Moment on Money

A Reader Asks #19: Personal Record Retention

A client recently emailed that she was cleaning out old files and wondered how long she should keep certain records. As a result of answering her questions, I have put together some basic guidelines of what to keep and how long to keep it.

	Retention Requirement	Recommendation
Tax Records	3 years min.	7 – 10 years
Bank/Credit Card Statements	None	File with tax records
Deposit Slips/ATM receipts Credit Card Transactions	None	Reconcile with statement then destroy
Pay Stubs	Most recent	File year end with tax records
Medical Records	None	Current physicians, treatments, and mediations. File medical expenses with tax records
Insurance Policies	None	Inforce polices. Maintain list of insurance policies and servicing agent.
Retirement Investment Accounts	None	Year end statement
Non-Retirement Investment Accounts	Cost basis	Year end statements for 7 – 10 years after investment is sold.

Tax Records – Generally the IRS has three years (from the date you filed) to audit your taxes. However, substantial omission of items (generally defined as over/under reporting income by 25%) extends the audit window to six years and there are situations such as filing a false return, willful attempt to avoid taxes, or failure to file a return which may be examined by the IRS at any time without limitation. If you are audited, the IRS can provide a copy of the return(s) you filed, but you need to provide the documentation and information that was used to prepare the return. Many sources recommend destroying tax information after seven years. That is plenty of time to defend yourself in an extended six year audit window. Frankly, you know if you should be concerned about an indefinite tax examination or not. I tend to hold tax documents longer that the standard seven year recommendation. I keep all tax records for ten years. For example, when I filed my 2010 taxes I destroyed my records from the 2000 tax year.

Bank/Credit Card Statements –These are essentially tax records. File them, by tax year, with tax records. Like all tax documents, keep them for ten years and then destroy them.

Deposit Slips/ATM Receipts/Credit Card Transactions – Save these only until the appropriate statement is received and reconciled. Once you know the statement is correct, it is okay to destroy these.

Pay Stubs – As long as your pay stub contains year-to-date information, you only need to retain your most recent pay stub. Keep the last pay stub of the year with your tax records.

Medical Records – It is a very good idea to keep records with the names and addresses of your family's personal physicians, medical history, and current prescriptions/treatments. Having this information at your fingertips will save you time and energy when you need to see a new doctor or have some other reason to summarize your health such as when purchasing insurance or, in some cases, getting a new job. Receipts and records for expenses related to healthcare should be retained with your tax records if you itemize and deduct your medical expenses.

Insurance Policies – Insurance policies are important, but replaceable. More important that keeping the actual policies is to keep the names and contact information for the agent who services your insurance. If need be, the agent can always get a replacement policy for you. But in a time of crisis, your agent should also be the first person you contact to initiate a claim.

Investment Accounts – what you need to keep really depends on the type of investment account

Retirement Accounts (including IRA's, Roth's, 401(k)'s, Pensions etc) – In general, these accounts are tax deferred so they are fully taxable when money is distributed. Throughout the year, you should retain all confirmations and statements. The final statement of the year will usually summarize all of the activity in the account for the year. You should keep this year end summary with your tax records. Roth accounts have a little greater need for recordkeeping. For Roth's, make sure you keep all your year end statements.

Non-Retirement Accounts – In order to calculate the taxes due when an investment is sold, you need to be able to document your cost basis (that is, how much you have paid in to the investment). If you purchased an investment in one "buy order" that can be pretty simple. But if you are making periodic investments over a long period of time, calculating cost basis may be a bit more difficult. Especially since the IRS allows for a couple different methods of keeping and tracking cost basis and there are special rules which apply to some investments like zero coupon bonds. The good news is, you don't really need to worry about it. Worrying about cost basis is your accountants' job. But you do need to provide your account the information they need. Just like retirement accounts, you need to keep a year end of summary of all your activity in your investment accounts. The difference is that you need to keep this information for as long as you own the investment… even if you own the same investment for decades. You should not consider destroying investment year end summaries for at least seven to ten years AFTER YOU SELL the investment. (By the way, new rules for investment companies will make this easier for investors. Soon investment companies will be required to track cost basis on your behalf).

