Alternative Minimum Tax

Credit: renjith krishnan

First of all, let me wish a happy end of “busy season” to all my Certified Public Accountant brethren out there who just finished the most stressful time of their year! Secondly, let me ask you: Did you have to file Form 6251?

Unless you have an incredible memory or were frighteningly thorough in reviewing your tax return, you may have already forgotten. If by some unfortunate twist, you, your tax software, or your accountant determined you actually owed Alternative Minimum Tax on Form 6251, you probably do remember that wretched form. Either way, even I, as a former tax preparer, have a white, hot hatred for the Alternative Minimum Tax, because it is an entirely parallel tax system that, in my opinion, has overreached its original intent.

You see, this mess all started when a predecessor, “Minimum Tax,” was enacted in 1969 when the federal government noticed that around 150 high-income taxpayers were not paying any taxes due to massive deductions and tax breaks. Congress addressed this national outrage by passing a bill that subjected around 19,000 taxpayers to an additional tax. The potential additional tax liability began in 1970, and was calculated as 10% of a taxpayer’s special tax preference items (certain deductions and tax breaks that had previously been allowed) that exceeded $30,000 in addition to their originally calculated tax liability. As most tax laws do, the “Minimum Tax” changed multiple times over the course of the 1970s and 1980s, and the most dramatic change occurred in 1982 when the “Minimum Tax” went away and the Alternative Minimum Tax (AMT), that we currently know and love, came into existence.

Whereas the “Minimum Tax” was an additional tax, AMT is a second tax system. To calculate AMT, you essentially start with your regular taxable income and add back quite a few deductions, credits, and exemptions, and then multiply your new AMT income by a rate between 26% and 28%.  In a nutshell, AMT is less generous than the normal tax system, and even according to the Internal Revenue Service, AMT is supposed to "limit the benefits that can be used to reduce total tax.” I wouldn’t begin to try to walk anyone through an entire tax system in a few paragraphs, but if you took fairly large deductions when compared to your income for state and local taxes, medical expenses, miscellaneous expenses, investment expenses, or mortgage interest to name just a few potential AMT-triggering items, you are going to want to be careful. In some cases, if you have passive income or passive losses, a net operating loss, foreign tax credits, or incentive stock options, you, too, could face AMT. The bottom line is that most individual filers with more than $50,000 worth of income and most married filing jointly taxpayers with more than $75,000 worth of income will need to figure out their tax liability under the normal tax system and the AMT system and be prepared to pay whichever is greater. (This surprisingly nice tool provided by the IRS can also help you decide if you will be required to pay AMT.)

Now as I’ve said before, I don’t do politics on 2MuchCents. However, I did make the “loaded” comment earlier that I believe AMT has overreached its original intent. What I meant is relative to the fact that in 1969, the government was going after 150 taxpayers; in 2011, around 4,000,000 taxpayers paid AMT and an estimated $39 billion was generated for the government by those taxpayers' additional liabilities. Don’t get me wrong, I’m for people earning their share and paying their share; I’m just not sure that the AMT that has evolved over the years (or could evolve in future years) is what the Congress of 1969 had in mind.

Not everything about AMT is doom and gloom, though. There are a few brighter spots. First, while the American Taxpayer Relief Act did not do a lot of things many people hoped it would do, it did permanently index some of the AMT parameters for inflation. While this will supposedly keep around 4 million taxpayers paying AMT annually, it is an improvement over the historical practice of always needing eleventh-hour congressional “patches” to increase AMT paramters for inflation that were annually reverting to their original 1982 amounts which, if left unchanged, would have caused millions more of Americans to face AMT consequences. Second, while AMT may not feel fair to you if you have to pay it, you are earning an AMT Credit. If you have ever previously had to pay AMT, and in the future you find your regular taxable liability is calculated to be higher than your AMT liability, then you could be allowed to reduce your regular tax liability down to the lower AMT liability, or by an amount equal to as much AMT as you have previously paid. It’s also worth mentioning that AMT credits are carried forward for an unlimited number of years.

To be completely honest, I always saved AMT calculations for last, like some rancid dessert, when I prepared individual tax returns and corporate tax returns. (Oh yes, there’s a corporate AMT as well, but I spared you from that!) AMT calculations could be complicated, confusing, and I never seemed to make anyone happy when I had to deliver the bad news that they faced Alternative Minimum Tax…

It’s my hope that you will look at Form 6251 a little closer next year. If you are an overachiever and look at your 2012 return and find that you are facing AMT or were pretty close, I would urge you to reach out to your CPA (or financial advisor) before their next “busy season” and after they’ve had a few weeks off because there are some planning strategies available that could save you from the dreaded AMT.

