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Archive for November, 2011


Funding for the SEC and SEC enforcement may be related

During the ongoing budget debate, discussion, morass, etc we read that the SEC thought they were underfunded to carryout its mandate.  They wanted resources to be more responsive in identifying problems (including fraud) and to be able to prosecute wrongdoers.  Congress pushed back on their request for funding.
More recently a judge would not approve a settlement that the SEC wanted to enter into with a “wrongdoer”.  The judge ruled that the proposed settlement was “…neither fair, nor adequate…”.  The SEC responded that they did not have the resources to prosecute the case.
An article in today’s Wall Street Journal, “SEC Pushes to Toughen Penalties for Offenders”, indicates that Congress has limited the SEC’s authority to impose penalties.  The SEC “…sought the power to impose much-larger penalties on financial firms and individuals that commit fraud.”
It could be argued that Congress faults the SEC for not carrying out its mandate and that Congress is a significant reason for that failure. 
With the many financial abuses and frauds that have come to light in recent years, most people would like to see improved detection and prosecutions.   I have seen very little in the media looking at both sides of this issue.  Either the failures or the lack of resources are discussed, not both.  We need to broaden our sources of information.  Only by learning the various sides of an issue can we responsibly know what to demand from our legislators.

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Do not wait till the last minute to harvest your investment losses.

Some of my prior posts stessed the importance of not waitng to December 31 to do your 2011 tax planning. November 29th post discusses why tax losses should be realized now.
Investment losses can offset investment gains.  The tax advantage is greater if you have short-term gains rather than long-term gains.  The 2011 tax rate for long-term capital gains are capped at 15%, whereas short-term gains can be taxed at the top marginal income tax rate of 35%.  Capital losses of $3,000 in excess of capital gains can be deducted from ordinary income.
Because most people try to avoid losses they hold losers too long.  They think they will sell once the stock price goes back to what they paid for the security.  If the stock is not performing and it has been identified as a loser, it is unlikely that there is an economic benefit to holding the stock.  If the period for the security to recover is in the distant future, it may be advantageous to sell for a loss, wait more than 30 days and buy it back.  If the stock is repurchased within 30 days the loss from the sale of the stock will not be currently deductible (wash sale).  Alternatively an index fund or exchange traded fund could be a better investment than the individual stock. 
If you think the stock should be sold, others may also.  If you wait to sell you may find there is mores selling preassure.  This could result in a lower stock price than now.
Year-end planning is also a good time to re-balance your portfolio.  You  have more control by implementing the changes now rather than waiting.  It is very difficult to know the future.  There are times when people have been correct in anticipating future events.  Very few if any, have been consistently correct in knowing the future. 
If you consistently know the future you have probably already completed your year-end planning.  

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A new meaning to tax planning>

The Wall Street Journal published “The Tax Mess Deepens” in the Weekend Investor Section of the Saturday/Sunday, November 26-27, 2011 edition.  The article highlights “What’s Expiring at the End of 2011” and “What’s Expiring at the End of 2012”.  After stating that this is the 3rd year that there are major tax issues that have not been resolved.  The article then discusses “Smart Moves to Make Before” 2012.
The article is a non sequitur.  How can you determine what to do in 2011 if there are major uncertainties about the 2012 tax laws?  The situation is the result of the current political situation.  If tax changes are proposed that are known to not be acceptable to the other party, nothing will get done.  This makes it even more difficult to know what changes will be made in the tax laws.
The first  step for your 2011 tax planning is to determine where you are now.  Then look at what alternatives might improve your 2011 tax situation.  Next review what you know will change in your situation.  Based on what you do know determine if you think your income or deductions will change in 2012.  Again what strategies would you follow on your expectations of 2012.  
Any attempt to modify your planning based on your forecast of the future changes in the tax laws will depend on how confident you are in knowing the future.  Even if you are certain you know what changes will be made, do you know what the effective date (s) of the changes will be?  Do you know what the transition rules are going to be?  Do you know what the dollar impact will be of the changes?  Yes, for most people,  the challenges to tax planning will be more difficult that in the past.  You should review your situation with your tax advisor now.  You need to allow time before December 31, to evaluate your alternatives and implement your strategy.

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Limited time available to complete non-cash charitable gifts before year-end

Using appreciated publicly traded securities to make charitable contributions can be an excellent year-end tax strategies.  If the securities have been held more than a year the appreciation (gain) on the securities that are transferred directly to a charity are not taxed.  Your deduction is the full fair market value on the date of the transfer.  If you sold the securities, the proceeds would be reduced by taxes.  That is, you after tax cost of making the contribution is less if you use appreciated publicly traded securities. 
You do not want to use securities that are worth less than your cost (basis).  In that case it would be better to sell the stock, deduct the loss and donate the cash proceeds to charity.
Be sure to allow enough time for the transaction to be completed before year-end.  Some custodians require 30 days to process the transaction.  Many charities have established brokerage accounts for this purpose.  You will need accurate information about the charities’ brokerage account to complete the transaction.  You should verify the information even if you made contribution to that account in the past.  If the account has been changed or moved the information you have about the account may not be accurate.  
If you want to donate publicly traded securities for 2011 you should follow-up before the end of November.
There are limitations and restrictions that may determine if this strategy would be beneficial for you.  Discuss this with your tax advisor before making the non-cash contribution. 

