Blog Archives - PFwise.com

What If Step-Up In Income Tax Basis on Death Changed?

2/28/2021

When you die most assets you own, under current law, have their income tax basis adjusted to equal the fair market value of the asset at the date of your death (or in certain circumstances 9 months later). For example, if you purchased stock for $1,000 that is now worth $100,000, the step up would eliminate the entire capita gain if your heirs later sell it.

President Biden has indicated he might eliminate the step up in income tax basis on death under Code Section 1014. That might revert to the tax system to what is referred to as a “carry over basis” system. So, the $1,000 you paid for the $100,000 of stock would carry over as the basis to your heirs.

Worse, there is the possibility that the Biden administration might try to enact in the alternative a system analogous to the Canadian estate taxation regime where there is a capital gain tax assessed on death.

There might be a combination of approaches, perhaps giving taxpayers an option to choose to remain subject to an estate tax and thereby also obtain a step up in income tax basis, or to instead face the loss of step up and avoid a capital gains tax on death. A recognition of gain at death would a be very far-reaching change that will have a significant impact on planning.

Consider that under current law many who are elderly or infirm intentionally hold highly appreciated assets until death to obtain a basis step up. In some instances, taxpayers create lines of credit to borrow against appreciated securities to avoid selling them. If a capital gains cost will be triggered on death that may eliminate the incentive to hold assets changing many estate planning, investment and other decisions.

How to Determine Your Risk Tolerance Levels

2/27/2021

While everyone’s risk tolerance is different, several factors will help determine your individual risk tolerance—the amount of risk you’re willing to take in your investment strategy.

Time horizon: How old, or young, you are and when you will need or want to use the money is a primary factor in your risk tolerance. Generally, the younger you are, the more time you may have to recover from losses in higher-risk investments. The older you are, the more risk averse you may be, worried that you won’t have time to recover from stock market losses.
Impact on lifestyle: The amount of money you are comfortable allocating to investments will contribute to decisions regarding your personal risk factor. If your lifestyle depends on the money you invest, your risk tolerance will be different from another investor whose money, if lost, won’t alter his or her day-to-day living.
Knowledge of investing: Some riskier investments require an in-depth knowledge of investing and may not be appropriate for someone who has limited knowledge. The more investing knowledge you have, the more comfortable you might be with a more aggressive portfolio.
Personal comfort level: Your natural inclination may be to be more aggressive, or more prudent, which can have an effect on your investment decisions.

Here are some examples of your investment strategies based on risk tolerance levels:

Short-term/No risk: 100 percent cash/bonds
Conservative: 70 percent cash/bonds, 30 percent stocks
Moderate: 40 percent cash/bonds, 60 percent stocks
Aggressive: 15 percent cash/bonds, 85 percent stocks
Ultra-aggressive: 100 percent stocks

Congress Gives a Gift to Permanent Life Purchases From 2021

2/26/2021

Effective January 1, 2021, after 35 years of dropping interest rates, Congress has finally adjusted the "Insurance Interest Rate" down to 2% for 2021 and a floating rate based on benchmarks for years thereafter.

What is the impact of this lower rate?

The MEC limit for permanent life insurance policies will be increased from 10% for older insured to around 200% for younger insured!

What is MEC Limit?
It stands for Modified Endowment Contract. IRS has a 7702 code which limits the amount of premium and cash value in a policy relative to the death benefit, so you cannot put too much money into your permanent life insurance policy and making it more like a "tax-free" investment.

To determine the maximum amount you can put into a policy, there is a "7-Pay Test", if your policy fails the 7-pay test, it will become a MEC, which effectively takes life insurance taxation and turns it into annuity taxation.

So with a higher MEC limit effective January 1, 2021, anyone who purchases permanent life policies (Whole Life, IULs, etc.) now will be able to put more money into their policies and that money will grow tax-free and taken out tax-free as policy loans.

The above will apply for new policies, unfortunately it won't apply for policies went effective prior to January 1, 2021.

Use IULs to Create Income for Life?

2/25/2021

For everyone, there are usually 3 needs for a life insurance, as outlined below, with #2 and #3 needs coming up in later life stages:

To protect incomes and pay for mortgages for beneficiaries if die prematurely
As an empty nester with the need to pay some college expenses
As a retiree with the need of supplementary funds so one doesn't outlive his or her retirement savings

Term life is the best solution for need #1.

A Holistic View of What a Life Insurance Policy Can Do
An IUL with a lifetime income rider provides the flexibility to address all of a person's changing financial needs at various stages of life.

When a person's children are independent and mortgage is paid, the need for death benefit is no longer as prominent. If he purchases an IUL policy it can adapt to meet the financial needs of he and his spouse as their circumstances and priorities change. For example, if he finds himself wanting to withdraw money as a policy loan to pay for a vacation or help his children with college expenses, his IUL has the flexibility to accommodate those needs.

And with a lifetime income rider on the IUL, he can use the policy to supplement his retirement savings with a guaranteed income he can't outlive. The rider is built into the policy, and you don't pay for it unless you use it.

How Lifetime Income Riders Work
The lifetime income rider is built into the life insurance chassis. If the policyholder activates the rider and begins to take an income stream, the carrier will base its payout on the policyholder's age and current account value. After the income payment is calculated there is a rider activation charge deducted from the policy's account value. The charge does not affect the income payment amount, as it is applied after the income calculation is made.

