News and Articles
December 22, 2009
People who need long-term care are paying more each year. You may be able to partially protect yourself by buying a long-term care insurance policy when you’re relatively young. For added protection, include a cost of living adjustment to the benefits you might receive.
According to the Genworth 2009 Cost of Care Survey, the national average daily rate for a private room in a nursing home is over $200: around $6,000 per month. A private one-bedroom unit in an assisted living facility costs over $2,800 per month, on average, and you’ll pay anywhere from $18.50 to $46.22 an hour, on average, to have an aide come to your home, depending on the type of agency you retain.
These figures are averages; you’ll pay less in some areas of the country, more in others. In Dubuque, Iowa, for example, the median annual cost for assisted living is $24,000. In Bridgeport, Connecticut, that cost is over $52,000. For almost any type of long-term care the cost is likely to be substantial.
Acquiring insurance
Many people will seek to buy insurance to cover the possible future cost of long-term care. Although many insurers offer such coverage, there is a catch to buying these policies. The longer you wait to buy coverage, the greater the chance you will be in poor health. If you have a health condition that increases the chance you’ll need care, you will pay more for a policy—and you might not be able to get coverage at any price.
Therefore, you may want to start shopping for a long-term care policy while you’re in your 50s or 60s. At that age, you have a good chance of getting coverage at a relatively low cost. But here there’s also a catch: you have to plan for possibly receiving benefits far in the future.
Example 1: Bruce Moore buys a long-term care insurance policy at age 62. He selects a policy that will pay a benefit of $200 per day, whether he needs care at home, in an assisted living facility, or in a nursing home. Bruce is in good health now but fears he’ll need care when he is in his 80s or 90s.
According to the Genworth survey, costs for assisted living facilities and nursing homes have been increasing at more than 4% per year. At a 4% rate, costs double in 18 years. Therefore, if Bruce needs care at age 80, his $200 daily benefit might pay only half of a $400 daily nursing home bill.
Coping with COLAs
Consumers who want protection from rising costs can buy a long-term care policy with a cost of living adjustment (COLA).
Example 2: Bruce chooses a 5% simple annual benefit increase as a COLA for his policy. Each year, his daily benefit will increase by $10: 5% of 200. Therefore, if Bruce needs care at age 80, 18 years after purchasing the policy, he will receive his $200 original benefit plus $180 (18 years of $10 COLAs) for a total of $380. That amount will cover nearly all of a $400 daily nursing home bill.
In recent years, insurers have added more choices to the COLA menu. Formerly, consumers typically had three choices: a 5% simple annual benefit increase, a 5% compound increase, or no inflation protection at all. Today, many companies offer a choice between 3%, 4% or 5% COLAs, simple or compound. You also might be able to buy a COLA that’s based on the Consumer Price Index (CPI). The more inflation protection you choose, the more you’ll pay. Thus, because the CPI has risen around 4% per year over the past 30 years, on average, a CPI COLA generally will cost less than a 5% COLA.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
If you are interested in buying a home, you might find a good deal these days. The same may be true if you have children who want to enter the housing market or parents who want to buy a retirement home. Both sellers whose home values have slumped and banks that own homes after foreclosures may offer bargains to buyers.
The National Association of Realtors (NAR) maintains a Housing Affordability Index, which reflects the relationships among household incomes, mortgage interest rates and housing prices. The index number is compiled by dividing the median household income by the median income a family needs to qualify for a mortgage on a median priced single family home. A higher index number indicates greater housing affordability: The index number rises as family incomes rise in relation to the cost of making mortgage payments on a median priced home.
In 2006, at the peak of the housing boom, the NAR index number was around 108. That is, the median household income was barely enough to qualify for a mortgage on a median priced home. Since then, median family income has climbed from around $58,400 to over $60,500. Mortgage rates have dropped from 6.6% to 5.3%, the NAR reports. Most important, the median price of a single family home has fallen from almost $222,000 to around $178,000. As a result, the NAR index number is about 159, as of this writing, and homes are much more affordable for many buyers.
Coming up short
You may find that buying a home today is not a simple process, however. For instance, you may want to buy a home in a “short sale”: a transaction in which the agreed-upon purchase price is less than the mortgage balance. If that is the case, the lender will have to approve the deal.
Example 1: Lyn Park finds a home she likes and bids $180,000. The seller accepts her bid. However, the seller bought the house a few years ago with a $210,000 home loan, which now has a balance of $205,000. On a $180,000 sale, the seller might net only $165,000 after expenses such as sales commissions. That $165,000 will be $40,000 less than the $205,000 that the seller owes the lender.