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Are money funds for you.

There has been an increased awareness about needed changes to money market funds from regulators, the investment community, the media, etc.
Money market funds were the vehicle of choice for many because they they were thought to be convenient, safe, liquid and paid a higher yield than was otherwise available.  Although they were not insured, they were structured to minimize losses.  Holding the value at $1 was a symbol of their safety.  They were considered safe because the value was stable.  They were not thought of as long term investments, primarily because they did not offer protection from inflation or fluctuations in the value of the dollar.
When the value of Primary Reserve Fund dropped below zero in 2008 red lights started to flash.  People started asking if the structure of money market funds was appropriate when the economy was under extreme and prolonged stress.  Interest rates in money market funds are minuscule.  Many funds waived some of their fees to keep a positive return.
It has been reported that at least half the funds hold European bank debt.  This has heightened the concern about money market funds.  That is, they have higher risks.  They have minimal yields, hold riskier debt and are not protected by insurance or any form of guaranty.
The funds have provided a source of short term funds for many businesses.  Historically they have been profitable for the funds .  Just because it is good for the funds and businesses that borrow from the money market funds does not mean they are good for the individual investor.  
Increasingly dividend paying stocks and short-term (and/or ultra short-term) bond funds are being considered as alternatives.  Before you take any action be sure you know what is best for you.  If you are looking for yield, you may be sacrificing safety and/or liquidity.  If this is part of your cash reserve, you may find yourself being forced to realize a loss to get the cash you need for short-term needs or those unexpected events that require cash. 
If you have not considered these issues, you should.  These issues should be reviewed periodically. 

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Is this the time to buy real estate as an investment?

Today”s article “Are You Ready to Be a Landlord?” in the Wall Street Journal discusses why there is an interest in buying investment properties.  The article outlines some of the traps and things to be considered before investing in real estate.
Shortly after leaving a national CPA firm I gave presentations before a local chapter of the National Association of Real Estate Investors (NAREI).  I kept in touch with the group and provided services (at this time I had a full service CPA firm) to some of its members.  
The leaders of this chapter stressed a do it yourself approach to real estate investments.  The emphasis was on sweat equity.  They tended to manage the properties themselves and do much of the maintenance and improvements themselves (the sweat).  As many had successful businesses and careers, much of the work was done at night or on the weekend.  Those that followed this formula had lower expenses and generated more cash than those that used outside managers and trades people.  When the real estate market turned down, real estate is cyclical, many of these people were able to weather the downturn.
Some were highly leveraged and were forced to liquidate the properties when real estate values dropped.  These investors tended to use available cash and credit to buy other properties.  Some people liquidated their stock and bonds and mortgaged their homes and businesses to increase their real estate holdings. One highly regarded group bought each property using little or no cash.  Each new property was bigger and more expensive.  When the real estate market dropped, their house of cards quickly fell.  That was not too different than what we are seeing now.  May be the lesson learned then were forgotten, not learned by the next generation of real estate investors or ignored because this time was different.  
Not accurately judging their cash flows and anticipating things that could go wrong were other common errors.  These were the properties without sufficient cash to operate or meet the cash needs of the unexpected.  Some were so blinded by income tax benefits that they ignored cash flows.   
Some did not make income from their properties but from speakers fees, seminar fees, books, etc. 
This time the economic climate is worse.  We need to remember the lessons as we move forward.  We also must recognize and understand our own unique situation to be able to plan for the future.  Once we know where we are financially and what we need, want and wish for in the future can we identify actions that will improve the probability of bettering our financial situation.  

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Understanding and action are required to navigate the current market.