The income is treated as tax-free since it is under the chassis of the life insurance policy. The insurance carrier will also guarantee a minimum death benefit and minimum account value for the life of the policyholder.

The conditions to Meet
In order to activate the lifetime income rider, insurers typically require: the insured age between 50 and 85, the insured not receiving benefits from other policy riders, and the policy has been issued at least 10 years.

Two ETFs Offer Protection From Inflation

2/24/2021

If you are concerned about inflation in the coming years, two new ETF products offer protection from inflation, although they take different approaches.

1. IVOL
The Quadratic Interest Rate Volatility and Inflation Hedge ETF uses Treasury-inflation-protected securities, or TIPS, and interest rate derivatives to hedge against inflation and fixed income volatility. While most people first think about TIPS to hedge inflation, the problem with TIPS is their long durations, which means they are prone to lower prices when their yields rise, so IVOL uses fixed income options to counter that duration risk, specifically ones based on the Treasury yield curve (the differences between the two and ten-year notes).

It was launched in May 2019.

2. INFL
The Horizon Kinetics Inflation Beneficiaries ETF concentrates on stocks that might benefit from inflation while generating superior returns over the entire economic cycle. Specifically, the funds emphasizes companies that are capital-light with exposure to hard assets.

These ETFs should be used as a complement to a typical portfolio.

Creating Alpha Through Regular Tax Loss Harvesting - Part C

2/23/2021

In last blogpost, we discussed wash sales. Now we will discuss another tax loss harvesting strategy that could create alpha.

Tax Arbitrage
Because the IRS taxes different types of income at different rates, you can utilize tax arbitrage to access lower tax rates.

For example, long-term capital losses are typically used to offset log-term capital gains, allowing you to avoid paying long-term rates (up to 23.8%) on those capital gains. If you can delay realizing those gains, you can let long-term capital losses offset short-term capital gains and ordinary income (up to 40.8%).

This strategy can add tax alpha because any leftover long term capital losses can be deducted against ordinary (up to $3,000 per year). Whenever possible, pairing long-term losses with short-term gains and ordinary income maximizes the value of those losses.

Creating Alpha Through Regular Tax Loss Harvesting - Part B

2/22/2021

In last blogpost, we discussed a 4-step approach to do tax loss harvesting.

Wash Sales
A wash sale occurs when you sell or trade securities at a loss and within 30 days before or after the sale, do the following:

Buy substantially identical securities
Acquire substantially identical securities in a fully taxable trade
Acquire a contract or option to buy substantially identical securities

The IRS leaves it up to investors to determine if a position is substantially identical. Here are some good practices you can follow when selecting a replacement security.

For example, if you sell an ETF or index fund, you can replace it with a product that tracks a different index. Most investors consider actively managed funds to be unique enough to be in safe territory.

In next blogpost, we will discuss a tax arbitrage practice.

Creating Alpha Through Regular Tax Loss Harvesting - Part A

2/21/2021

Tax loss harvesting is usually done at year end, however, it doesn't have to be. Doing it on a periodic basis (such as quarterly or semi-annualy) might be a better approach.

4-step Approach
First, identify a list of nonqualified accounts to review individually.

Second, look at all the holdings across all the identified accounts, and identify what are the unrealized gains and losses.

Third, once positions have been identified as harvesting candidates, confirm no purchases of the security have been made in any accounts in the past 30 days, including retirement accounts.

Last, decide if you would like to keep the proceeds in cash or invest them in a replacement security. A replacement security is recommended so you can stay in the market instead of timing the market.

There is one thing needs attention - wash sales, we will discuss in next blogpost.

Strategies to Lower or Eliminate Capital Gain Taxes

2/20/2021

Capital gains taxes become due when you sell your investment. For example, if you own a rental property that has increased significantly in value over the years of your ownership, you will not owe a capital gains tax during those years of ownership. However, once you sell the property, you must report the profit on your tax return and pay a tax at your income bracket’s capital gains rate. As you will note, capital gains taxes are often a form of double taxation in that you will have paid taxes annually on all income derived from the asset (assuming it is an income-producing asset) and you will be taxed again (at the federal and, most likely, also at the state level) when you sell the asset.

What are the available strategies to lower or even eliminate capital gain taxes?

BloombergTax.com has an article that discusses several strategies, the list is here, for details, please read the article here.

Section 1031
Invest in QOZ via QOF
Section 121 (exclusion of gain from sale of principal residence)
Section 453 (the installment sale provision)
Sections 170(a), 170(c) and 501(c)(3) (Charitable Donations and Tax-Exempt Organizations—Charitable Remainder Trusts, Donor-Advised Funds and Family Foundations)
Charitable Remainder Trusts (CRTs)
Donor-Advised Funds (DAFs)
Family Foundations
Section 1202 (the Small Business Stocks Gains Exclusion)
Section 179, the JOBS Act and the CARES Act (election to expense certain depreciable business assets)

12 Tax Tips for the 2021 Filing Season

2/19/2021

This Financial-Planning.com article identifies 12 tax tips for the 2021 filing season.

For example, the Paycheck Protection Program was initially introduced in April, then changed in June and again in December. If you haven’t kept up, you can be two bills behind.