When cleaning out files (especially after the years end), there can be a lot of documents which no longer need to be kept. Remember that DV Financial has a document shredding procedure which is compliant to military standards. As a service to you, you may bring in your documents and put them in our secure and confidential destruction bin. Your documents will be destroyed at no charge.

Have I missed anything? Let me know!

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

Fork In The Road: The US Debt Ceiling Impasse

In the last several days the volume of calls have increased and the common question is "Should I go to cash?"

The way I see it, there is only two ways for this to ultimately turn out. Either the government will come to a compromise and raise the debt ceiling, or they won't.

I put the odds of the government letting the August 2^nd deadline come without a resolution to the matter at "very unlikely". There is simply too much for both sides to lose. The only question is how both sides can emerge from the mess they have created, and still declare themselves the winner.

As an investor you have a choice. The market has declined quite a bit this week as uncertainty worked its way into pricing. Selling now and going to cash, you have protected yourself from a potential meltdown next week but you are also locking in the losses. Frankly, if you were to go to cash, the time to do that was about two weeks ago.

I believe that once a compromise is reached in Washington the markets will respond positively. If you are in cash you will miss out on that opportunity to grow or at least recapture the recent declines. Given that I think a political compromise is the most probable outcome, I am making no changes to portfolios unless a client specifically directs me to.

The Fund Evaluation Group, LLC released this summary, perspective, and recommendation yesterday:

July 28, 2011

The following email describes FEG's perspective on the U.S. debt ceiling impasse and our recommendation that clients stay the course with their existing portfolio allocations.

This week the U.S. Congress continued negotiations between its two major political caucuses and the Obama Administration on conditions for raising the United States' legal borrowing limit (i.e., the debt ceiling). The conditions being negotiated include the magnitude of potential spending cuts and/or revenue enhancements targeted to reduce the Federal budget deficit and the size of the debt limit increase, which in turn will dictate how quickly the Administration and Congress will have to start debt ceiling talks all over again. The stakes during these negotiations are especially high because the major credit rating agencies have threatened to downgrade the United States' AAA credit rating.

While Congress has raised the debt ceiling on sixteen previous occasions since 1993, negotiations this time have been particularly challenging as House Republicans hold out for significant spending reductions.

The U.S. hit its borrowing limit on May 16, at which time U.S. Treasury Secretary Timothy Geithner announced he would suspend contributions to Federal retirement funds. The Treasury Department has implemented other measures to keep total borrowing under the legal limit, but it says the U.S. will be forced to default on its financial obligations if the debt ceiling is not increased by August 2.

With the August 2 deadline fast approaching, we would like to share FEG's view on potential ramifications for client portfolios.

First, it is important to recognize the U.S. debt ceiling is a self-imposed political constraint enacted by Congress. Unlike Europe where there is a real debt crisis, the U.S. version is completely manufactured. Congress and the Administration already passed a budget for fiscal year 2011 so the approximate increase in the deficit was well known and the amount of additional borrowing needed to offset the deficit was also transparent.

Comparisons to Greece's debt situation are inevitable, but the differences between the U.S. and Greece (and other European Union nations) could not be more stark. The U.S. issues its own fiat currency and its debts are denominated in that currency. That means it is physically impossible for the U.S. to default on its debt unless it chooses to do so willingly. It can always print more currency to make interest payments and pay down debt.

Furthermore, the U.S. does not issue debt or raise taxes in order to have money to spend. Under a fiat currency system, it spends electronically by debiting bank reserves and checking accounts. With a fiat currency, the only reason to issue debt or raise taxes is to manage the money supply so as to avoid inflation. Consequently, the U.S. is not going to run out of money and it can easily meet its financial obligations if Congress and the Administration so chooses.

That is why we believe S&P's and Moody's credit rating for the U.S. is not really an outlook on the nation's solvency but more an opinion on the nation's political process.

Meanwhile, Greece, as a member of the European Union, does not control its own sovereign currency, and consequently, has no means of paying outstanding liabilities, which are denominated in the euro, unless it raises tax revenues or imposes massive spending cuts. Greece and other peripheral European nations face real debt crises, while the U.S. short-term debt crisis is artificial. Debt ratings in Europe truly are a reflection of those nations' solvency.