In such a transaction, the seller will have to ask the lender for permission to sell for $180,000. The lender may refuse, thinking that it can do better by foreclosing on the loan, acquiring the house, and selling it for a higher price. Alternatively, the lender may examine the seller’s financial situation and earning prospects to negotiate payment of the $40,000 shortfall.
Generally, the process of getting a short sale approved can take weeks or even months. As a buyer, you may end up obtaining a desirable home at a reasonable price, but you’ll probably need to be patient.
Buying from the bank
As home foreclosures increase, lenders own more properties. Such homes are known as REO: real estate owned by the bank. Generally, banks would rather hold cash than real estate, so they may be motivated to offer an attractive price to generate a quick sale.
When you buy REO property from a lender, you may get a property that’s clear of obligations incurred by the prior owner. A bank that’s eager to sell the property may have made sure there are no outstanding liens, property taxes, homeowners’ association dues or assessments, and so on.
However, you should not assume that an REO house is trouble free. Typically, these properties are sold “as is.” The prior owner, facing foreclosure, may have neglected maintenance or even vandalized the home. If the home has been empty for a while before the sale, uninvited guests may have caused further damage. Therefore, you should not make any binding commitments to a home purchase—especially an REO purchase—before you have the home inspected and examine the report. If the house will need work, you may want to reduce your bid or even start looking for another place to buy.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
Some investors will receive higher after-tax yields from tax-exempt municipal (muni) bonds than from taxable bonds. To find out what’s best for you, you must crunch some numbers.
Try an online calculator
One option is to use one of several online calculators to help you determine your personalized tax-exempt yield.
Example 1: Ashley Burns enters her federal tax rate of 33% into an online calculator. She also enters her North Carolina state tax rate of 7.75%. Ashley enters 4% as the current tax-exempt yield from a muni bond fund. The calculator shows her “tax-equivalent” yield to be 6.49%. That is, if Ashley earns 6.49% on a taxable bond and pays federal as well as state income tax on her interest income, she’ll net the same 4% interest she can get from the muni bond fund she is considering.
Real world math
A second option is to compare the after-tax yield you’d receive on a taxable bond with the yield of a tax-exempt bond using real world numbers.
Example 2: Suppose Ashley can earn 5% interest from a hypothetical mutual fund that invests in Treasury bonds or 4% interest from a hypothetical fund that invests in high quality tax-exempt muni bonds. Because both funds hold intermediate term bonds, their exposure to interest rate risk is similar.
If Ashley receives 5% interest from this Treasury bond fund and pays 33% of it to the IRS, she will net 3.35%. She will owe no tax to North Carolina because Treasury bond interest is exempt from state and local income tax. Thus, Ashley will earn more, after tax, from this muni bond fund than from this Treasury bond fund.
Example 3: Ashley’s son Eric is in a 15% federal tax bracket. If Eric invests in the Treasury bond fund yielding 5% and pays 15% to the IRS, he will net 4.25% after tax. Therefore, Eric will earn more after tax from the Treasury bond fund than from the muni bond fund.
Example 4: Ashley also is considering a bond fund that holds high quality intermediate term corporate bonds. It yields 6%. However, Ashley would owe income tax to North Carolina as well as to the IRS on that 6% interest. She can deduct the tax she’ll pay to North Carolina on her federal tax return, which will reduce the effective federal tax she’ll pay. Ultimately, Ashley will owe about 38% in tax on that 6% yield, so she’ll net about 3.7% after tax. Her after-tax yield would be lower than the muni fund’s 4%. (The math would be different if Ashley were subject to the alternative minimum tax and, consequently, could not deduct state tax payments on her federal tax return.)
Typically, the higher your tax bracket, the greater the advantage of muni bonds and muni funds. Many observers expect tax rates to increase in the next few years, especially for high-bracket taxpayers. Our office can help you determine whether you will earn higher yields, after tax, from taxable or tax-exempt investments.
