This year, we’re spending our time either congratulating our clients for sticking it out when the market goes up or reminding our clients to keep a long-term perspective when the market goes down. And, in between all of the hand holding, we’re dealing changing tax laws! So, why would I suggest that this might be the time to consider donor advised funds?
Our clients are potentially facing higher taxable income this year because of Roth IRA conversions. Even if we’re harvesting tax losses, only $3,000 can be used to offset conversion income. Coming up with additional deductions might be helpful, but might also lead to Alternative Minimum Tax. How can we help our clients lower their tax bills? A donor advised fund (DAF) may be the answer.
A DAF works like a “charitable IRA.” The donor contributes cash or appreciated securities to the fund and receives an immediate charitable deduction equal to the fair market value of the contribution. The fund can invest the proceeds, which can earn income on a tax-free basis. The donor can then recommend grants from the fund to pay out to qualified charitable organizations. The benefits of a DAF are many:
•Immediate tax deduction upon contribution to the DAF
•Tax-free earnings within the DAF
•A pool from which the donor can make contributions currently or in the future
Establishing and making significant DAF contributions this year can offset Roth conversion income. And, better yet, charitable contributions are not subject to Alternative Minimum Tax! If you have a client that normally makes charitable donations and is in a high tax bracket this year (because of Roth conversion income), recommending a DAF could make you a hero! You might even be a super-hero if your client has appreciated securities to donate!
It seems that we're hearing about the fiscal cliff every day. Is disaster looming? Should our clients worry? Should we, as advisors, be concerned?
Anything that is covered by the media ad nauseum needs to be addressed. But, first, we need to understand what it is! The fiscal cliff refers to the potentially disastrous impact on the economy due to scheduled tax law changes combined with spending cuts required by the debt ceiling compromise in 2011. Higher taxes and reduced government spending would significantly cut the deficit, but could also cause a major slowdown at a time when the economy is already on shaky ground.
The fiscal cliff can be largely avoided if Congress can agree on limited tax increases and cuts in spending. Based on recent history, it is hard to imagine the two opposing parties agreeing on anything. However, times have changed. Compromise might be possible now that with the election behind us and neither side wants to take blame. However, a bi-partisan solution might be logistically impossible before year end. A retroactive decision occuring early 2013 is more likely.
So, how can we prepare? Our clients are nervous about the stock market and taxes. Communicating with clients is imperative - even if you only repeat the standard "stay the course" advice.
No matter what Congress decides to do, we can count on taxes going up. Congressional inaction will result in the expiration of the Bush tax cuts along with the Obamacare tax increases. Even with a compromise, tax hikes will certainly be a realtime and we can expect ordinary tax rates to increase for the wealthy, higher taxes to apply to investment income and capital gain rates to bump up for all.
The bottom line is that advisors need to pay attention to taxes more than ever. I am not a proponent of accelerating capital gains into 2012 - unless the client has a significant one-time gain, such as the sale of a business. It will be important to harvest tax losses on an ongoing basis, pay attention to location optimization (putting income-producing investments in IRAs and appreciating assets in taxable accounts), choose high cost tax lots on sales, and look at greater allocations to municipal bonds. Although permanent tax reduction is best, postponing taxes is a worthwhile goal. To the extent clients hold appreciated assets at death, the step-up will eliminate any tax.
The complexity of implementing and coordinating all of these strategies when managing hundreds of portfolios is difficult at best. To truly meet the ever-expanding needs of clients, automated portfolio management is essential. Just as CPAs no longer attempt to prepare tax returns by hand, advisors must embrace software. Rebalancing software's ability to rebalance at the household level, minimize numbers of transactions, avoid redemption fees, avoid short-term gains, automatically consider location optimization, and harvest tax losses instantaneously, will result in lower taxes for clients, greater efficiency for advisors and the elimination of trade errors.
Clients are becoming more educated and more demanding. To successfully compete and serve clients well, advisors must make tax considerations a material part of portfolio management.
The 3.8% surtax is likely to add selling pressure in the stock market in the near-term and make life insurance and annuities more popular for the long-term. Those were just two of the emerging trends that will be reshaping the wealth management landscape for high-net-worth individuals in the months ahead, according to comments at a webinar last Friday by tax expert Robert Keebler.
