Enlightened Financial Planning

2014 Tax Planning Tips      November 24th, 2014

As tax season approaches, we offer a few common sense tips for taxpayers in a variety of taxable income levels. Please keep in mind that federal tax rules continue to become more rather than less complex. Our most important tip – consider consulting with a qualified tax or financial advisor before the end of 2014 to take advantage of your unique planning opportunities.


Pay all MN income taxes by December 31 – If you make quarterly estimated income tax payments, make sure the fourth quarter MN estimated payment is made before December 31 in order to claim the payment as a 2014 federal itemized deduction.


Taxability of Social Security income – For joint returns, if adjusted gross income (AGI which is total income listed on the bottom line of Form 1040’s first page) minus half of social security is less than $32,000, then none of your social security benefit is taxable. Between $32,000 and $44,000, 50% of the benefit is taxable and over $44,000, 85% of social security is taxable. Each year, you should evaluate if you can reduce the taxability of social security income by avoiding or taking only your minimum required taxable IRA withdrawal. You might be able to take a Roth IRA withdrawal which is tax free or take a larger than necessary taxable withdrawal every other year.


Remember your federal taxable income is taxed in layers at ever increasing tax rates. For joint returns, the largest increase in federal tax rate occurs once taxable income exceeds $73,800 (up to a maximum of $148,850) causing rates to increase from 15% to 25%. Tax rates keep rising until the top rate of 39.6% is reached (taxable income over $457,600). To avoid jumping into a higher tax bracket, consider ways to increase deductions (or delay income if possible). Examples include:

o     Investment interest expense can offset investment income. Investment management fees over 2% of adjusted gross income (AGI) are deductible.

o     Maximize deductible work retirement contributions and work health savings contributions. Current year maximum 401k contribution limit is $17,500 ($23,000 for those 50 or older).

o     Bunch several years of expenses into one year

       Charitable gifts

       Medical expenses – in order to exceed the 10% of AGI floor (7.5% for age 65 or older), consider doing all elective procedures in one year. Remember, long term care costs are                                  qualified deductible medical expenses.


A Net Investment Income surcharge of 3.8% applies to joint filers with adjusted gross income over $250,000. Net investment income includes dividends, interest income and capital gains (and a few other less common items). The 3.8% surcharge applies to lesser of 1) current year net investment income or 2) the excess of AGI over the $250,000 threshold ($200,000 if filing Single).

Suggestions for minimizing the surcharge include:

o     Using municipal bonds for much of your taxable account bond allocation since municipal bond interest is exempt from the 3.8% surcharge.

o     Take capital losses before year end to reduce capital gain exposure.

o     When possible, delay income, to reduce the amount of AGI over the $250,000 threshold. A few examples include delaying a bonus to next year or delaying exercising stock options.

o     Certain expenses reduce AGI such as self-employed health premiums, health savings contributions, moving costs and payment of taxable alimony.

o     For large capital gains, say from the sale of investment property, consider using the installment method of reporting to stretch the gain over a number of years.


Charitable Gifting – first, be aware that certain limitations exist on the amount of deductible charitable contributions you can make in one year.

o     To leverage the value of your gift, consider using an appreciated security.  Assume you wish to make a large one time gift of $30,000 and have a mutual fund valued at $30,000 with cost basis of $10,000. By directly gifting the mutual fund, you avoid paying federal and MN taxes on the $20,000 gain that would result from the sale of the mutual fund. For folks in higher tax brackets, gifting the appreciated mutual fund could save up to $7,000 in taxes.

o     Charitable IRA transfer – watch to see if Congress once again extends to this year, the provision allowing taxpayers age 70.5 or older to make direct transfers to charities of up to $100,000 from their IRA. The charitable transfer also qualifies as your minimum required distribution for the year.

Why Do Losses Really Matter      November 11th, 2014

Everybody who told us that the steep market drops earlier last month wouldn’t last can rightly claim they’re right.  When the S&P 500 was down 7.4% during a two-week selloff, there was no way to know whether we’d have to endure more of the same.  Staying the course turned out to be exactly the right strategy, but that doesn’t mean that we shouldn’t be concerned about downside risk.  In fact, during the downturn, all of us should have been working hard to keep our portfolios from falling as far and as fast as the American indices.