2009 Tax Brackets
| Tax rate |
Single filers
taxable income |
Married filing jointly
taxable income |
| 10% |
Not over $8,350 |
Not over $16,700 |
| 15% |
$8,351–$33,950 |
$16,701–$67,900 |
| 25% |
$33,951–$82,250 |
$67,901–$137,050 |
| 28% |
$82,251–$171,550 |
$137,051–$208,850 |
| 33% |
$171,551–$372,950 |
$208,851–$372,950 |
| 35% |
$372,951 or more |
$372,951 or more |
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
The Hope scholarship tax credit was created by the Taxpayer Relief Act of 1997. Earlier this year, the American Recovery and Reinvestment Act of 2009 (Recovery Act) effectively replaced the Hope tax credit with the American opportunity tax credit, which is available in 2009 and 2010. With the new credit, taxpayers who pay at least $2,000 for tuition, fees, books and materials for higher education can get a dollar-for-dollar tax credit, saving $2,000 in tax. Above $2,000, the tax credit is 25 cents on the dollar. When a taxpayer reaches $4,000 of expenses, he or she will qualify for the maximum credit of $2,500.
Six states—California, Florida, Michigan, Nevada, Arizona and Illinois—accounted for 62% of the nation’s total foreclosure activity in August 2009. While first place California’s total was down 15% from July 2009, second place Florida saw a 10% increase from July 2009.
Source: RealtyTrac
December 4, 2009
A rule requiring “creditors” and “financial institutions” to implement identity theft prevention programs is scheduled to go into effect on November 1, 2009. Small business owners, professionals, and corporate managers—at a minimum—should head to the Federal Trade Commission’s (FTC) website to learn what the Red Flags Rule is and how it may affect their business. The website is www.ftc.gov/redflagsrule.
At this time, it appears that many professionals and businesses may fall under the rule. According to the FTC, “creditors” may be “finance companies, automobile dealers that provide or arrange financing, mortgage brokers, utility companies, telecommunications companies, nonprofit and government entities that defer payments for goods and services, and businesses that provide services and bill later, including many lawyers, doctors, and other professionals.” Accepting credit cards as payment does not, by itself, make an entity a creditor.
The FTC’s Red Flags Rule website offers a number of resources to help entities determine if they are covered and, if so, how to comply with the rule. The website includes an online, fillable compliance template that enables companies to design their own identity theft program, FAQs, guidance manuals, and articles directed to specific businesses and industries. In addition, the FTC has stated that it will create a specific web link for small and low-risk entities with materials to help them navigate the rule.
Our office can help you determine whether you or your business will be covered by the Red Flags Rule and what you should do to comply with it.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
Through 2009, you can convert a traditional IRA to a Roth IRA only if your 2009 modified adjusted gross income (MAGI) is no greater than $100,000 on a single or joint tax return. The $100,000 cap will come off in January 2010. Under current law, this change is permanent. Therefore, high income taxpayers can convert traditional IRAs to Roth IRAs in 2010, 2011, 2012, and so on. For tax-payers whose 2009 MAGI is $100,000 or less, year-end 2009 presents a dilemma.
Example #1: Wendy Ames expects her MAGI to be $80,000 this year. She would like to invest in a Roth IRA because these accounts may permit tax-free withdrawals in the future and Roth IRA owners don’t have to take required distributions. Also, if she wishes, Wendy can leave her Roth IRA intact for her beneficiaries, who will have to take scheduled distributions but will owe no tax as long as the account is at least five years old.
Crafting a conversion
Should Wendy convert her traditional IRA to a Roth IRA in 2009 or wait until 2010? Although she will owe tax on the amount she converts, in this example her traditional IRA has a much lower value now than it did in 2007. Therefore, a Roth IRA conversion now would generate a lower tax obligation than it would have created two years ago. A 2009 conversion also will lock in this year’s income tax rates, which might be higher in the future and start the five year clock for tax-free withdrawals at January 1, 2009.
On the other hand, Wendy can wait a short time and convert in 2010. Her IRA balance might be little changed by then, and tax rates for moderate income individuals like Wendy may not move up in the near future. If she waits a few weeks and converts in 2010, Wendy will have two choices. She can report the taxable income from her 2010 Roth IRA conversion on her 2010 tax return or she can take advantage of a special rule for 2010 conversions and report half of the income on her 2011 tax return and the remaining half on her 2012 return, thus obtaining a period of tax deferral.
Taking action
Some taxpayers may choose to convert by year-end 2009 because they will have a chance to reverse their conversion. All Roth IRA conversions can be recharacterized by October 15 of the following year; the account will revert to a traditional IRA and the taxpayer will get a refund of any tax paid on the conversion.