The bond market understands the difference between Greece and the U.S. without the help of the major rating agencies. That is why weeks before the potential default of both countries, two-year bonds in Greece are yielding over 27% while in the U.S. they yield a meager 0.4%, although volatility in the U.S. has recently picked up. ¹

A second important consideration is the August 2 deadline is not firm. Again, with a fiat currency the constraint is not when will the U.S. run out of money, as it certainly will not. The real constraint is when will the U.S. Treasury Department no longer have the political authority to spend because the U.S. has hit its self imposed debt limit and tax receipts are no longer sufficient to offset expenditures. By offset, we mean from an accounting perspective not a cash flow perspective.

The debt ceiling was reached in May, and since then the Treasury Department has deferred some expenses in favor of others. With an estimated $29 billion in interest on the debt due in August compared to an estimated $200 billion in tax receipts, it remains unlikely that the Treasury Department would elect to not pay scheduled interest payments and incur a default. ²

Still, having already reached the debt limit, the Treasury Department will be forced to defer more and more financial obligations. It is these ongoing deferrals and the severity and timing of reductions in government expenditures that gives us concern and potentially has negative consequences for risk assets.

The deficit as a percent of GDP remains extraordinarily high because the private sector is still in recovery mode. During the recession, tax receipts plummeted as corporate profitability and household incomes fell while government transfer payments increased due to high unemployment. Additional stimulus measures were also taken to jump-start the economy. Only recently have tax receipts begun to recover and expenditures decline as a percent of GDP.

Consequently, there is a risk that the recovery will falter if government cuts are both significant and accelerated and the private sector does not step in to fill the void. A significantly higher tax burden could also hurt the recovery. Given that households continue to struggle with high debt burdens and miniscule income growth, the corporate sector will need to replace the drop-off in government spending through capital investment and hiring. Perhaps corporations are hesitant to invest due to the uncertainty regarding the U.S. fiscal situation, which is all the more reason Congress needs to act expeditiously to raise the debt ceiling.

We continue to believe the risk of U.S. default is low. Congressional negotiations have focused more on timing and the size of a debt ceiling / deficit reduction package rather than whether one should be passed at all. Only a few have suggested the U.S. should not raise the debt ceiling.

Nevertheless, political brinkmanship can go awry so a default is still a possibility. The ripple effect and unintended consequences of a default and/or credit down grade is what is most disconcerting. Given the complexity of financial markets and proliferation of derivative securities, such as credit default swaps, no one knows the potential cascade of secondary and tertiary consequences such a default/downgrade could set in motion. When the risk-free rate is no longer risk-free because Congress did not raise the debt ceiling in time, the market reaction could be quite volatile, particularly if there are forced liquidations and/or settlements of securities and derivatives priced off of or tied to formerly "risk-free" Treasuries.

On the other hand, a successful resolution of the debt crisis could be favorable to capital markets.

That leaves investors in the uncomfortable position of deciding whether to reduce risk to mitigate a low probability, highly politicized event with unknown consequences of uncertain duration. These types of unknown unknowns are typically dealt with through diversification.

Therefore, FEG recommends long-term investors stay the course for now. If the economy shows signs of contracting and/or market sentiment deteriorates, we will work with clients to take appropriate portfolio actions.

¹ Bloomberg
² "Debt Limit Analysis", Bipartisan Policy Center, July 2011

Fork in the road by Leo Reynolds

An Alternative View of Taxes

It is the dreaded today. Today is the last day to pay 2010 Federal Income Taxes on time. To commemorate the occasion I thought we could examine an alternative view of taxes from Douglas J. Amy, Professor of Politics at Mount Holyoke College. He has a website, Government is Good: An Unapologetic Defense of a Vital Institution on which he chronicles The Forgotten Achievements of Government including:

• Public Health Programs which have eliminated polio, cholera, and smallpox from our society and have significantly reduced our risks of contracting hepatitis B, measles, mumps, tetanus, rubella, and diphtheria.
• Interstate Highways which George Will called "the most successful public works program in the history of the world".
• Anti-Discrimination Programs which have made substantial progress in eliminating racist and sexist practices that had existed for centuries.
• Clean Water and Clean Air Programs which has made the water we drink and air we breathe safe and dependable.
• The Military: Our Army, Navy, and Air Forces are the most effective military organizations in the world.
• National Weather Service serves us in many ways from warning us of dangerous conditions to ensuring the safety of planes and ships.
• Student Financial Aid Programs which gives every willing and qualified student an opportunity to receive an education regardless of their resources or background.
• Food and Drug Safety Programs which protect us from consuming products which threaten our health.
• Funding Scientific Research which would be unprofitable to pursue commercially.