Qualified Opportunity Funds 101

2/18/2021

Background on Opportunity Zones and Qualified Opportunity Funds
To revitalize the economy, the 2017 Tax Cuts and Jobs Act introduced tax incentives for capital gains invested in a Qualified Opportunity Fund (QOF).

You may be able to defer and reduce capital gains tax if you invest capital gains in a Qualified Opportunity Fund. Aside from that, the gains realized by the QOF may become completely tax-free.

Qualified Opportunity Funds invest in Opportunity Zones. Each state may nominate areas to be classified as an Opportunity Zone and the Secretary of the U.S. Treasury certifies this nomination through the IRS. There are over 8,700 Opportunity zones in the District of Columbia, across all 50 US states and in five territories.

The Opportunity Zones benefit is valid from December 23, 2017 until December 31, 2026, unless the Congress decides to renew the program.

What is a Qualified Opportunity Fund?
The Qualified Opportunity Fund is a partnership or a C corporation investing in a Qualified Opportunity Zone. A business, which may be new or existing, has to self-certify that it is a Qualified Opportunity Fund by filing Form 8996 to the IRS.

The Qualified Opportunity Fund must use at least 90% of its assets to invest in a subsidiary operating in a qualified Opportunity Zone or to operate a business in an opportunity zone.

There are three main benefits of investing in Opportunity Zones
1. Deferral of capital gains on the original sale up until the QOF is sold or on December 31, 2026, whichever comes first.

The sale should have been made to an “unrelated” party. For this program, a shareholder who owned at least 20% of a corporation is a related party.

2. Taxable capital gains are reduced by 10% if the QOF is held for five years and reduced by 15% if held for seven years

3. Capital gains from the QOF are tax-free if the QOF funds are held for 10 years.
Here’s a scenario on what happens based on how long you hold the investment.
Some rules:

Deferral of the capital gains is not automatic. For this program, the taxpayer has to elect to defer the gain through Form 8949. You need to file this form together with your annual tax return for the year the capital gains tax is due.

The program is only open to new investments in a Qualified Opportunity Fund. Any investments made before the business became a certified QOF will not be eligible for preferential treatment of capital gains.

The investment made on the QOF should also be an equity investment made through the purchase of stocks or partnership interest. Investments made through debt instruments will not be eligible for this program.

Transaction Example
If you sold stocks you acquired for $2 million at $5 million, you have to pay capital gains tax on $3 million ($5 million less $2 million). If you reinvest the capital gains in a QOF, you can defer the capital gains tax on the $3 million gain until you sell the investment or until December 26, 2027, whichever comes first. If you reinvest the $3M on traditional funds, you have to pay capital gains tax on the $3M right away.

If You Hold for 5 Years
If you hold your investment in a qualified opportunity fund for at least five years, you can avoid paying taxes on 10% of the deferred capital gain.

Following the example above, assume that the $3M capital gains invested in a QOF increase to $3.2M in five years. If you decided to sell by then, you have to pay capital gains tax on the following:

$200,000 from the appreciation of your QOF ($3.2M less $3M)
$2.7M from the $3M you reinvested in QOF. The deferred gains are reduced by 10% or 300K (10% of $3M) since you decided to hold your investment for 5 years.

Hold for 7 Years
If you hold your investment for seven years, the capital gains will be reduced by an additional 5%, decreasing the original capitals gains by 15%. If at this point, you sell the QOF at $3.3M, you have to pay capital gains tax on the following:

$300,000 from the appreciation of your QOF ($3.3M less $3M)
$2.55 M from the $3M reinvested in a QOF. At this point, the deferred gains are reduced by 15% or 450K (15% of $3M) since the QOF was held for at least 7 years.

To get a reduction in the original capital gains, the five-year and seven-year period should be within the program period which has a December 31, 2026 deadline.

Following this rule, you will only get this 15% reduction in capital gains if you invest in 2019. Beyond 2019, the seventh-year anniversary of the QOF will fall outside the program period.

Likewise, the five-year reduction in capital gains will only be applicable for funds you invest in until 2021.

Hold for 10 Years
If you hold the QOF investment for ten years, you can reduce capital gains by 15% in the seventh year and exclude any capital gains from the QOF investment when you sell. The only condition is that the investor MUST sell the QOF before December 31, 2047.

If on the 10th year, you sell your $3M investments on a QOF for $3.5M, you have to pay capital gains tax on:

$2.55 M from the $3M capital gains reinvested in a QOF. On the seventh year, the deferred gains decrease by 15% or 450K (15% of $3M).

The 500K ($3.5 less $3M) gain is exempt from taxes if you held the investment for at least 10 years.

MLPs - High Yield Plays

2/17/2021

If you are looking for high yields and could take high risks, Master Limited Partnerships (MLPs) could be the one.

What are MLPs?
MLPs are spin-offs from energy firms nd operate gas or oil pipelines. MLPs pay out most of their income to investors and don't pay corporate income taxes on that income. Those who buy individual MLPs will receive a K-1 tax form, which spells out the income, losses, deductions and credits that the business earned and your share of each.

Most MLP ETFs and mutual funds don't issue a K-1, you will receive a 1099 form reporting the income you received from the funds.

The Risks
In theory, MLPs performances should be independent of oil prices because they collect fees on the amount they move, no matter the price. However, in reality, they are in sync.

Higher production levels should mean a good year for pipeline firms.