Example #2: Tim Bradley decides to convert his $100,000 traditional IRA to a Roth IRA in late 2009 to take advantage of a low IRA balance and today’s relatively low tax rates. He pays the tax on $100,000 of income on his 2009 tax return. In October 2010, Tim sees that his Roth IRA is worth $125,000. He decides to leave his Roth IRA in place, with $25,000 of tax-free growth in the account.
Example #3: Assume the same facts as in Example #2, except that Tim’s Roth IRA has declined to $80,000 by October 2010. He recharacterizes the account to a traditional IRA and files an amended tax return for a refund. After waiting at least 31 days, Tim can re-convert this traditional IRA to a Roth IRA. If the account value has not changed materially in the interim, Tim will owe less tax on this Roth IRA conversion than he owed on his 2009 conversion. What’s more, if he executes the re-conversion in 2010, he can defer the tax payments to 2011 and 2012, as explained previously.
Be prepared
Taxpayers who expect their 2009 MAGI to be over $100,000 also may want to do some year-end IRA planning for 2010, when it will be possible to convert a traditional IRA to a Roth IRA regardless of income. Following are three steps you should take.
First, decide whether you want to convert your traditional IRA to a Roth IRA. If you are concerned that upper income individuals and couples will pay much higher taxes in the future, you may want to convert your tax-deferred traditional IRA to a tax-free Roth IRA.
Second, if you would like to have a Roth IRA, decide how much you are willing to convert. If you do a partial conversion, you will reduce your tax obligation.
Finally, if you decide to convert your traditional IRA to a Roth IRA, and you have determined how much you’d like to convert, notify the custodian of your traditional IRA in advance. There may be a rush to convert to Roth IRAs at the beginning of the year as many taxpayers seek to take advantage of their IRAs’ diminished values. By notifying your IRA custodian in advance about your plans, you may be able to get your paperwork ready for a Roth IRA conversion in early 2010.
If you or a loved one face a similar decision, our office can help you make an IRA plan that’s appropriate for your specific circumstances.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
Mutual fund methods
If you invest in mutual funds, proceed cautiously at year end. At this time of year, funds may distribute any net capital gains for 2009 to their shareholders. These distributions are taxable to investors (unless the fund is held in a tax-favored retirement account), and the share price typically drops to reflect the distribution.
Example #1: Caitlin Carter invests $10,000 in Mutual Fund ABC in early December 2009. She acquires 500 shares at $20 apiece. One week later, ABC makes a $2-per-share capital gain distribution, and the share price drops to $18. Caitlin owes tax on a $1,000 capital gain distribution ($2 per share times 500 shares)—even though the distribution is essentially a return of her own money.
Therefore, if you are going to invest in a mutual fund between now and December 31, 2009, you may be better off waiting until after any distribution. You might be able to avoid this tax trap and buy at the post-distribution reduced trading price. Check the fund’s website for information about capital gain distributions; if the fund won’t distribute capital gains because of bear market losses, you can buy at a time of your choosing.
If you are thinking of selling mutual fund shares, on the other hand, you may decide to advance your plans if you learn that your fund will make a capital gain distribution.
Example #2: Steve Davis invested $10,000 in Mutual Fund XYZ many years ago. He now owns 700 shares of the fund, trading at $25, for a total of $17,500. Steve wishes to take his gains in 2009 while the maximum tax rate on long-term gains is 15%.
On the XYZ website, Steve sees that a $3 per share distribution is planned for December 15, 2009. The fund estimates that $2.50 per share of that distribution will be in the form of short-term capital gains from this year’s rally. Thus, if Steve holds onto his shares, he will receive a distribution of $2,100 ($3 times 700 shares), most of which will be taxed in his 28% ordinary income tax bracket as short-term capital gains.
Instead, Steve sells before XYZ’s distribution. With a $10,000 cost basis and a $17,500 selling price, Steve will have a $7,500 long-term gain, all of which will be taxed at only 15%.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
November 17, 2009
If you expect to sell securities for a profit in a taxable account, consider doing so in 2009 while tax rates are at low levels. Some predict that those rates may soon move higher. What’s more, you may be able to shift your gains to loved ones who’ll owe no tax in 2009.
Example #1: John Brown has two children, ages 18 and 21. Both will be full-time college students in 2010. To pay their college bills, John expects to sell some securities. Because all the securities in his taxable account now trade at prices higher than his purchase price, John expects to generate capital gains when he sells them to raise money for college costs. John may be able to avoid some capital gains tax if he transfers appreciated securities to his children and takes advantage of the “kiddie tax.” Under the “kiddie tax” rules, full-time students under 24 are considered to be “kiddies” as long as their earned income is less than half of their support. These “kiddies” can sell appreciated assets and owe 0% tax under rules in effect in 2009.