Admittedly, I do not agree with every program Professor Amy considers a success of our government. But especially today I encourage everyone to consider that regardless of our political views, we can agree on our love for our country and take pride in the support we offer our government through taxes.

American Flag by superman_ha_muerto

IRS Warns of Frivolous Tax Arguments

Sometimes the truth is stranger than fiction. Directly from the IRS's website:

The IRS and Treasury have issued notices warning taxpayers that if returns are filed under the theory that U.S. citizens and residents aren't subject to tax on their wages and other income earned or derived within the United States, they may be subject to penalties. This argument is known as the "zero tax theory" and is possibly known by other names. Despite all the warnings about this and other frivolous arguments, some taxpayers insist on presenting frivolous arguments in court. The law allows the courts to impose a penalty of up to $25,000 when the court comes to any of three conclusions:

• a taxpayer instituted a proceeding primarily for delay,
• a position is frivolous or groundless, or
• a taxpayer unreasonably failed to pursue administrative remedies.

On March 4, 2011, the Internal Revenue Service released the 2011 version of its discussion and rebuttal of many of the more common frivolous arguments made by individuals and groups that oppose compliance with federal tax laws. Anyone who contemplates arguing on legal grounds against paying their fair share of taxes should first read the 84-page document, The Truth About Frivolous Tax Arguments. This past year, the courts have not only rebuked these arguments numerous times, but also have imposed thousands of dollars in fines on taxpayers or their attorneys for pursuing frivolous cases.  Some individuals have even be [sic] criminal prosecuted and sent to prison.

Photo Taxes by John-Morgan

A Reader Asks #18: Iowa Inheritance Tax Question

This comment was left on The Iowa Inheritance Tax post this summer. Doing the research on it brought some unusual twists and turns so it took more time to answer than I would have expected. Despite the delay, I still think it is interesting enough to address.

Thank you so much on your Iowa inheritance tax info. On the tax schedule it had a different tax for, "Unknown heirs, as distinguished from beneficiaries who are not presently ascertainable, due to contingent events." I recently found out that my mother was left around 100,000 in a will, unfortunately my mother passed away many years ago- so according to the lawyer this amount comes to me. Would I fall into this "unknown heir" category possibly?

The key to Iowa Inheritance Tax is the relationship between the decedent (the person who died) and the beneficiary (the person receiving the inheritance). In your scenario, we don't know the relationship between your mother and the decedent. Only that your mother died before the person who's estate is now being settled, and that as your mothers daughter you are entitled to at least a part of her inheritance. It is likely that your mother was named in the decedent's will as a per stirpes beneficiary, which means that if she had already passed then her lineal descendents are entitled to her inheritance. You are a lineal descendant of your mother. If your mother is a lineal descendant of the individual who died, then you would owe no Iowa Inheritance Tax since lineal ascendants and descendants pay no Iowa Inheritance Tax.

I am just going to guess that if that was in fact the case, you never would have asked the question.

I am not an attorney, but I do have access to some through my support systems. They did some research for me and even called the State of Iowa for clarification. You see, we cannot figure out any scenario where Schedule F would actually apply. Once you know who the beneficiary is the tax would be based on that person's relationship to the decedent and be covered under Schedule B or C, or not taxed as a lineal ascendant / descendant. When they called the State, the contact person there could not provide an example of a Schedule F scenario and told us that she has never seen Schedule F actually invoked.

That got us thinking about why someone would want to invoke Schedule F. That is when we noticed that the tax rate on Schedule F is 5%, while schedules B and C have higher brackets. Are you attempting to reduce the amount of tax due by employing schedule F rates instead of schedule B or C?

