanted taxes now, obviously this could help you from paying an even larger tax later. 

It's important to consider a diversified tax strategy as you would a diversified portfolio and to treat each year as a new decision for contributions and/or conversions.  It’s never a one-time solution.

Withdrawals on a traditional IRA are subject to income taxes and, if withdrawn prior to age 59 1/2, may also be subject to a 10% federal penalty.  Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status and other factors.  In a Roth IR, contributions are made after-tax.  The account grows tax-deferred and qualified distributions are tax-free.  Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. 

In a Roth IRA conversion, each converted amount may be subject to its own five-year holding period.  Converting a traditional IRA into a Roth IRA has tax implications.  You should discuss any tax or legal matters with the appropriate professional.

Hold the Check, Please

Many of us will never need to worry about deferring compensation. In fact, the idea of waiting to get paid for work we do now until a year or more in the future would seem ludicrous. But if you're in a position where you're being offered a Nonqualified Deferred Compensation Plan, first count yourself lucky because you're likely a high-paid executive, then take a close look at your options. 

Simply put, deferred compensation is an agreement between an employer and an employee to hold back a portion of earnings for work performed today for payment in the future. Deferred compensation plans are a benefit most commonly offered in executive pay packages. Because the planning and tax implications associated with deferred comp are complex we recommend consulting with your financial advisor before making the decision to sign on. But the following points will help give you a basic understanding.  

Key takeaways from a tax and financial planning perspective: 

• Participation will reduce current taxable income
• Earnings grow tax deferred until distribution
• Consider maxing out 401k savings first; then NQDC, since this will provide the opportunity to save more, potentially filling the gap that can arise between income needed in retirement and income received from 401 (k) plans, pensions and Social Security
• Consider flexible distribution options - either during employment or in retirement. To qualify for a tax advantage, the IRS requires a written agreement stating the specified period of deferral of income.  An election to defer income must be irrevocable and must be made prior to performing the service for which income deferral is sought (Ex: An election to participate for 2012 must be filed in December 2011).            

A big challenge when it comes to saving for retirement is creating alignment between current income needs and saving for the future. If you are eligible to participate in a Nonqualified Deferred Compensation Plan then the next step is to see how this type of retirement savings fits into your overall plan for wealth accumulation and financial independence. 

The good news is that the decision is up to you and there is a great deal of flexibility. Plus, the impact of working now and getting paid later can be invaluable.  Talk with your financial advisor to see if it makes sense for you. 

Note:  Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors with RJFS, we are not qualified to render advice on tax matters.  You should discuss tax matters with the appropriate professional.

No Free Lunch – But Maybe a Free Capital Gain?

fThe financial and investment profession is full of acronyms, jargon, and common phrases such as “buy low – sell high” and is “there’s no free lunch when it comes to investing”.  Believe it or not, some things are free in personal finance (and our role is to help you find them) such as the 0% capital gain rate for many taxpayers.  Yes…..0%....and hopefully we don’t have to argue that that is a good rate! 

Single taxpayers with taxable incomes of less than $34,500 and married couples filing jointly with taxable incomes below $69,000 are considered to be in the 10% or 15% marginal bracket.  One of the luxuries of being in the 10% or 15% marginal tax brackets is a 0% capital gain rate through the end of 2012. Those in marginal brackets higher than the 10% and 15% currently are subject to a 15% capital gain rate.   

Here are a few examples of who might benefit from such a rate: 

• Those holding appreciated securities that have been hesitant to sell because of the tax implications.
• Those interested in selling an appreciated security in order to reset the cost basis. (Don’t forget to avoid the wash sale rules)
• Those in higher tax brackets looking to make gifts to relatives that are in lower brackets (say a child that has moved back into their high school bedroom). 

Example:   John and Mary’s son Steven recently graduate and is finding full time employment illusive.  John and Mary expect to help Steven out with expenses for the near future.  John and Mary are in the 28% marginal bracket and Steven (with little income) is in the 10% marginal bracket.  John and Mary can gift Steven appreciated securities….Steven can then sell them and take advantage of the 0% capital gain rate. 

As always, work with your professional advisors before implementing any tax strategies….and possibly enjoy a free lunch thanks to a free capital gain.

Note: Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.

Taking IRA Distributions Before You Need Them?

My wife truly enjoys talking to our two dogs – not that she expects them to talk back (I don’t think so at least) – but who doesn’t enjoy seeing their heads turn as if that will really help them understand what she has to say.  I had a client give me a similar look a few years back when I suggested taking money from his IRA even though he didn’t need it for current spending.  (The client was past age 59.5 but younger than age 70.5 so he didn’t have to take a distribution quite yet.) 

While, like my dogs, he didn’t say anything his look suggested that he was thinking “why would I take a distribution that I don’t need and accelerate income taxes?”  His head started to turn straight again when I illustrated that he might want to maximize the lower tax brackets.  A married couple filing jointly can have taxable income up to $69,000 in 2011 and still remain in the 15% marginal income tax bracket (remember taxable income is adjusted gross income minus exemptions and deductions). For this client, they could take out roughly $25,000 from their IRA and still be within the 15% marginal bracket.  While no one knows what income tax rates will be for sure in the future –locking in a 15% rate seemed attractive. 

2011 IRS Tax Brackets

To find out if accelerating IRA distributions is the right move for you, work with your financial planner and tax preparer to run “what if” scenarios.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Timothy W. Wyman, CFP®, JD, and Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James. Please note, changes in tax laws or regulations may occur at any time and could substantially impact your situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS we are not qualified to render advice on tax or legal matters.