Suppose, in this example, that John’s two children will each have $400 in interest from bank accounts this year and no other investment income. John transfers appreciated securities that he has held for more than one year to each of his children. (He should make these transfers as soon as possible so the children can sell the securities in 2009.) If each child sells securities for a $1,500 gain, each will have $1,900 of unearned income this year: $1,500 of long-term capital gains plus $400 of interest. John’s children, who qualify as “kiddies,” can sell the appreciated assets and owe 0% tax.
Thus, if your children qualify as “kiddies” and you hold appreciated securities, transfer those you’ve held for more than one year to your children for a sale this year. Such sales will qualify for the 0% rate as long as each child’s total unearned income, including any transfers, is no more than $1,900. As of this writing, the 0% tax rate for low-income taxpayers is scheduled to remain in effect for 2010. If that is still the case in January, you can repeat this maneuver then. In fact, the $1,900 kiddie tax ceiling might be slightly higher in 2010 because it increases with inflation. (In the “Green Book” published by the Treasury Department in May 2009, the Obama administration proposes to retain the 0% tax rate for low-income taxpayers.)
Other loved ones, such as your parents and children 24 and older, are not subject to the $1,900 kiddie tax limit. Single taxpayers may have taxable income up to $33,950 and owe 0% on long-term capital gains in 2009. For couples filing joint returns, the upper limit is $67,900. If you plan to sell appreciated securities, you may wish to transfer them to taxpayers who will be under those ceilings for tax-free sales in 2009.
The 15% Solution
In the preceding example, the securities that John Brown transfers to his children might not provide enough money to pay their college bills. If that’s the case, John may have to sell more appreciated securities and pay tax on long-term capital gains. John can wait until 2010, thus deferring his tax bill. However, there is no guarantee that the 15% maximum tax rate on long-term gains will remain in effect next year. Congress may respond to financial pressures on the federal government by raising that rate, perhaps limiting the increase to high-income taxpayers. For this reason, John might decide to make planned sales in 2009, locking in the tax on the gains at 2009 rates. (The Green Book proposes an increase in the tax on high-income taxpayers’ long-term capital gains from 15% now to 20% in 2011. However, Congress might legislate such an increase in 2010.)
Selling short
If some of your stocks are now worth less than you paid for them, you may want to sell them—and realize those losses—before year end. You can offset net capital losses up to $3,000 against your ordinary income on your 2009 tax return and carry forward capital losses over $3,000 to future years’ tax returns with no time limits. Piling up a “bank” of capital losses may help you if you have gains from a 2009 investment and want to take profits. If you sell securities you’ve held for one year or less, you’ll generate short-term gains, which are taxable at ordinary income rates (up to 35% in 2009). Instead, you can use your capital losses to offset the gains you generate by selling the securities held short term—and avoid tax.
Looking backward
As mentioned previously, you can deduct up to $3,000 worth of net capital losses on your tax return and carry forward excess losses to future years. Therefore, you should check your 2008 tax return to see if you’re carrying forward any unused capital losses. You’ll find that information on Schedule D of Form 1040. If you have such losses from the 2008 bear market or prior years, you can take gains to soak them up without paying any taxes out of pocket.
Example #2: Louis Ward has $20,000 worth of loss carry forwards from previous years. He hasn’t taken any capital gains or losses this year. If Louis generates $17,000 in net capital gains by the end of 2009, his loss carry forwards will offset the tax on those gains. He can deduct the remaining $3,000 of net loss against his 2009 ordinary income, reducing his existing taxable income for the year and his resulting tax obligation.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
November 3, 2009
When you buy life insurance, you may be better off with term coverage. Term life policies have relatively low premiums because they pay only if the insured individual dies during a certain time period. You might buy a 20-year term policy, for instance, to protect your family until your children are grown. However, term insurance might not be ideal for an indeterminate need.
Example: Ken Collins wants to leave his family business to his daughter Amanda, his chosen successor. He also wants to provide for his other daughter Melanie. To equalize their inheritances, Ken buys $1 million of insurance on his life, payable to Melanie. Ken doesn’t know when he’ll die, so he buys permanent life insurance.
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Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., New York, NY 10036-8775.