Obviously there are facts and details which have been omitted and make all the difference in this scenario. This is not intended as tax or other legal advice. For advice on your specific situation you should contact an attorney who is well versed in the Iowa Inheritance Tax.

By the way, it has brought to my attention that my post on The Iowa Inheritance Tax has a tax rate schedule which is out of date. Here is the most current Iowa Inheritance Tax Rate Schedule.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

Self Employed Retirement Plan Options for 2009

One of the disadvantages of being self employed is the lack of an employer sponsored retirement plan. Fortunately, there are several options available depending on how much you want to contribute each year.

$6,000 or less

The simplest retirement plans are the Traditional IRA and Roth IRA which are available to everyone, self employed or not. Eligible taxpayers can contribute $5,000 per year to a Traditional IRA and/or a Roth IRA. Taxpayers who are 50 or older can contribute an additional $6,000. Most self employed people are not an active participant in an employer sponsored retirement plan. Therefore, they are eligible to make a tax deductable contribution to a traditional IRA. Self-employed people who are active participants in an employer sponsored plan such as a 410(k) may still be eligible subject to phase out rules based on adjusted gross income(AGI). Roth IRA eligibility is based solely on AGI. The phase out ranges are $166,000 - $176,000 (married filing jointly), $105,000 - $120,000 (single and head of household), and $0 - $10,000 of modified AGI for married filing separate.

$5,000 - $14,000

For the self employed who want to contribute more than a Traditional IRA would allow, the next option would be a SIMPLE plan. SIMPLE is an acronym for Savings Incentive Match Plan for Employees, and not a description of how easy the plan is. As the name implies, if you have employees you must make an employer contribution or match for them. But if you are your only employee the SIMPLE allows you to contribute up to $11,500 regardless of your age or income. If you are 50 or older you can contribute up to $14,000.

Up to $49,000

By employing a SEP (Simplified Employee Pension) plan, you can contribute up to 25% of your income to a maximum of $49,000. Like the SIMPLE, you must also make contributions for your employees which can be a significant factor to consider. But if you are the only employee, the SEP works very well. Another alternative that allows you to exceed the 25% limitation, is the solo 401(k) (often referred to as the solo k) which is a 401(k) plan for one person businesses. With the solo k you can make a salary deferral election of $16,500 ($22,000 if you are 50 or over) and also make an employer contribution of 25% of your income as long as it does not exceed $49,000 limit.

While the retirement landscape seems complex, a qualified financial planner can point out the advantages and disadvantages of the options and assist in designing the retirement plan which fits your goals and budget.

The Retirement by ted.sali

Definition of Marginal and Effective Tax Rates

In January someone told me that most people have broken their New Year's resolutions by the end of February. Armed with that trivia and the knowledge that my resolution to post to this blog once a week wasn't broken until April provides no solace. I "owe" you guys a couple of posts and will be posting some extra ones soon.

Everyone knows tax day was yesterday, April 15^th, so it seems appropriate that we discuss an often misunderstood element of taxes and financial planning – tax brackets.

Our tax system is a progressive tax. That means that you pay an increasing percentage of your income as taxes as your income increases. But moving up to a new tax bracket only affects the additional dollars you have earned. It does not increase your tax liability on all your income¹. For example, let's study the 2008 Married Filing Jointly tax brackets.

Taxable Income Over…	But Less Than…	The Tax Is…	Of the Amount Over…
$0	$16,500	$0 + 10%	$0
$16,050	$65,100	$1,605 + 15%	$16,050
$65,100	$131,450	$8,962.50 + 25%	$65,100
$131,450	$200,300	$25,550 + 33%	$131,450
$200,300	$357,700	$44,828 + 33%	$200,300
$357,700	And Over	$96,770 + 35%	$357,700

So how do you read this chart?

Start with your taxable income or the amount of income you are actually taxed on after taking all your legal deductions and exemptions. Chances are you earn much more than your taxable income. For example, let us examine a married couple. He is self employed and has gross earnings of $105,604 and his wife is a W-2 employee with gross earnings (after pre-tax deductions like 401(k) and health insurance) of $49,228. Their banker saw $154,832 flow through their checking account but after business expenses and self employed retirement savings they are able to reduce their adjusted gross income (AGI) down to $112,705. Their taxable income is even lower at $70,241 which is found by starting with their AGI and subtracting itemized deductions and personal exemption amounts.