Attendance was strong at the webinar, indicating that advisors know that the new surtax — part of the health care law that the U.S. Supreme Court upheld on June 29 — is going to play an important role in wealth management in the months ahead. However, Keebler’s assessment included some surprising twists, including a prediction that life permanent life insurance and annuities will return to popularity to shield income.
Keebler also said that avoiding paying the surtax on investment income could cause investors to sell assets with big gains. With the stock market rising 100% since its low during the global financial crisis, that could add selling pressure in the stock market.
Keebler received an amazing 4.67 score from attendees (on a five-point scale) and their comments are below.
Very helpful. Great topic. One of the best ones I've seen lately
Very helpful and timely, great examples
Should provide slides
Helpful but a lot of information; would like to have the slides.
Very well done. Made a confusing topic much more understandable.
Numerous sound problems!
Good detailed information
Interesting insight on a new planning subject.
Very valuable...wish there had been more time!
Dry topic, good presentation though.
Good information on a very timely topic.
As usual, Bob Keebler has added a better (detailed) understanding of a very complex tax topic that will (unfortunately) be a part of most of our clients' future financial reality. His ideas on how to help mitigate this surtax has already got me thinking in new directions to now approach with my clients. VERY GOOD STUFF!
I really enjoyed it, thought it was very informative
Excellent discussion of the mechanics of the tax and strategies for dealing with it.
A little hard to follow.
Great topic, info.
Overall very good
I need to watch it in your archive about three more times to understand it.
It was very well done, congratulations on collaborating with Bob, A REAL PROFESSIONAL.
Fabulous job once again Bob! Thank you to you and Andy.
I would have liked it to be longer for more Q and A.
Very good. Thanks for the timely subject
Great to see the examples. They clarify the confusing part of the requirements.
Good, nice use of examples, got kind of rushed at the end.
Good info on a new delightful subject!
Excellent and very timely.
GREAT information and sale ideas
Great information that is critical to be aware of.
Tough topic - presented very well
Chock full of information.
Good info, but went way too fast. Too many details glossed over
Very timely and informative
Robert is fantastic!
Good information, but should provide slides. Felt like an exam review much of the time, but concept was solid
Very helpful in understanding the surtaxes. Do you know of anyone that has created a calculator to assess if the surtax is applicable and subsequently the extra tax that will have to be paid due to the surtax?
Information overload. Perhaps you break this one into two segments
Reminder: 60-Day Rollover Not Available To Inherited IRAs
Friday, July 27, 2012 18:51
A recent summary decision by the U.S. Tax Court serves as a reminder that inherited IRAs are not allowed the 60-day rollover period. Instead, once funds have left an inherited IRA, they cannot be placed back in, and they become subject to ordinary income tax.
In Beech v. Commissioner (T.C. Summary Opinion 2012-74), Mrs. Beech inherited a Citi Smith Barney IRA from her mother in 2008. Citi Smith Barney subsequently made death benefit distributions to Mrs. Beech. At the time, Mrs. Beech established an inherited traditional IRA with American Funds and deposited the death benefit distribution into the inherited traditional IRA. Such death benefit distribution amount was not reported as taxable income on Mr. and Mrs. Beech’s tax return. The IRS issued Mr. and Mrs. Beech a notice of deficiency indicating that all of the retirement income Mr. and Mrs. Beech reported on their 2008 return was taxable income.
While IRC Section 408 provides that a distribution is not includible in gross income if the entire amount of the distribution is paid into an IRA for the benefit of that individual within 60 days of the distribution, such provision is not applicable to inherited IRAs. According, the Court ruled against the Beeches and the death benefit distribution was taxable income for 2008.
This is an issue that we unfortunately see all too often. Taxpayers request or are sent a distribution check from an inherited IRA, not knowing that such amounts cannot be placed back into an inherited IRA. Once the funds have left the IRA wrapper, they are taxable. A taxpayer is not treated as having received a taxable distribution from an IRA, however, if funds in the IRA are transferred from one account trustee directly. As highlighted in the Beech case, handling an inherited IRA incorrectly can lead to immediate taxation of the entire IRA, while a prudent decision can result in a significantly larger tax deferral for the beneficiaries. Accordingly, funds from an inherited IRA should only be moved via trustee-to-trustee transfers.