Isn’t this a contradiction?  There is no contradiction between holding on during market downturns and building portfolios that are unlikely to keep pace with a bear market free-fall.  You hold on because no living person knows when the stock markets will recover, but history tells us that they always do seem to recover and eventually deliver returns that are higher, on average, than the returns you get when the money is safely stored under your mattress. 


But you also pay attention to downturns because the further your portfolio falls, the harder it is to recover.  There’s actually a rational reason why you tend to fear losses more than you enjoy your gains.


The mathematics show the asymmetrical effect of losses vs. gains.  If your $1 million portfolio loses 10%, falling to $900,000, then it requires an 11.11% gain to get you back where you started.  It doesn’t seem fair, but that’s how it is.  A 20% loss requires a 25% gain, and if your portfolio were to drop 40%, you’d need a subsequent 66.67% gain to climb back to your original $1 million nest egg.


Chances are, you know how we fortify portfolios against losses: we include a variety of different types of assets–including bonds which, against every single market prediction at the start of the year, are actually delivering positive returns almost all the way across the maturity spectrum.   We include foreign stocks, which haven’t exactly been knocking the lights out this year, but which will, someday, offer strong gains when the U.S. markets are weakening.  All of these different movements tend to have a calming effect on the portfolio’s returns, not always in every circumstance, but fairly reliably over time.


The result?  A smoother ride puts more money in your pocket.  If an investor experienced returns of +20% and -10% in alternate years over the next 20 years, a $100,000 portfolio would grow to just under $216,000.  If a more diversified investor experienced a smoother ride of 10% a year, her portfolio would grow to just under $673,000.  The power of steady compounding is a marvelous thing to see.  The drag of losses can be debilitating to a portfolio’s growth.


You won’t experience either of those trajectories, of course.  But if you can somehow soften the worst of the market’s falls, even if it means never beating the market during the up-cycles, you raise your chances of long-term success.  If you can do this and remain invested through a lot of uncertainty, like we experienced earlier this month, chances are you’ll enjoy better long-term returns than a lot of the “experts” you see screaming at you to buy or sell on the cable finance channels.


Oh, and that 7.4% drop?  The S&P 500 did go up as of the end of last month more than the required 7.99% to recover the ground it lost in that two-week sell-off period.


Making Sense of Employment Statistics      October 30th, 2014

We are deluged with numbers like how many jobs were created this month and last month, or the ever-fluctuating number of jobless claims, or number of people who may or may not have stopped looking for work. The most recent Bureau of Labor Statistics report says that U.S. employers had 4.635 million job openings in May, which is up from 4.464 million in April. The Labor Department recently released its latest reporting, telling us that non-farm employers hired a “seasonally-adjusted” 288,000 workers in June, and we are told that the unemployment rate now stands at 6.1%.

But what does that tell people who are actually looking for work? What does that tell us about the real economy? Is there a better way to make sense of today’s job picture?

The accompanying chart puts the current and historical U.S. labor situation into much clearer perspective. It shows the number of unemployed persons per job opening as of last week, and the same number going back to 2001. Back before the “tech wreck” bubble burst, there was approximately one job seeker per job opening. That doesn’t mean that everybody was trained or suitable for every job, but it does indicate that finding work was probably not impossible for able-bodied and skilled individuals.

During the Great Recession, that number jumped up to an average of roughly 7 job seekers for every opening. Today, after a long, slightly choppy improvement in the prospects of workers, there are 2.11 unemployed workers for every job opening, and the trend is the friend of the unemployed.

This chart shows, perhaps more clearly than other indicators, an improving economy and tightening labor markets, which usually signals more competitive pay packages as companies start doing something they haven’t been doing for years: actually competing for qualified workers. That, in turn, could cause the Federal Reserve Board–which watches unemployment numbers closely as it sets rates–to raise interest rates sooner than expected. It may also raise the cost of doing business for companies throughout the economy, raising the inflation rate as those extra employment costs are passed on to consumers.