Now we can look at the chart. The taxable income is over $65,100 and less than $131,450 so we use the third line. The total tax due is $10,247.75 which and this it is calculated $8,962.50 + 25% of ($70,241 - $65,100). In other words, they are pay 25% only on the amount over $65,100.

What tax bracket is this couple in? The third line down is the 25% bracket, but they paid nothing close to $38,708 which is 25% of $154,832 which is why we must distinguish between marginal and effective tax rates.

Marginal tax rate is the amount of tax you would pay on the next dollar you earn. For this couple that is 25%.

Effective tax rate is the percentage of taxable income actually paid in taxes. This couple has an effective tax rate of 14.6%.

In financial planning, we most often use marginal tax rates. Financial planners think "if my client had an opportunity to increase their income by $1000, they would owe $250 in additional taxes and would net $750", but when you file your tax return, effective tax rates are the most accurate measurement of your tax liability.

AIC does not give legal or tax advice. For specific information applying a strategy consult your attorney or tax professional.

¹ An increase in adjusted gross income can increase your tax liability by disqualifying various deductions and credits.

A Reader Asks #17: Taxing Annuity Changes

This question came recently via emai:

Dear Mr. Dinkin,

I found your website after searching the web for an answer to a 1099-R question. I thought your website was helpful, but I'm not sure how to decipher the 1099-R I received.

My situation is this. My husband and I took out annuities through [company name removed] for our children; one in 1987 and the other in 1988. We took these annuities out for each of them as a 'college savings account'. Each of the annuities had both my husband's name and the individual child's name on them. My husband was listed as the owner and our child was listed as the annuitant.

Both of the children turned 21, we of course still had the annuities. When they turned 21 the annuities were turned over to them, without our request. The company said this happened because they turned the 'age of majority.' My husband and I gladly relinquished this money to them, but we ended up receiving a 1099-R form for them and had to claim it on our income taxes due to a code of 1 in box 7 on the 1099-R.

I learned about these codes by reading your article Unlocking Box 7. I simply don't understand why we had to pay taxes on these contractual annuities when there was no cash distribution.

Is it possible for you to help me shed some light on this puzzle?

I can shed some light on this, but unfortunately I may raise more questions than I answer. From my perspective as a financial planner, there are several key issues to consider.

Account Ownership

As presented, something is not quite right in regards to who owns these annuities. Since ownership of the annuities automatically transferred to the children when they reached the age of majority, I do not think the husband ever really owned the annuities. It sounds like the husband was the custodian of the annuities and his role was to act in the best interests of the children until they reached the age of majority and assume the responsibility for themselves. If I am correct that the annuities were set up under UGMA/UTMA, then there was no change of ownership when the children reached the age of majority. On the other hand, if the husband actually was the owner of the annuities then I cannot explain why his property transferred to the children without his consent.

The account ownership issue is quite significant. Not only does that directly affect potential taxes on a change of ownership (see below), but there is also the issue of a potential 10% penalty for premature distribution from an annuity. If the child is the true owner of the annuity, then it makes a poor choice for college funding. While the annuity enjoys tax deferral during accumulation, there is a 10% penalty on amounts withdrawn prior to the owners age 59 ½. My guess is that most parents want their children to receive their education before they are middle aged.

Income Tax

Again, annuities are tax deferred vehicles so no income taxes are due on gains within the contract until they are "recognized". Generally, this means that money is withdrawn from the policy but recognition can also occur when ownership of the annuity is transferred. When the annuity is transferred, the previous owner recognizes (and pays ordinary income tax) on any gain in the annuity. The new owner's cost basis is the value at the time of the ownership change.

I think this is why this person received a 1099. Since there was a change in ownership, the amount in the account at the time of ownership change is reported to the IRS. If that balance is more than the sum of the contributions, the previous owner has an income tax liability. In the email, the person indicated that Box 7 of the 1099 was coded with a 1 which indicates that the owner is younger than age 59 1/2. In addition to income tax the 10% penalty may also apply.