-Tom

Uh-oh!

Credit: imagerymajestic

Have you ever had one of those Snickers “Wanna get away” moments? I know I have. There was the time when I was playing the White Rabbit in a comical version of Alice in Wonderland, and right in the middle of my solo, I looked over and realized my nice, fluffy, white tail had become detached from my pants. There was also the time when I complimented the beauty of someone’s relative’s cremation urn. Most recently, there was that moment when I came downstairs to see my “angelic” dachshund playing in the confetti of what used to be my wife’s work time sheet and to-do list for the week that she had asked me to move a little earlier in the day if I was going to let the puppy out. Uh-oh!

Uh-oh moments are a part of life, but some can be prevented. Part of my job as a financial planner is helping clients try to prevent financial uh-ohs, and the most common areas where I see blatant financial uh-ohs are actually estate planning and beneficiary designations. Today, I want to talk about a few common estate planning uh-ohs that you will want to make sure you and your loved ones avoid.

• Whose Name is Where?
• Many people are surprised to learn that their designated beneficiaries on retirement accounts and life insurance policies trump any designations in their wills. If a husband was suddenly killed and left everything in his will to his second wife, but the most recent beneficiary designation on file with his company’s 401(k) plan still lists his first wife as the beneficiary, the first wife will walk away with the 401(k) plan proceeds. If a grandmother’s relationship has fallen apart with one of her three grandchildren, and in her will she states her wishes to transfer assets to only two of her grandchildren, but the most recent beneficiary designation on file for her life insurance policy lists all three, the grandchild who has fallen out of favor will still receive his/her share. Wills and estate plans are not worth the paper they are written on if you do not make sure your beneficiary designations are properly coordinated with your wishes!
• Are Your People Still Your People?
• I’m not naive enough to think that most people enjoy updating their estate plan, but it really is necessary to periodically examine what you have in place to ensure that your wishes are actually fulfilled. Are your children’s named guardians still the people who you would like guarding your children? Have you even named a guardian for your children? Do you still want to give your uncle who has developed that gambling problem a share of your earthly wealth? At his age, is your older brother still mentally and physically capable to serve as your executor? Is your daughter who has now moved across the country still the best person to be your financial and health care power of attorney should something happen? Life changes and people do, too. If it’s been awhile since you looked at your will, there is a chance someone has passed away, someone has moved, someone is no longer capable to act in the capacity you formerly intended, or someone is no longer an individual who you would like to benefit through your final wishes. If any of these possibilities are the case, it’s probably worth dusting off your old estate plan to make sure there is no stone unturned.
• Is It Still Going Where It is Supposed To Go?
• Attorneys often use relatively flexible language in their client’s wills so that every time Congress slightly tweaks the tax law, their clients don’t have to come running back to rewrite their wills to match the new laws. While this is a great practice and an idea appreciated by all parties involved, the estate tax law has changed a good bit over the past few years - enough that I would urge you to take a look at your estate plan if it’s been awhile. For example, let’s say a lady has $3 million, and she specified in her 2003 will that she wanted to leave the maximum estate tax exemption at the time of her death to her son and the remainder to her husband. Well at the time the will was written in 2003 that meant $1 million to her son and $2 million to her husband. However, in 2013, that means $3 million to her son and not a dime to her husband because the current estate tax exemption is $5.25 million. I know this example has a lot of zeroes, but the point is the same - if the lady with the $3 million dies without reading this post and updating her will, her surviving husband will probably be saying more than “Uh-oh!”

 

Death is one of the two certainties in life according to Benjamin Franklin, and it is often a big enough burden on the deceased’s friends and family without a nasty financial surprise. If this post has given you the slightest doubt in your current estate plan’s ability to fulfill your wishes, I urge you to please make time to take a look.

