Fagan Associates Archive for December, 2010

President Obama along with cooperation and what some may call it coercion from Republicans passed an all encompassing tax reduction plan, comprised of an extension of the Bush-era tax cuts for the next two years along with several new initiatives, all intended to stimulate economic growth.  The package signed into law this past Friday by President Obama will cost approximately $900 billion over the next two years and is intended to propel the U.S. economy into a sustainable, more rapid path to recovery, rather than the sluggish trajectory we are currently travelling.  There is something in the tax package for every American, from the least to most wealthy, a fact that caused some pushback from both parties.  However, unlike over the past two years, both sides of the political aisle were able to suppress some of the fringe opinions and come to a consensus.  Hopefully, this is a sign of positive compromise to come.

First and foremost, according to data supplied by the American Society of Certified Public Accountants (AICPA) and reported by The Wall Street Journal, the average individual filing single with adjusted gross income of approximately $40,000 will save around $400 per year, the average individual filing single with adjusted gross income of approximately $80,000 will save around $1,600 per year while the average individuals filing jointly with adjusted gross income of approximately $80,000 will save around $2,200 and those individuals filing jointly with adjusted gross income of approximately $160,00 will save around $5,500 for each of the next two years.  All of this is in comparison to what their federal tax burden would have been if the Bush-era tax cuts had been allowed to expire at the end of calendar year 2010.  The White House projected that the average taxpayer would save approximately $3,000 per year over the next two years.

A second major extension to the tax cuts that was passed was a continuation of the taxation of capital gains and dividends at a maximum rate of 15% rather than the 28% that was the previous cap on capital gains and the taxation of dividends as ordinary income, a rate that would have been as high as 39.6%.

The Child Tax Credit of $1,000 was also extended for the next two years.  The credit is available to parents whom have children living with them in their home.  It was set to fall to $500 on January 1^st if the tax package had not passed.  Furthermore, the tax package includes an extension of the Tuition Tax Credit, a credit of up to $2,500 for college students.

The bill also includes several new initiatives, all intended to spur economic growth.  For working Americans, the employee contribution to Social Security will be reduced to 4.2% of the first $106,800 of wages from the usual 6.2% that is currently being levied.  Although it may not sound like a lot, for joint filers with $80,000 of earnings, this will amount to $1,600 in savings.

The wealthy also stand to benefit from the tax package.  The legislation provides an exemption of any Federal Estate Tax for estates up to $5.0 million dollars while those with estates over that will be taxed at 35% beginning in 2011.  If the legislation had not passed or had been delayed, the exempted amount would have been $3.5 million dollars with a tax rate of 45%.

Finally, the tax package also allows for businesses to expense rather than amortize or depreciate business investments in 2011 which should provide an incentive for investment.  Analysts expect this benefit will save corporations approximately $100 billion, marking the largest temporary incentive to businesses in the history of the United States.

THE BOTTOM LINE – We, like many others, view this as another stimulus package, designed to help the United States economy permanently emerge from its deepest recession since World War II.  We also believe that this package could have been better designed, perhaps allocating more of the $900 billion to those with incomes at or around the median and less for those with incomes above.  However, we also believe that the provision for companies to expense capital investment is a home run as is the extension of the income tax rates and the reduction in the employee component of Social Security.  That said, it better work.  We, as a country, are running out of time and money.  All in all, we give this program a B+.

This time of year, we all have a lot on our minds.  If you are like us, you are still raking leaves and cleaning up the year.  For our family, it is certainly time (and perhaps a little past time) to begin to get ready for the holidays and unfortunately, it will soon be time to retrieve our snow shovels.  As calendar year 2010 draws to a close, it is also time to clean up your portfolio and begin to prepare for next year.  With this in mind, we have put together a small list of some “portfolio chores” that may put more bucks in your wallet in the form of tax savings.  Please note that some of these suggestions only pertain to investments in non-qualified or currently taxable accounts.

Despite the recent rally, as of this writing the Standard & Poor’s 500 remains more than twenty percent below its record high set back in early October 2007.  For this reason, it is likely that many of our readers have stocks that are well below your purchase price.  However, you may also believe in the long term growth prospects of the investment.  Assuming the investment is in a taxable account (non-qualified), one might double up on the current share balance in an investment, wait thirty days, and then sell the shares he/she initially held.  The benefit would be a deductible loss on the shares you ultimately sold without losing your position in the security.  The risk would be that over the next thirty days, the stock declines thereby increasing your loss due to the additional shares.  Another risk would be that your portfolio becomes too heavily weighted in a particular stock or industry for those thirty days.  Nonetheless, the widely practiced strategy merits a look.  Here’s how it works.  Let’s assume that you purchased 100 shares of General Electric at $50.00 per share.  Despite the climb from its lows to its current prices of approximately $16.00, you have still lost $3,400 in this investment.  According to the “doubling up” model, you would purchase another 100 shares of G.E. at its current price, wait thirty days and then sell your initial shares.  This exercise would enable you to deduct the loss on G.E. up to a limit of $3,000.  It would also not compromise your investment in G.E. over the next thirty days, should the stock begin to move upward.

One thought regarding the above paragraph, take out your calendar year 2009 Federal Income Tax return, look at Schedule D and determine if you are carrying forward any losses beyond the $3,000 limit mentioned above.  If you are, include this in your year-end investment planning.

Call your mutual fund and ask them if they are planning any year-end distributions.  Do not add insult to injury by having to pay taxes on capital gain distributions despite the fact that you are losing money in the fund.  Remember, capital gains declared by mutual funds are taxable despite the fact that you, as an individual, may not have benefited from the investment, and may indeed be losing money.  Furthermore, that capital gain is taxable despite the fact that you may be reinvesting in additional shares.  Upon calling, should you learn that your mutual fund is intending to declare a capital gain, find out how much it will be on a per share basis and on what date it will be paid.  This information will help you determine what steps need to be taken in order to minimize the impact.

Swap the mutual fund that you are losing money in for a similar fund.  Two thoughts pertain to this statement, the first being that, given the fact that there are over seven thousand mutual funds to choose from, there is always an appropriate alternative for your current fund.  The second thought is more of a reminder.  Remember that your basis for tax purposes in your investment consists of any out of pocket deposits you have made into the fund plus any dividends and/or capital gains that you have reinvested into the fund either during this calendar years or prior years minus any withdrawals you have taken from the fund.  Once again, given the length and depth of this bear market, many investors may be in a position that they are losing money when comparing the current market value of their fund versus their cost basis.

Don’t wait.  Take a couple of hours to clean up your portfolio.  Our guess is that it will be time well spent.  We will be touching on other tax-savings techniques regarding your investments in the coming weeks.