Gift Taxes

Don't overlook this potential problem too. If the annuities are worth more than $13,000 ($12,000 if we are referring to 2008), then you need to consider gift tax consequences too. Since the person in this example is married, they can elect to split the gifts between the spouses which effectively doubles the gift tax threshold.

The account ownership issue continues to puzzle me. Knowing that your children automatically became the account owners, I have to question if your husband was ever the actual owner of the contracts. It seems to me that your husband was acting as the custodian on behalf of your children but then I cannot explain a tax issue on transfer. If your husband truly was the account owner, then I cannot explain why ownership transferred without his consent.

I would definitely bring this to the attention of my tax advisor before filing a tax return.

This is not intended as tax or other legal advice. For advice on your specific situation you should contact your attorney.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

Death & Taxes

You know the old saying, "There are only two certainties in life; death and taxes." Yet there has been a lot of uncertainty in the last decade when it comes to estate taxes caused by the Economic Growth and Tax Reconciliation Act of 2001 (EGGTRA). One of the goals of the legislation was to raise the estate tax threshold.

Prior to EGGTRA, anyone with a net worth of around $500,000 had to at least consider how their estate might be taxed. Over the past decade that threshold has increased and now it takes an estate of at least $3.5 million to trigger an estate tax liability. And in 2010 the estate tax is repealed! Unfortunately, it will not be gone for long. As part of the political compromise required to pass the law, there is a "sunset provision" which brings back the estate tax with a $1,000,000 threshold in 2011. I, personally, would not want to be a rich old man on life support in December 2010 whose family was considering the tax impact of my potential demise.

No one really expected EGGTRA to survive, unchanged, until 2011 but no one could tell you what a future estate tax would be and when it would be triggered. This uncertainty has been a dilemma for anyone with some assets who was trying to do estate planning.

With President Obama's proposed budget there may finally be some clarity on the horizon. As submitted to Congress, the President has budgeted for an estate tax that looks like the 2009 version; a $3.5 million trigger with a top tax rate of 45% and a continuation of the step up in cost basis. Furthermore the budget suggests that the $3.5 million exemption be indexed for inflation which would eliminate the need to legislate maintenance for estate taxes.

Now it will be interesting to see how Congress responds.

death and taxes by aja joy

Savings Bonds: A potential tax trap?

When I was a kid I often received savings bonds as gifts from grandparents and relatives. My parents diligently kept them in the family's fireproof box and I remember taking them out and depositing them into my bank account as I prepared to leave for college. Fast forward a couple decades and now I have savings bonds for my children in our family safe.

A quick review of Series EE Savings Bonds

The traditional, or paper, bonds are sold for half their face value of $50, $75, $100, $200, $500, $1000, $5000, and $10,000. When the bond reaches maturity it is worth its full face value. The maturity date is based on current interest rates at the time of issue. The lower the interest rates, the longer it will take for the bond to mature. Newer electronic bonds are sold at face value. As time passes the value of the bond increases as interest is credited to the bond.

Bonds can be redeemed at any time but bonds redeemed within the first 5 years forfeit the three most recent months of interest credit. Even when the bond reaches maturity the government continues to credit interest until the bond reaches its final maturity date. At that point the bond has reached its highest value and additional interest will be credited.

These bonds are not known for their outstanding returns but rather their safety, ease of use, and tax deferral of the interest credited until the bond is redeemed or it has reached its maturity date.

The potential problem

Here is where it gets a bit sticky. According to IRS publication 550, the interest deferred on savings bonds must be reported in the year the bond matures, regardless of whether the bond was redeemed or not.

I have been unable to verify the figure, but one article I recently read indicated that according the US Treasury on September 30, 2008, there were $16.3 Billion in outstanding bonds which had reached final maturity and tens of billions of about-to-mature bonds in the pipeline. Not only does that amount to an interest free loan to the government, but holders of these bonds are subject to the risk that the IRS could declare that they under-reported their income by not recognizing the accrued interest on matured bonds.

Learn more

• Savings bonds are a great way to save on taxes, as long as you follow the rules @ WalletPop
• EE Savings Bonds in Depth @ TreasuryDirect.gov

A Crop That Never Fails. 1944 WWII bond poster for the 6^th War Loan by Joan Thewlis