 

-Tom

Household Spending Breakdown

Credit: jannoon028

One of the things I sometimes ask clients for is a breakdown of their living expenses for several months. Just like a tax return, you can actually tell a lot about someone based on their living expenses. Think about it - if someone had a few minutes with your checkbook or credit card statement, don’t you think they could develop a decent theory about your current income, paint a rough picture of how you typically spend your money, and maybe even infer a few things about your personality? Scary to think about, huh? (Don’t worry; I treat all client information with the highest degree of confidentiality.) Anyway, back to living expenses…

I usually ask clients for a breakdown of their living expenses for one of a few common reasons. Maybe I’m trying to figure out if they can retire, or why they’re finding it difficult to hit their saving goals. Perhaps they have a consistently negative cash flow (they are spending more than they are taking in) that is threatening their financial independence, or, sometimes, they simply have no idea where all their money is actually going. I don’t judge anyone’s expenses as I wouldn’t want anyone to judge mine, but it really can be eye-opening. I’ve had clients go through this exercise and realize they can retire if they pay off their mortgage and get rid of that fixed monthly expense, I’ve had clients realize to their horror they are spending more than five digits in a year at a particular discount retailer, and I’ve even had clients who appeared to actually spend more on drink than food. It’s their money, and I would never attempt to tell anyone how to spend their hard-earned money, but I’ve seen many people right before my very eyes become truly enlightened after we have taken the time to break down their household spending.

Rewind to the 2012 holiday season - sometime between Thanksgiving and Christmas: I harassed my very selective, very thrifty, and always-conscientiously-saving wife about how many “bargains” she acquired in a relatively short period of time. It wasn’t an accusation, and it didn’t lead to a “domestic difference of opinion,” but it did help motivate me to take the time to perform the very same analysis on our living expenses that I've done for so many others. I would later find out that I was dead wrong about my wife's spending and the magnitude of our joint discretionary spending relative to our living expenses. As a CPA and CFP, I didn’t even know my own household spending breakdown as well as I thought I did! As a friend of mine in college often used to say, “How embarrassing!”

I won’t bore you with all the details of the Presley Household Spending Breakdown, but I will share with you a few observations:

• Gas and automotive expenses are considerable. When I was a kid, I remember when gas was $.79 a gallon… I must be getting old.
• The costs of going out to eat can add up. I think I’ll ask my wife for a few more homemade dishes and cook a little more myself going forward. It’s probably healthier, too!
• University of Georgia football expenses for tickets and tailgating should not be a separate category from discretionary (optional) spending. Anyone who knows me at all knows I’m a loyal alumni and a huge fan, but I realized that I was actually viewing UGA expenses separately from our discretionary spending, like a normal person would view utility bills. I bet I’m not alone in this twisted logic, as trying to convince some people I know that golfing, hunting, tennis, and seasonal clothes shopping are not required would be a “tough row to hoe.” I’m still trying to convince myself that I really don’t have to go to every home game, but it’s still a work in progress.
• As many of you have probably picked up on from reading my other posts, I’m not a big advocate of debt. My wife and I work really hard and save really hard to try to put additional principal towards our mortgage whenever we can. This analysis actually showed me that we were putting unnecessary pressure on our cash flow and probably saying no to some opportunities that we should take advantage of as a relatively young couple. I still hate debt, and everyone should still have an emergency fund, but by closely examining our living expenses, I came to the somewhat obvious realization that taking a little more time to pay off our mortgage and having a full (and less financially stressful) life would probably be a better choice than paying off our mortgage as soon as absolutely possible and having a lot of spare time.

 

I hope you will take the time to look at the entries in your checkbook for the past few months, view those spending reports that are available online through many bank accounts and credit card accounts, or look at last year’s W-2 to see if you can figure out where all that money went. It can be helpful financially, but it can even be personally enlightening, too.

 

I still want to know what one client was feeding her cat. It had to be surf and turf!

 

-Tom

Appreciating Appreciated Securities

 


Credit: David Castillo Dominici

If you have not started preparing your 2012 taxes, consider this your reminder. If you have already prepared your 2012 taxes, did you have any charitable deductions? If you did, I may have an idea for you to consider in 2013.

Giving cash or clothes to churches, charities, or other qualified organizations is a very admirable gesture in my book. You are sacrificing to help others who are less fortunate. In addition to the good feeling you will probably experience from your generous gifts of cash, clothes, shoes, or books, the U.S. Tax Code will also likely allow you to take a charitable deduction that could potentially lower your income tax bill. It seems like a win-win situation, but it could be even better; the U.S. Tax Code also offers tax benefits to those who gift stock, particularly appreciated stock (stock that has gone up since you bought it), to charitable organizations.

