Enlightened Financial Planning

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.


Powerful Compounding      September 17th, 2014

Your teenager is in the last month of his or her summer job, and chances are the wages have been collecting in a bank account. What should happen with that money when your child goes back to school?

One possibility is to start a custodial Roth Individual Retirement Account, owned by your teenager. All you need is a custodial account with an adult co-signing (if the teen is under 18). That money can grow for many decades and come out tax-free 30 or 50 years down the road.

How much are we talking about? If the money were to grow at an average rate of 5% a year (which, of course, is not guaranteed, but is in line with long-term averages for a balanced portfolio), then a $5,500 contribution at age 17 would grow to $63,070 by age 67.

If your child continued that habit through college, then the $33,000 saved during those six years (ages 17 – 22) grows to a whopping $336,132 at age 67. Since the $336,132 is a tax free value, the equivalent pretax 401k savings amount using a combined federal/state tax rate of 30%, would amount to $480,000. Quite a nice start to their retirement savings before they even start their full time work career.

Suppose your teen decides to spend some of that summer wage money, or use it for college tuition? Parents and/or grandparents can match whatever Roth contribution the child decides to make, to bring the total back up to $5,500 (annual contributions are limited to lesser of $5,500 or 100% of your teen’s earned income). The money in a Roth or other retirement account doesn’t count toward the Fafsa financial aid form, so you don’t have to worry about compromising the teen’s financial aid eligibility. And having a hefty Roth IRA at retirement might address the possibility that Social Security won’t be around, or as robust, when your kids eventually retire.

Fiduciary vs. Suitability – Why You Should Care      September 3rd, 2014

If you care about you and your family’s financial future, you should care. Doesn’t sound like much of a big deal, but these two words, fiduciary and suitability, are critical to determining the type of care you receive from your trusted financial advisor.  Unfortunately, most people are not aware that a minority of advisors are held to a fiduciary standard while the vast majority of advisors are held to a much lower, suitability standard of care.

Who is held to a Fiduciary standard of care and who to a Suitability standard of care?

Currently, only independent Registered Investment Advisors are required to act in a fiduciary capacity. Brokers or “financial advisors” working for a broker dealer firm or an insurance company are only held to a suitability standard (not a fiduciary standard).  Not sure who’s a broker dealer firm? Two well known firms include Merrill Lynch and Ameriprise.

What is the difference between Fiduciary standard of care vs. Suitability standard of care?

Part of the reason this difference is not well known is that these terms are not easy to describe. And of course, large firms who could afford to spread the word, obviously have no interest in doing so.

Fiduciary standard of care means doing what is best for the client; namely, always putting the client’s interest before the advisors. It also means disclosing any possible conflicts of interest including compensation related to products or referrals.

Suitability standard of care usually means an advisor need only suggest products that are suitable for your objectives, your income level and your age. Also, no disclosure is required for possible conflicts of interest.

Fiduciary vs. Suitability Illustration

Let’s try an everyday example: buying a car. Assume you are looking for a car that costs less than $30,000 and gets over 25 mpg. Those two requirements alone would leave you with a rather long list of cars that would be “suitable” to you. However most of us would do further investigation and consider additional criteria.

For example: Which models have the best safety record? Which ones have the best maintenance/repair history? Which ones have the best resell value? And so on. You work to find a car that does not just meet your basic needs or is “suitable” but one that is “best” for you.

Going one step further, would you feel comfortable making your car buying decision by simply relying on the salesperson representing the car manufacturer? Or, would you feel more comfortable using an independent research organization such as Consumer Reports to help find the best car for you? I think you know the answer. Why not then demand an independent, fiduciary level of care for something of much greater importance, your financial future?

Financial Reform Legislation

The July 2010 Dodd-Frank Financial Reform legislation attempted to deal with the fiduciary issue. The law gave the SEC authority to create rules requiring investment advisors, who provide personalized investment advice about securities, to act in the best interest of their customer. It also allows the SEC to require these advisors to disclose material conflicts of interest and obtain consent from the customer.

Thanks to heavy lobbying by large broker dealer and insurance firms, no action has yet been taken to hold all brokers/advisors to a fiduciary standard of care. It does not appear likely this will happen in the near future. Let’s hope the SEC and Congress do the right thing for consumers by requiring a fiduciary standard for all financial advisors.

In the meantime, ask your current or prospective financial advisor if they will sign a written fiduciary oath requiring them to put your interests first and disclosing any conflicts of interests. If they will not or cannot, ask yourself whose best interest are they working for?


In fairness and following our duty of full disclosure, Clerestory Advisors is an independent Registered Investment Advisory firm in the State of Minnesota and as such holds its advisors to a Fiduciary standard of care for all clients.

Fewer Stocks, Missed Opportunities      August 21st, 2014

Investment pundits and gurus have been pouring over an interesting chart, reproduced here, that was published last year in the Financial Analysts Journal. The chart shows that, despite the recent high returns for stocks, investors, in aggregate, actually held only 37% of their portfolios in stocks at the end of 2012. Follow up research has shown that even with five-year returns of 18% or more since the Great Recession of 2008, that percentage has hardly budged.

If you want to translate these statistics into real money, the research strongly suggests that many people didn’t reap the full benefits of the recent stock market boom, and their portfolios today hold far fewer stocks than in 1959, when the data-set begins.

What’s going on? You can see a few clues from the chart itself. The stock ownership percentage went down dramatically from 1999–when equities made up a near-record 62% of the average investor’s portfolio–to 2002, when the Tech Wreck market decline sent investors scurrying to the sidelines and drove stock allocations below 45%. These timid investors moved back into the market over the next four years, taking their equity allocations above 50%, just in time for the market to crash all over again.

“Twice burned, quite shy” is one explanation for why so many investors have missed out on the strong returns we’ve experienced recently. Many have moved into bonds, which currently make up 57% of the aggregate investor portfolio today.

In addition, an unprecedented number of other investments are competing for space in an investor’s portfolio–certainly more today than in the 1960s or 1980s. Hedge funds and private equity firms now hold 9% of investors’ aggregate portfolios. Gold and commodities have become increasingly popular investments, as have real estate investment trusts.

The markets are impossible to predict, in part because the behavior of people–in aggregate as well as individually–is impossible to predict. But it is possible that the high fees and disappointing returns of hedge funds might cause some investors to rethink some of their more exotic allocations, and any rise in interest rates could startle the investor herd away from their record-high allocation to bonds. One possible future scenario would have the next data point on the chart show a return to stocks. Since higher levels of demand are one engine that drives stock prices higher, we could experience more years of high returns, which could, in turn, bring about one of those cycles that feeds on itself.

Until, of course, the next downturn–which, alas, is also unpredictable. The tragedy is how many people have largely missed out on the recovery returns since 2008. It is the nature of markets that they frighten people off while long-term investors enjoy their best years, and lure people back in as stock prices are just about to go over a cliff. The first part of this unhappy tale seems to have played itself out as usual.

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