In addition, as economist David E. Kelley has pointed out, more jobs at the tail end of a market expansion can add an unexpected boost to GDP growth by raising corporate capital spending. In a presentation in San Francisco, he recently said that when companies lay off people, and then eventually start hiring back to previous staffing levels, they really don’t need to buy anything new. They can give their new employees the cubicle, computer and desk of the fired workers.

But once they’ve replaced the jobs lost, the next hire needs new equipment. “What we’re seeing now is that the economy is going to need capital spending to go with the improvement in employment,” Kelley told the group, “and we are starting to see that in capital goods orders.”

For investors, higher inflation, higher interest rates, but more employment and higher GDP, is kind of a mixed bag. But at least the jobs situation can be better understood with this new chart, and more jobs and higher salaries are ultimately better for the American people as a whole.

By Bob Veres, publisher of Inside Information – the premier publication of financial industry trends and

information for leading practitioners in the financial planning profession.



Hiding Profits From the Tax Man      October 14th, 2014

On July 14, the Foreign Account Tax Compliance Act became effective, and instantly virtually all foreign banks were required to keep track of, and report on, all assets held by U.S. citizens. Individuals who don’t report income on those assets and pay taxes to Uncle Sam face draconian penalties in excess of the actual money in the account.

But hiding income abroad is nothing more than business as usual for large American companies. Some are now ducking through a corporate tax loophole by relocating their tax base overseas. These so-called “inversions” hit the mainstream news media when medical device manufacturer Medtronic bought rival Covidien, which is domiciled in Ireland, and then began stripping income out of the U.S., where the top corporate rate is 35%. The merged firm is paying taxes on most of its net income in Ireland, at a 12.5% rate. This will save the company between $3.5 billion and $4.2 billion in overall taxes.

Others are following suit. Wallgreens Co. is purchasing a Swiss company it partially owns, and pharmaceutical giant Pfizer Inc. openly pursued an inversion this year when it sought to purchase British drug maker AstraZeneca. Chicago-based pharmaceutical company AbbVie is buying Irish drug maker Shire, and two U.S.-based pharmaceuticals, Muylan Laboratories and Abbot Laboratories are planning to merge and reincorporate in the Netherlands. Overall, nearly 50 U.S. companies have used this tactic over the past decade. The net effect is to reduce U.S. tax revenues by an estimated $17 billion over the next decade.

Still others are assigning their valuable patents to a subsidiary in a more tax-friendly locale. For example, Apple, Inc. now generates 30% of its total net profits through an affiliated firm based in Ireland, saving an estimated $7.7 billion in U.S. taxes in 2011 alone. When the Wall Street Journal examined the books of 60 big U.S. companies, it found that they had shielded more than 40% of their annual profits from Uncle Sam.

An inversion works like this: A U.S. company buys or merges with a smaller company in the same business that happens to be located in a country where the corporate tax rate is lower than the maximum 35% federal rate here in the U.S.–plus, of course, state taxes. This covers a lot of territory. According to the latest update in Wikipedia, only the United Arab Emirates, Guyana, Japan and Cameroon assess higher corporate tax rates than the U.S.; their rates top out at 55%, 40%, 38% and 38.5% respectively.)

Next, the company is reincorporated, and its global headquarters is shifted to the foreign country. Operations continue exactly as they were before, which may mean that most of the sales and profits are still coming from the U.S. market. But the taxes are now paid at the lower rates of the overseas location.

The net result is to shift tax revenue to Ireland, the Netherlands, Switzerland and Canada, which offer a combination of low corporate tax rates and a territorial tax system, whereby income from foreign sources (like, for instance, the U.S.) isn’t taxed at all.