The Candidates
Here are just some possible candidates:

Magellan Midstream Partners (MMP)
Alerian MLP ETF (AMLP)
Clearbridge Energy Midstream Opportunity (EMO)

2021 Tax Guidelines

2/16/2021

Many 2021 tax limits have changed. See the new itemized deduction caps, qualified business income deductions, capital gains and dividends tax rates, and more, below!

2 Strategies to Protect Yourself From Fear of Loss - Part C

2/15/2021

In last two blogposts, we discussed 2 strategies to protect your investment.

Determining which, if either, strategy may make sense for you will depend on a number of factors, including your investing goal, interest rate environment, fees on your investments, your time horizon, and your tolerance for risk. First consider if you might be better off investing in a diversified portfolio, because either of these strategies (anchor or protected accumulation) may limit your upside growth potential—and the diversified portfolio may offer a greater long-term benefit.

You also need to consider when you will need access to these assets, because both strategies might penalize early withdrawals. For instance, redeeming a CD before it matures typically means forfeiting some or all of the interest earned, while annuities may levy a surrender charge representing a percentage of the account value. So if your goal is less than 10 years away, the protected accumulation strategy is not a good fit.

Bottom line:
The decision may well come down to your investor personality. With your principal protected from loss, would you gain the confidence to invest more aggressively than you are today?

The protected accumulation strategy requires little action from you aside from your initial investment and an annual decision whether to lock in any growth.
The anchor strategy requires that you invest the assets that are left over after establishing your anchor.

2 Strategies to Protect Yourself From Fear of Loss - Part B

2/14/2021

In last blogpost, we discussed Anchor Strategy. Now we will discuss the second strategy.

2. Protected Accumulation Strategy
The protected accumulation strategy takes advantage of principal protection features on variable annuities. A guaranteed minimum accumulation benefit (GMAB) rider on an annuity is the most basic of these. Your assets are invested in a portfolio that typically has a larger equity position than the roughly 10% stake outlined in the anchor strategy above. For a fee, the GMAB rider guarantees that at the end of the annuity's investment period—typically 10 years—you'll have at least the same asset value you started with.

Another potential benefit is that most GMAB riders let you reset the level of principal protection each year if your investments have grown in value. If you do lock in a higher balance, the investment period resets and your balance is guaranteed for another 10 years. It is possible that your fee may increase if you elect this option and annuity features will vary by the issuing company.

For example, say you originally invested $100,000 in a variable annuity with a GMAB rider. After the first year, the annuity's underlying investments grew to a value of $105,000. Locking in that new balance would guarantee that you would have at least $105,000, regardless of how the markets performed after a new 10-year period. On the other hand, if the underlying investments lost value in that first year, you could be comforted by the knowledge that your original $100,000 was guaranteed.

Please note: If you do decide to implement a protected accumulation strategy, you should do your research as the GMAB terms and fees vary from one product or company to another.

In next blogpost, we will discuss how to determine which strategy is right for you.

2 Strategies to Protect Yourself From Fear of Loss - Part A

2/13/2021

Excessive fear of loss causes many investors to act counterproductively. If this sounds like you, you could consider 2 strategies to protect your principal.

1. Anchor strategy
2. Protected accumulation strategy

1. Anchor Strategy
An anchor strategy involves dividing your portfolio into 2 parts, a conservative anchor and more growth-oriented investments. The anchor portion of your portfolio uses investments that offer a fixed return, such as certificates of deposit (CDs) or single-premium deferred annuities (SPDAs). These assets have a set lifespan, and the amount you invest is designed to grow back with interest to your original principal. This portion of your portfolio acts as your anchor, while your remaining assets are invested in more volatile, growth-oriented securities such as stock mutual funds or ETFs.

A true anchor strategy protects your entire starting principal. For example, say you have $100,000 in assets and a 5-year investment period in a tax-deferred account. You could invest $88,400 in a 5-year SPDA yielding 2.50%—leaving you free to invest the remaining $11,600 for growth—because after 5 years that SPDA would be worth $100,016, just over your original principal.

The anchor strategy can remove the negative outcomes cautious investors sometimes fear because even if the markets fall, your anchor makes sure you at least have what you started out with.

Please note, inflation can erode the purchasing power of your original investment over time and this strategy generates taxes each year in a taxable account.

In next blogpost, we will discuss protected accumulation strategy.

How to Claim Missing Stimulus Money When You File 2020 Tax Return - Part B

2/12/2021

In last blogpost, we discussed several possible reasons you didn't get your stimulus check.

Technically, stimulus payments are an advance on a tax credit for the 2020 tax year. The IRS calls this credit the Recovery Rebate Credit. Unlike a tax deduction, which reduces your taxable income (and therefore your tax payment), a tax credit reduces the amount of tax you owe, dollar for dollar. Even better, and unlike most credits, the Recovery Rebate Credit will give you money back even if it's more than the tax you owe or paid. For example, if you owe $700 in federal income taxes for 2020, a $1,200 stimulus tax credit would net you a $500 tax refund.

You need to file federal tax form 1040 or 1040-SR for 2020 to claim your Recovery Rebate Credit. You'll also need your IRS Notice 1444, the letter the IRS should have sent to you a few days after you got your first stimulus check, and IRS Notice 1444-B, which you would have gotten after your second stimulus check. If you didn't get a stimulus check, you don't need either notice.