How could giving stock be better you ask? Let me give you an example of one of the best tax planning “tricks” in the book!

Example: Bob and his wife Susan want to give $10,000 to the Salvation Army. They have some extra cash laying around, their closets are overflowing with clothes and shoes, and they have a considerable amount of Home Depot stock in a brokerage account Bob has been adding to over the years. Bob knows he could write a check to the Salvation Army like he does every year, he and Susan have needed to go through their closets for longer than they’d like to admit, and Bob remembers his friend Steve talking about what a “great deal” he got by giving his church some stock last year, but what should Bob do?

Bob and Susan can obviously give anything they choose in any manner(s) they choose, but here are the likely results of their three different options:

• Cash: This is probably the easiest and quickest way to give. Write a check, donate online, pay by credit card - whatever. You will help a charity and likely get a tax benefit. You will need to keep good records though (see “Records to Keep, Cash Contributions”).
• Non-Cash Items: While this is a great way to clean out your house and instantly provide gently used items to those in need, it will require more effort both when you clean out your closet and when you file your taxes. The number of hoops you will have to jump through  (see “Records to Keep, Noncash Contributions”) in order to claim a charitable deduction grows as your non-cash donations increase from less than $250, to between $250 and $500, to between $500 and $5,000, and above $5,000, so please keep this in mind if you choose to donate non-cash items. I’m not saying this isn’t a good way to give charitably, and I’m certainly not giving you another excuse to neglect your overflowing closet, but I am saying that you might want to box up your stuff and give $500 or less of non-cash items per year so that you don’t have to remember the day you bought a sweater and how much you originally paid for it, pay your CPA more to fill out another very detailed tax form, or even have to consider bringing in an appraiser. 
• Stock: As I mentioned earlier, Bob has a brokerage account with a lot of Home Depot stock in it. While he’s bought additional shares from time to time, he bought most of the shares on August 17, 2000, for $51.37 per share. Considering Home Depot closed at $71.37 per share on March 8, 2013, that means he has unrealized gains of $20 per share on most of his shares. If Bob and Susan want to give $10,000 to the Salvation Army, and Home Depot is at a price of $71.37 per share, Bob will need to transfer about 141 shares to the Salvation Army ($10,000 / $71.37 = 140.11 shares). Transferring these shares will likely require a call to his broker or financial advisor (and maybe even the Salvation Army) and some paperwork, so this is more complicated than just writing a check, but this is the strategy I would probably recommend for Bob, and here is why:
• If Bob transfers 141 shares of Home Depot to the Salvation Army, he and Susan will probably be allowed to take a charitable deduction for the current fair market value of the stock at the time of the transfer ($71.37 per share in our example) of around $10,000. That’s just as good as giving cash!
• If Bob transfers 141 shares of Home Depot to the Salvation Army, he and Susan will not have to worry about any of the long-term capital gain taxes they would have encountered had they sold 141 shares of Home Depot stock and then given the cash to the Salvation Army, or used the cash themselves. Assuming Bob and Susan would have faced the 15% long-term capital gain rates, by giving the stock directly they saved themselves around $423 in taxes [($71.37 fair market value price - $51.37 purchase price) x 141 shares x 15% tax rate]. If they were higher-income taxpayers and faced the new 23.8% long-term capital gain rates, they saved themselves around $671 in taxes [($71.37 fair market value price - $51.37 purchase price) x 141 shares x 23.8% tax rate]. Those tax savings make giving appreciated securities better than cash!
• Now that Bob has $10,000 less of Home Depot stock than he might want, he can take $10,000 worth of his excess cash and purchase some new Home Depot shares. He would once again own around the same amount of Home Depot stock, and his new shares would have been purchased at around the current fair market value price of $71.37 per share. That means if Home Depot’s stock price continues to rise and he ever decides to sell the stock in the future, the gains on his new shares would only be based on stock price appreciation above his $71.37 purchase price - not the $51.37 purchase price of the shares he gave to the Salvation Army. Those potential, future tax savings could be worth something as well! (Of course, Bob could also decide not to use $10,000 of his excess cash to replace the Home Depot shares, and he could add those funds to his prudently diversified portfolio, but that’s for a different day…)

If you give charitably, I applaud you, and I hope you will keep on giving. If you currently don’t give charitably, please look after you and your family first, but I hope you will one day consider it. Either way, after today’s post, it is my goal that you now appreciate your appreciated securities a little bit more, and will consider the potential tax benefits of making stock gifting part of your charitable gifting strategy in 2013.