How does this affect you? First of all, you will bear a slightly higher tax burden as the government seeks to recover lost revenues. The Journal report found that if just 19 of the 60 companies had to pay U.S. taxes on their earnings like you or me, the $98 billion in additional tax revenues would more than offset the $85 billion in automatic spending cuts that were triggered by the fiscal cliff negotiations. In addition, companies that are holding assets offshore for tax reasons have effectively made that money unavailable to invest in the U.S., which could lower economic growth and cost jobs for the U.S. economy.

More directly, that offshore money is no longer available to pay dividends to shareholders like you and me, or to buy back shares, which raises the value of our stock holdings.

Finally, an inversion could actually trigger higher taxes for its shareholders.

How? When the company inverts or reincorporates abroad, all current shareholders are required to pay capital gains taxes on their holdings in that year, as they are issued new stock in the new company. So if you happen to own $100,000 worth of Medtronic, and your shares originally cost you $20,000, you would get a 1099 in the mail saying that you have $80,000 in realized gains, subject to capital gains taxes immediately. If you had planned to hold those assets until death, and get a step-up in basis for your heirs, well, that strategy is preempted by the company’s decision to invert. If you were holding the stock long-term to avoid annual taxation, or trying to shift tax obligations to next year, tough luck. You’re paying taxes now, whether you like it or not.

Is there a way to bring these assets back into the U.S. tax system? One obvious possibility is to lower our corporate tax rates below the rates of other countries. But there is no guarantee that those nations wouldn’t lower their rates in turn, leading to a global race to the bottom, with the logical outcome that corporations would be essentially granted a 0% tax rate everywhere. And a lower corporate tax rate would, of course, mean higher individual tax rates, which is politically unlikely at the moment.  Opponents would note that the share of federal revenues paid by corporations has already fallen from 32% in 1952 to just 8.9% today.

Another possibility is being explored in Congress. A recently proposed bill would require the foreign partner of any inversion tactic to be larger than the American merger partner; otherwise, the company is assumed, for tax purposes, to be domiciled in the U.S. The argument is a good one: these companies want to take advantage of U.S. laws and have full access to the U.S. consumer market, but not have to pay for it.

By Bob Veres, publisher of Inside Information – the premier publication of financial industry trends and information for leading practitioners in the financial planning profession


The Surprising Benefits of Sleep      October 1st, 2014

Are you and the other members of your family getting enough sleep? How do you know?

One of the best articles on healthy sleep can be found here: http://jamesclear.com/better-sleep?hvid=4efDS; it describes a study conducted by researchers at the University of Pennsylvania and Washington State University that prescribed different levels of sleep for four groups of healthy men and women. The first group had to stay awake for two days without sleeping. Group two slept for four hours a night for two weeks, while group three slept for six hours a night over the same time period. The final group was asked to sleep for eight hours a night.

When the researchers tested the different groups on their physical and mental performance, the volunteers who received a full eight hours of sleep showed no declines in their cognitive ability, attention or motor skills. They were, in other words, fully-functional, bright and chipper. Meanwhile, the groups who received four and six hours of sleep a night steadily declined in all categories with each passing day. After one week, 25% of the six-hour group began falling asleep at random times a day, and by the end of the two weeks, their performance deficits in all categories were the same as those who had stayed up for two days straight. The four-hour sleepers did even worse.

Interestingly, none of the volunteers noticed their own performance declines. When they graded themselves, they said that their performance might have declined for a few days, but then it tapered off–when in fact they were continuing to get worse each day. In the real world, symptoms of sleep deprivation totally ruin any potential benefits of skimping on sleep and working those additional hours.

The researchers, and others, concluded that, to operate at peak performance and stay healthy, 95% of adults need 7-9 hours of sleep each night. Yet at least 20% of Americans sleep fewer than six hours per night.

The article talks about the importance of slow wave (deep) sleep–which helps the body heal itself and recover from hard exercise–and REM (dreaming) sleep, which boosts your memory, facilitates learning and helps the brain’s neurons grow. Both are important, and there is evidence that people who get sufficient sleep live longer in addition to performing better.

And so far, researchers have found no substitute for sleeping.

By Bob Veres, publisher of Inside Information – the premier publication of financial industry trends and information for leading practitioners in the financial planning profession.