Category Archives: Investing

Keeping perspective while the debt ceiling “crisis” continues ….

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While Congress and the President continue the political battle on the “debt crisis,” here is more for proper perspective:

First, the yield on Treasuries if falling, not rising. If there were a serious issue about the US ability to repay, then US bonds would see high rates. That is, unlike Greece, which is in real trouble, or even Spain or Portugal, the US is still able to borrow at very favorable rates. So, the markets in general, up to this point, believe that the “crisis” has nothing to do with the economy or the strength of the US relative to other nations.

Second, the debt issues have come about after the extended bull market ended in 2008. That is, high stock values and prosperous markets yielded high tax revenues. With this, there were years of budget surpluses, even after tax cuts were enacted. But, post 2008, that has changed. The change in the economy and stock values, even with some markets approaching their 2008 high points, has led to much lower tax revenues.

Finally, from Floyd Norris in the New York Times, we have this summary:

“If rationality does prevail, the debt ceiling will be raised. For that matter, there is no good reason to have a debt ceiling other than to give politicians a chance to grandstand. The important decisions for Congress and the White House concern spending and taxing. Borrowing, or paying back debt as happened for a couple of years before the Bush tax cuts, is a result of the interplay of those decisions and the state of the economy.”
And
“There is a risk that many analysts now are making the opposite mistake. Deficits have skyrocketed in recent years for reasons that are clearly temporary, or that will be temporary if the economy recovers. In some of the debate, the short-term problems are mixed up with longer-term demographic concerns caused by the aging and retirement of the baby boomers and the rising costs of Medicare, the health insurance program for Americans over the age of 65.”

So, with fingers crossed for the prevailing of rationality soon, that is my update. Let me know if you have questions or comments

Tax Trap: risk of double taxation on contributions to Qualified Plans by certain states.

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If you contribute to a Keogh, SEP-IRA, Money-Purchase or Profit-Sharing Plan as a self-employed taxpayer, or if you have made deductible contributions to an IRA, then you may have a tax issue on distributions from that plan or IRA. (Obviously, this does not apply to Roth IRAs but it can apply to roll-over IRAs.)

Many states follow the federal tax rules, allowing a deduction to these plans. However, Commonwealth of Massachusetts, among others, does not.

That is, in the case of contributions to all of these Plans and even a traditional IRA, Massachusetts gives you no deduction on the contribution. Therefore, you have to take a deduction for that contribution against later distributions. Otherwise, you have paid tax twice on that amount.

To say it differently, because Massachusetts does not allow a deduction at the time of the contribution, i.e., it was “after-tax” money when contributed, you must offset those amounts against withdrawals, amortizing over time, so that you are not taxed on the after-tax contribution when it comes back out as a part of the distributions.

Therefore, you will want to track the contributions made, so that the total can offset the amount taxed by Massachusetts when you withdraw.

We are addressing this issue in an appeal to the Massachusetts DOR Appellate Court, as certain plans face double taxation.

Roth Conversions – decisions on 2010, recharacterize now or pay taxes over two years?

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You can still decide as late as October 15th (if you extend filing of your tax returns) to either recharacterize or pay the taxes in 2011 and 2012 instead of on your 2010 taxes for your 2010 conversion to a Roth IRA.

Recharacterize – if you have the misfortune of losing value on the IRA after converting, you can “un-convert” by “recharacterizing” the Roth IRA as a traditional IRA using an IRA-to-IRA transfer (do not distribute funds to yourself, as that distribution voids the recharacterization). You can do this for all or a portion of the account. Once you do so, you cannot convert again until later of 30 days after the recharacterization or the year after the year of the original conversion.
This strategy is useful to address a decreased IRA value or to shift the conversion into future years with less income, so you are in a lower tax bracket.

Tax payments – 2010 is the only year where you can choose to have the income of the conversion split in half and carried onto your 2011 and 2012 tax returns. This (1) spreads the time to come up with funds to pay the taxes (you never want to use the funds in the IRA as that defeats the purpose) and (2) gives you earnings on funds already available to pay the taxes until the payment due date.

Note: if you are paying taxes on the conversion with your 2010 taxes, the amounts are due April 18, 2011, even if you extend to have the option of recharacterizing. If you do recharacterize, then you will have over paid and have a refund due …. until you convert again.

AMT rescue for 2010 and 2011

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First, a quick reminder of what the Alternative Minimum Tax (AMT) is:

This is the tax that Congress imposed over four decades ago, when very rich people with clever advisors were able to pay $0 taxes. Unfortunately, it was never indexed for inflation and has, especially over the last decade, grabbed more and more taxpayers. This has led to several patches, including the law just passed by Congress.

Today, the tax has a 28% rate and removes many deductions, such state income taxes, most exemptions and then adds in other items, or “preferences”, like the spread on incentive stock options purchased but not yet sold.

For the new law, middle class taxpayers are rescued from the AMT – at least for 2010 and 2011.

That is, the compromise tax package from Congress boosts the exemption levels for the AMT to cover over 20 million middle-income taxpayers.

Someday, perhaps an inflation adjustment will be added…..

Roth IRA, to convert or not to convert?

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The answer depends on your tax rate now and expected tax rate when you plan to take withdrawals. Also, you should consider this only if you can cover the taxes with funds from outside of your IRAs, otherwise you are forfeiting the tax deferral on those funds.

For example, someone with a low tax rate now, from large losses, large deductions or low income, may have less in taxes to pay now so that the rate of tax is less than what it could be in the future, making converting a wise financial move.

As a separate matter, the taxes can be paid over two years, however, if you expect a higher rate for 2011, the interest you earn will not make it worth waiting.

Someone with high taxes now, or in the AMT, would be a bad candidate for converting.

If you are considering this and want more analysis, we created a tool for that purpose so let us know.