Michael A. Pollick’s November 7th article in the Wall Street Journal presents seven pointers to “Rest Easy in a Crazy Market”.  Some of the points need to be emphasized and some to need to be tweaked.
Understanding your risk tolerance, tolerance for pain, tolerance for volatility, etc. is difficult for most people.  My clients often sound like they understand their tolerances.  As I have heard them and observed their actions  I can recognize their inconsistencies.  Discussing the inconsistencies helps them understand what is in their portfolios and what the expectations are for their portfolio. 
It is important for investors to have a plan that allows them to sleep at night.  They also need to understand what their financial goals are what is needed to achieve those goals.  Clients often seem to be reacting to the media.  The media’s purpose is the attract readers, listeners, etc.  Bad news seems to attract more people than than good news.  Most of the “information” is static.  Investors need to know what their investment philosophy, approach, time horizon, etc. and ignore what is not relevant.
The article encourages investors to find funds with a wider net.  Not all funds with a wide net are good for everyone.  Funds could be following a strategy that is not consistent with the needs of all their investors.  Having separate funds for different holdings and strategies increases the inventors ability to construct a portfolio that is appropriate to their individual situation. 
The article notes that “Investors have a bad record of calling market tops and markets bottoms.”  Not only is it extremely difficult to know the future, it is also extremely difficult to know the consequences of future events.  This makes market timing unlikely to benefit an investor over the long term.
Knowing what your investment strategy, understanging your investments, knowing your investment goals, knowing your time horizon, etc. helps prevent an investor form shooting themselves.

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Can bubbles be spotted before they burst?

Jason Zweig’s November 5th article in the Wall Street Journal discusses “The Extraordinary Popular Delusion of Bubble Spotting”.  He believes that “If you watch carefully for signs of euphoria, you can sidestep the damage when markets go mad.”  Therefore he warns Investors to always guard against glib assertions of pundits who claim they can detect bubbles before they burst.
He reminds us that Benjamin Graham “; the famed speculator who survived the crash of 1929 suggested that investors should never have less than 25% or more than 75% of their money in stocks.  He argued for reducing the allocation to stocks “when in the judgment of the investor the market level has become dangerously high.”  But, because no one can perfectly predict a bubble, you should never go either to zero or 100%.
The observations and antidotes makes for an interesting article.

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Some topics keep coming back, flat tax is an example.

Training at the Internal Revenue Service started before we were permitted to audit tax returns.  One of the first subjects discussed was the fairness of the Internal Revenue Code. 
Generally our studies of a code section began with the purpose of the tax provision.  Many provisions were attempts to reflect a persons ability to pay taxes.  For example, if medical expenses or casualty expenses were higher than a stated threshold, the taxpayer was thought to have less ability to pay taxes than those with lower medical or casualty expenses.  
The same was true for businesses.  The total income of a business was reduced by ordinary and necessary business expenses.  A business with lower profits had less ability to pay taxes than businesses with high profits.
Sections of the Internal Revenue Code also contained provisions to encourage certainactivities.  Charitable contributions and home mortgage expenses are examples of activities directed toward individuals.  Oil and gas intangible drilling costs, depletion allowances and expensing of plant and equipment are examples aimed at businesses. 
We were told that if we could suggest how to make the tax laws fairer or simpler we would be rewarded.  We had a lengthy discussion as to whose perspective would be used to determine fairness.  This reminded me of an economic course I took in college.  We looked at various industries that wanted regulation and taxation to be reduced.  Each industry we looked at were granted exclusive rights and/or tax deductions that they were not willing to give up.  Those regulations and tax deductions were considered a separate topic that were not to be part of the discussion.    
There were discussions in the 60’s about why deductions, exemptions and exclusions should be eliminated.  I believe the primary author was a professor Surey from Harvard.  His argument was that these amounted to tax deduction that were not reflected in the budget.  This made it difficult to track and quantify the expenditures (lost revenue).  He suggested that direct payments should be made directly to taxpayers.  This would allow an analysis of the cost and benefits of the expenditures. 
When a flat tax was was discussed in the past, business were not sure how their income would be measured.  Could they reduce their income by all the deductions they were used to taking?  Would the timing of when they recognize income and deductions be changed?
Not-for -profit organizations were concerned that the amount they collected would drop.  How would the housing industry be affected if home mortgage and real estate taxes were not deductible.  There were discussion about the loss of the progressive nature of our income tax system.  Should the amount of tax paid or the percentage of income be used to determine fairness?  Would gross income, net income, adjusted gross income, taxable income or some other measurement be used?
How would we transition to the new system?  What should happen to unused operating losses and capital losses?  How should amounts in qualified retirement plans, Individual retirement accounts (IRAs), Roth IRAs, etc. be handled?
If it was difficult to deal with those types of questions then.  Think about how much more difficult it would be in the current political climate.  
Another issue confusingthe discussions relates to the comparison to our system to those of other countries.  Many countries have a Value Added Tax (VAT)   in addition to an income tax.  The VAT tax is similar to a national sales tax.  A tax is applied at each incremental step in the production of a product.  When comparing our rates to the other countries, why aren’t their VAT considered?
The above are a small sampling of questions that have come back form the past.  It would take volumes to discuss and try to resolve these issues.   Hopefully I have given you something to think about as you listen to the current discussion about our tax laws.  I would not be surprised if some have stopped listening and thinking about these issues.

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