-Tom

Last Call

Credit: Stuart Miles

Three years ago, my wife and I bought a townhome. And, by bought, I mean took out a mortgage for a townhome. At the time, our parents and friends were high-fiving us for the interest rate we got: 4.75%. It was amazing. I mean, there was no way interest rates could get any lower, could they?

Fast-forward to the present: interest rates have gotten lower. To be honest with you, my 4.75% was actually beginning to smell a little as I have casually been comparing it to the mortgage rates that many of my clients  have been sharing with me over the past few months. The rule of thumb is that you are usually wasting your time refinancing if the refinanced interest rate is not at least 1% less than your current rate, but just as I could have never envisioned in 2010, many current interest rates have fallen more than 1% when compared to my 4.75%. Thus, my wife and I are right in the middle of doing what I have advised many clients to consider doing over the past few years: refinancing.

So, why all the fuss this week? Why not another post on what you should do after you have a kid, why you should check your engine now, or how to make sure you can survive mayhem? Because I personally think interest rates have, to quote the musical Oklahoma!, “gone (down) about as far as they can go.” Think about your checking account interest rate – it’s pretty close to 0%. Chances are that, unless you have refinanced within the last three years, current refinancing interest rates are probably worth your looking into. And you should look into them soon because the housing market is beginning to pick up a little steam, and the Federal Reserve has recently started signaling that the Fed could be thinking about scaling back their bond-buying program (many economists believe the Federal Reserve’s bond-buying program has been artificially keeping interest rates low).

If you heed my advice and look into refinancing, let me share a few tips that I think you will find helpful:

• Reach out to multiple lenders, including your current mortgage holder. The rates and fees will likely be very similar, but it’s worth talking to several lenders before you proceed as a sanity check just to make sure the particular lender you are considering is shooting straight with you. A crafty representative or two may try to pressure you by saying that “rates could change by the end of the day,” but don’t let that bother you; being thorough and comfortable is likely more important than one day’s worth of difference in rates and fees. Also, rates and fees aren’t necessarily going to get worse in 24 hours; they could improve, but not all loan representatives will mention that...
• Your current lender could offer a smoother transition than someone new, but if there is a relative tie in rates and fees, I would lean towards whoever seems the most knowledgeable and responsive, and offers the best customer service.
• Try to have some idea of what you are looking for before you call a lender. Are you looking to refinance into a 30-year mortgage? Are you looking to go from a 30-year mortgage to a 15-year mortgage? Are you planning on owning the property for the life of the loan? The more you can tell the potential lender upfront, the more specific and helpful information they will be able to quickly provide. Don’t worry though, because after you practice on potential lender #1, you will be much more comfortable when you reach out to potential lender #2!
• If it were me, I’d ask lenders for three scenarios: their lowest interest rate possible (will likely require additional money from you at closing, but gives you the best interest rate), a no-closing cost scenario (don’t let the name fool you - there will be fees, but you will likely pay less at closing and your interest rate will only be a little higher than the lowest rate), and a lowest total dollar amount scenario (kind of a happy medium between the lowest interest rate and no-closing cost scenarios where you pay a little at closing and get an interest rate between the lowest rate and the no-closing cost rate). This will likely give you three, pretty-solid options to consider as you decide what is best for your particular financial situation.
• Finally, know what you’re getting into. Refinancing can be a nuisance to the posterior, if you know what I mean, but going through the process can offer some real financial benefits. If you go forward with refinancing, you will have to provide tons of documentation, answer lots of seemingly ridiculous questions, and sign numerous forms relatively quickly. Don’t get overwhelmed, though. Take a deep breath, respond as quickly as you can, and by all means, carefully read what you are signing.

Sadly, Donna Summer’s Last Dance came to my mind as I started writing this post because I was thinking about the possibility that right now could be the last chance for many of us mortgage holders to benefit from these historically low interest rates. Have no fear though, since hearing from my soon-to-be new lender that my wife and I have been approved for a new mortgage (that’s even more favorable than the one we got in 2010), I’ve found myself humming Semisonic’s Closing Time.

What? Don’t judge. If you refinance, you might find yourself singing, too!

-Tom