You can file a 1040 or 1040-SR even if you didn't earn enough income to require filing a federal tax return. If you earned no money in 2020, simply put down zero as your income on Line 1. Then proceed to the Recovery Rebate Credit worksheet on page 59 of the instructions for the 1040 or 1040-SR, where you can figure how much money you're entitled to for the credit. Remember, even if you owed no taxes or paid no taxes in 2020, you still might be eligible for the first and second stimulus payments, as well as any payments for eligible dependent children.

The worksheet for the credit will tell you whether you're eligible, and how much more you're entitled to if you didn't get the full amount. Although the one-page, 21-line worksheet looks intimidating, it essentially walks you through calculating whether you're entitled to a stimulus credit, and how much that credit is. The amount from the Recovery Rebate Credit worksheet goes on line 30 of your 1040 form. If you aren't entitled to a Recovery Rebate Credit, leave line 30 blank.

You have nothing to lose by filing a tax return for your stimulus payment. The credit won't increase your taxes or reduce your refund. The second stimulus payment can't be seized by creditors or garnished by the government for nonpayment of child support. And, the IRS says, if your adjusted gross income is less than $72,000, you can use its Free File service at no charge to calculate your credit and file a tax return electronically.

How to Claim Missing Stimulus Money When You File 2020 Tax Return - Part A

2/11/2021

If you didn't receive money from the first or second round of stimulus payments — or you didn't get the full amount you should have — don't give up. You'll need to file the standard 1040 federal tax return form, or the 1040-SR tax return for people 65 or older, to get your missing stimulus money in the form of a tax credit that will either lower the amount of tax you owe or increase the size of your refund.

The eligibilities to get the stimulus money

The first round of stimulus checks, mandated by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, was signed into law in March 2020. The CARES Act gave a maximum $1,200 per person and $500 per eligible dependent child under 17. Payments were limited by 2019 or 2018 income as reported on federal income tax forms. Individuals who had more than $75,000 in adjusted gross income had their stimulus check reduced by $5 for every $100 of income, and the same was true for married couples filing jointly with income above $150,000. Individuals who earned more than $99,000 and couples who earned more than $198,000 jointly did not receive checks.

The second round of stimulus checks gives a maximum $600 per eligible person and dependent child. Married couples who filed jointly in 2019 receive $1,200 total ($600 apiece). Families get an additional $600 for each eligible dependent child under 17. The income limits are the same for the second round of stimulus payments as they were for the first, though the phaseout amounts are lower since the maximum payment is $600 vs. $1,200 during the first round. Individuals who earned more than $87,000 and couples who earned more than $174,000 jointly won't receive second-round checks. The deadline for the IRS to issue second-round payments is Jan. 15.

Why you may be missing stimulus money

Income limits are one reason you might not have gotten your first stimulus check, or that your first stimulus check wasn't as much as you thought it should be. For example, the IRS used 2019 tax returns to calculate the amount of some stimulus checks. If you lost your job in 2020, your 2019 income may have been too high for you to get a full check, or even any payment at all. Your 2020 tax return gives you a chance to get whatever amount you're still owed.
Many people who automatically received the first round of stimulus checks because they were getting federal benefits from the Social Security Administration or Department of Veterans Affairs may not have gotten stimulus payments for their dependent children. Others may have run into snafus with the online tool on IRS.gov.
You had or adopted a baby in 2020. The IRS used 2018 or 2019 tax returns to calculate stimulus payments. If you gained another member of your family in 2020 who is eligible for the stimulus payment, you're entitled to a $500 credit from the first stimulus round, and $600 for the second.
Your income fell in 2020, so you got less than you should be entitled to, based on your higher 2019 income.
You weren't required to file a tax return in 2019 or 2018 and didn't use the online IRS tool to register your bank information. (The tool is now closed.)

In next blogpost, we will discuss how to get your stimulus checks back.

With Higher Taxes Possible, Here’s What to Do Now

2/10/2021

Below is a New York Times article by Paul Sullivan that discusses this topic on Jan 26, 2021.

President Joe Biden has already made clear his tax priorities. His proposed $1.9 trillion pandemic relief bill would cut taxes for lower- and middle-income Americans, and he is expected to call for higher taxes on corporations and the rich.

How many of his plans become law remains to be seen. But he has given a signal that he is moving toward fulfilling his pledge of rolling back former President Donald Trump’s tax cuts. Biden’s campaign plan would increase taxes by more than $2 trillion over a decade, according to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.

“It’s more useful to think about what President Biden has proposed as a $3 trillion tax increase on corporations and high earners and a $1 trillion tax cut for everyone else,” said Howard Gleckman, a senior fellow at the Tax Policy Center. “My sense is it will be easier in the current political dynamic to get the tax cuts he talked about than the tax increases.”
Last week, I wrote about long-term tax-planning issues, focusing on how proposed changes to the estate tax could affect many more people. This week, I’m turning my attention to some of the short- and medium-term tax proposals that could affect people’s earnings and financial decisions.

Of course, making a decision affecting taxes is not easy without knowing what the political landscape will look like. But for many wealthier people, it may make more sense to pay the taxes now rather than risk a rise in rates later in the year, particularly if you were going to do something that would incur the tax anyway.

There are some immediate tax questions that need to be addressed.

Business owners who received a loan under the first Paycheck Protection Program got good news regarding federal taxation of that money as 2020 ended: Expenses paid with the loan are deductible. But the last-minute nature of that decision caused confusion at the state level.

“Many states, including my home state of California, are not showing any signs that they are going to conform with the federal changes,” said Robert Seltzer, founder and president of financial advisory firm Seltzer Business Management. “If they don’t, that means that for many clients, they will have significant differences between their federal and state returns. Practitioners are not yet sure how to present those differences on the state returns.”

Seltzer used his own $53,400 loan as an example. With the 9% state tax rate for his business, a C corporation, his Paycheck Protection Program expenses would cost him an additional $5,000 in state taxes. If his business were one whose earnings were taxed on his individual income tax form, the rate could be as high at 13%.

“It creates a separate tax burden,” he said.

State deductibility is something to keep in mind as business owners apply for a second loan from the Paycheck Protection Program.

Some tax issues will play out later this year. One of them involves individuals who own businesses and pay the self-employment tax. They pay 12.4% of their income in Social Security taxes and 2.8% for Medicare, but only on the first $142,800. That cap could be lifted, making all income subject to the self-employment taxes.

One strategy is for owners to convert their business from a limited liability company to a subchapter S corporation, which could reduce the self-employment tax, said Edward Reitmeyer, a partner in charge of tax and business services at Marcum, an accounting firm.

But it has to be done carefully. What an S corporation pays in distributions from the earnings of the company itself is free from self-employment tax. But the owner of the S corporation can’t simply issue distributions to himself; he needs to take some amount of compensation that will be subject to the self-employment tax.

“The IRS comes after you if your compensation is too low,” Reitmeyer said. “But with this structure, you’re at least prepared if there’s a change to unlimited self-employment tax on income.”

Perhaps the biggest concern for this year is what happens to the capital gains tax rate, currently 20%. Most wealth advisers are betting on an increase, probably to the same level as the tax on income. That is not such a jump for most earners, but it would be for someone in the highest tax bracket, 37%.

How much tax you pay on the increase in the value of your stock holdings is one of the few taxes you can control, since it’s up to you when you sell securities. But you need to calculate whether it makes more sense to sell securities that have appreciated, particularly after the run-up in 2020, and pay the tax now or hold on to them.

Several factors come into play here. If the strategy is to hold those securities until you die and not pay capital gains tax, that tax break could come to an end, as my column last week pointed out. The Biden administration could do away with the provision that sets the value of assets in an estate at the time of the owner’s death, erasing years of capital gains. The administration could instead require that heirs pay taxes on those gains when they sell the assets.

More sophisticated investors holding on to appreciating securities without selling could borrow against the portfolio. There would be interest on the loan, but it would be far less than the tax bill.

If there is a significant drop in asset values, that’s another matter. Savvy investors may decide to sell, pay their taxes and reinvest their money in preparation for potentially higher taxes.

“Capital gains is still a real issue because markets are still high,” said Marya Robben, a partner in the law firm Lathrop GPM. “When the correction happens, there’s going to be a surge in planning.”

There’s also the possibility of tax increases on deferred compensation. That’s often used as an inducement for high-earning executives who don’t need the money immediately and can pay lower taxes later when they retire.

Higher taxes in the future may make this strategy less attractive. “If you’re faced with an opportunity to defer taxes, that may not be the right decision now,” said Pam Lucina, chief fiduciary officer and head of trust and advisory services at financial services firm Northern Trust. “You may be better off taking the compensation and paying the tax now.”

Also keep in mind that deferred compensation is tied to the security of a company and that many companies are struggling in the pandemic, so deferring compensation could be a riskier prospect today than it was a year ago. Hundreds of people lost their deferred compensation when Lehman Brothers failed in the last big crisis in 2008.

There are other concerns that people may want to address as the year goes on. Required minimum distributions from retirement accounts were suspended last year in the pandemic, but they’ve been reinstated for anyone over 72.

Then there is the perennial issue of whether to convert a traditional individual retirement account — where the money goes in tax free but is taxed when you take it out — to a Roth IRA, where taxes are paid upfront but the money in the account grows tax free.
There are a number of possible strategies if you expect tax rates to rise. The all-out conversion to a Roth can be painful, given the tax bill you would have to pay after the stock market’s performance since March.

But Lucina said she had recommended that clients ladder their tax obligations the way some investors ladder their tax-free municipal bond allocations. This means converting some retirement accounts to Roth IRAs and leaving others untouched.
“You might want to hedge the uncertainty by organizing the portfolio so you have tax diversification,” Lucina said. “Having a bucket that is taxable versus one that is tax free lets you have optionality in the future.”

Others are more bullish on paying taxes now at a known rate. They advocate what is called a backdoor Roth conversion — essentially putting money into a traditional retirement account and then immediately moving it into a Roth and paying the taxes on it.

“It’s straightforward — you report it on your tax return each year,” said Brian Glavotsky, tax partner in family office services at accounting firm Wiss & Co.

He added that these incremental and immediate moves were easier than wholesale Roth conversions. “The market is at an all-time high. Invested assets are at an all-time high,” he said. “Many more people were running to do conversions in March 2020.”

That points to the need for a plan and not just the hope that you can time the market for taxes.

Homeowners Insurance vs. Renters Insurance - Part D

2/9/2021

In last blogpost, we discussed what are not covered by either homeowners insurance or renters insurance.

Which insurance is right for you?

Usually, the answer will depend on whether you’re owning or renting. Mortgage lenders usually require borrowers to have homeowners’ coverage, and landlords may require renters’ coverage.

Renters should make sure to get a policy that protects their personal property, not just the landlord’s liability.

If you own a home and rent rooms
A homeowners’ policy makes sense if you live in the building full-time or if you have furnishings and belongings there you want to protect.

Homeowners’ policies don’t typically cover damage caused by renters, so your renters should be encouraged to purchase their own coverage.

If you don’t live in the building, you might be considered a renter yourself, meaning you might not need a standard homeowners’ policy. Different insurance providers have different guidelines. When in doubt, however, it’s best to get full coverage including dwelling coverage.

If you live in a rent-to-own space
Most often you’ll be considered a tenant until you actually purchase the home. As a tenant, you’ll need renters insurance.

Once you officially own the home you’ll have to cough up for homeowners insurance, but not until then.

If you live in a co-op or condo
These housing arrangements may have specific insurance requirements. As a general rule, however, condo owners will want a homeowners policy with dwelling coverage.

Co-op owners only own a percentage of their building, so a renters or tenant policy should suffice.

Homeowners Insurance vs. Renters Insurance - Part C

2/8/2021

In last blogpost, we discussed what does a renter's insurance cover. Now we will discuss what are not covered by either insurance.

What a homeowner's insurance does not cover?

Floods and earthquakes are major enough to require their own separate policies. They’re almost never included in dwelling coverage. If you live in a flood- or earthquake-prone area, you can get additional coverage for a cost.

And insurance providers won’t cover homeowner neglect: damages that could have been prevented by basic maintenance and upkeep.

Policies also don’t extend to government demolition or power failure (if the power source is outside of your residence).

What a renter's insurance does not cover?

Since renters don’t own the buildings they live in, their insurance won’t include dwelling coverage, which means it won’t pay for structural damage to the building.

As with homeowners policies, renters’ personal property compensation is limited to “covered events” or perils listed by the insurance company.

And unless you’re married or living with your family, a renters insurance policy will only cover the belongings and liability of the person who pays for it. If you have roommates you’ll need to get separate policies if everyone wants coverage.

In next blogpost, we will discuss which insurance is right for you.

Homeowners Insurance vs. Renters Insurance - Part B

2/7/2021

In last blogpost, we discussed what does a homeowner's insurance cover.

What does a renters insurance cover

Personal property
This is mostly what you’re paying for. Renters insurance protects your personal property — electronics, clothing, equipment, and other valuable items.

Before buying a policy you’ll take an inventory of what you own and determine what it costs to replace. This approximate amount will be your coverage limit.

You may have the option to select “replacement-cost” coverage or “cash-value” coverage (the cash value of your belongings). Replacement-cost means a bigger payout if your items are damaged or destroyed, so the policy is nominally more expensive — $20 to $50 a year more.

Cars aren’t included in the policy since they’re covered under your auto insurance. Objects stolen from your car will be covered, though, even if the car’s not on your property at the time.

Personal liability
This coverage kicks in if someone’s injured on your property, much like homeowners coverage. It also protects you from a landlord’s lawsuit if you cause accidental damages to the building.

Medical payments and additional living expenses
Both homeowners and renters get this coverage.

In next blogpost, we will discuss what are not covered by homeowners insurance and renters insurance.

Homeowners Insurance vs. Renters Insurance - Part A

2/6/2021

Homeowners insurance and renters insurance both cover slightly different types of property damage, and it’s good to know the difference before you get coverage.

What does a Homeowner's Insurance Cover?

Dwelling coverage
This is the key difference between homeowners and renters insurance: only homeowners insurance includes dwelling coverage, which covers damage to the actual structure of the home.

This includes anything from a broken door or window to total building demolition. Dwelling coverage extends to other structures on property you own, such as a fence, garden, or garage.

Not all damages will qualify you for a payout. Most companies have what’s called a “named peril” policy which lists qualifying perils or “covered events” — the damages your insurance will pay to repair. Weather phenomena like heavy wind and hail, two of the most common dangers, are usually on the list.

Other covered events might range from smoke, fire, falling ice, and water damage to vandalism and theft.

Personal property
Personal property coverage protects the belongings inside your home. Even if the object isn’t physically in your home — for instance, if your laptop or bicycle is stolen from your car — the policy kicks in.

For homeowners, the price is usually included as a percentage of your dwelling coverage, but you can raise or lower the amount as needed before buying a policy.

Personal liability
If someone’s injured in your home, or if someone sues you for damage to themselves or their property, this is where personal liability insurance comes into play. The amount is flexible. Pet owners whose animals tend to be aggressive, for example, often end up paying more.

Medical payments
This insurance covers medical costs if someone gets hurt on your property and needs a doctor’s attention. Unlike personal liability, medical coverage is on a no-fault basis; you won’t be held legally liable.

Additional living expenses
This catch-all phrase just means you’ll have money for living expenses, including a hotel or rental if you need to vacate your home after a covered peril.

In the next blogpost, we will show you what does a renter's insurance cover.

Free Online Social Security Benefits Maximization Calculator

2/5/2021

There are a number of online social security benefits calculators to choose from. One of them is Open Social Security. It is free and it allows you to easily change claiming dates to see the impact.

Below are three cases that a recent Wall Street Journal reported using this free calculator. In each case, the couple adjusted the numbers to fit their own situation—and realized that conventional wisdom doesn't always make sense.

Couple No. 1
A husband and wife plan to retire together at age 62. Each will get $36,000 a year from Social Security if they wait until their full retirement ages of 67 to start benefits. However, they plan to start benefits immediately and so will each receive $25,350 a year, or a total of $50,700.

What the calculator recommends
One spouse should file for benefits at age 65 and five months and get $32,200 a year. The other spouse should wait until age 70 to file and receive $44,640. Together, the couple will collect $76,840 a year at age 70, about 52% more than they would by both claiming at age 62.

When one of them dies, the survivor will receive the higher of the two checks, or $44,460, for the rest of his or her life. By contrast, if they both retire at age 62, the survivor will receive only $29,700.

The calculator estimates the couple will receive 12.5% more value by following its recommendation than by both retiring at age 62.

What the couple ends up doing
The couple decides that one of them should hold off collecting benefits until age 70 to maximize the survivor benefit. But they plan to travel in their early 60s, and they would like at least one Social Security check to help cover costs. By studying the calculator, they notice they still will achieve 99.6% of the optimal strategy if the other spouse starts collecting Social Security immediately. So that is what they do.

Couple No. 2
A 63-year-old man is married to a 38-year-old man. The older man plans to start collecting Social Security when he reaches his full retirement age of 66 and six months and will receive $30,000 a year. The younger man is projected to receive $12,000 a year in Social Security benefits at age 67.

What the calculator recommends
The older man, the higher earner, should wait until age 70 to start benefits, when he will collect $38,400 a year. Because of their age difference, it is unlikely they will simultaneously collect Social Security for a long period. Thus, the young man should begin Social Security at 62 and one month, when he will receive $10,413 if his husband is still alive.

After one of them dies, the survivor will receive $38,400.

What the couple ends up doing
The older man doesn’t think he can continue working until 70. So, he compromises and delays collecting retirement to 68 and a half. That increases his benefit to $34,800. It is less than the $38,400 he would receive by waiting all the way to 70 but is more than the $30,000 he would receive by drawing benefits at 66 and six months. The calculator estimates this compromise has a lifetime value 4.8% below the optimal strategy.

Couple No. 3
A 60-year-old woman has just retired and plans to collect Social Security at her full retirement age, 67, which means a benefit of $24,000 a year. Her 64-year-old husband stayed home for most of their marriage to care for their 40-year-old son, who is disabled, so the husband didn’t work long enough to qualify for Social Security. The woman has saved up enough money to cover them until she begins collecting benefits.

What the calculator recommends
The woman should file for Social Security at age 62 and one month. Her husband should file for child in-care spousal benefit at that time, and her son should file for a benefit because he is disabled. The woman will receive $16,900, and her husband and the disabled child will each get $9,761.

This is one of the rare instances where the calculator recommends the main earner claim Social Security early. The reason is that neither the son nor the husband can begin collecting benefits until the woman begins drawing Social Security.

What the couple ends up doing
The woman comes from a family where the women routinely live well into their 90s. If she lives this long, she wants to have plenty of money to support herself and her disabled son.

So, she adjusts the calculator so that it assumes she will die at age 95, 10 years longer than the mortality tables used in its default setting.

That changes everything. With the longer age, the calculator now tells her she should begin drawing benefits at age 70 to maximize the money Social Security gives her family, even though it means delaying benefits for her husband and her disabled son until then.

The woman doesn’t have enough money to wait until 70. But she does have enough to wait until age 67, her original plan. Delaying five years beyond the computer’s original recommendation boosts her family’s yearly benefit by $7,100 a year for the rest of her life.

With the assumption that she will live so long, the calculator estimates that retiring at age 67 will produce almost 2.4% in additional lifetime benefits for the family than retiring at age 62 and one month. And the lifetime benefits will only be 1.7% less than if she retired at 70.

In this case, the woman has longevity information that the calculator doesn’t, and it makes all the difference.

5 Commonly Overlooked Tax Savings for Small Business Owners

2/4/2021

When it comes to managing and lowering your small business' taxes, remember these tips based on the Tax Cuts and Jobs Act of 2017 (TCJA) that will affect you now and in the future.

With the TCJA laws, your business expenses may be taxed differently than before. However, you can still write off standard business expenses, such as marketing, business equipment, employee costs and financial planning software. Here are five changes you should understand and consider:

Meals and entertainment: While entertainment expense deductions have mostly been cut to zero, you can still write off 50 percent of client meals, if you stay within specific IRS criteria.
Depreciation of assets: Small business owners can immediately write off more property expenses under the TCJA. You can deduct 100 percent of the cost of certain business assets in the first year, and the TCJA also increases the deduction ceiling from $500,000 to $1 million.
Accounting method: Businesses with an average of less than $25 million in profits for the last three years can now use the cash method of accounting, so your taxes can reflect only real profits.
Transportation costs: The TCJA cuts any tax deductions for commuting costs for you or your employees — with one exception. If you have a program in place for your employees to get reimbursed for expenses so they can commute via bicycle, those costs can be deducted.
Employer credit for paid family or medical leave: Business owners can now deduct a percentage of wages for qualifying employees for up to 12 weeks per taxable year. There are specific rules for calculating the percentage, which has a maximum of 25 percent, so consult your tax advisor.