If you have been considering strategies for passing some of your wealth on to heirs as tax efficiently as possible, you might want to know about an important window of opportunity for gifting. It’s available right now, but it may not be beyond 2012.

Among the many tidbits found within the December Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 are particularly favorable gift tax exemptions: an increase for lifetime tax-free gifting to $5 million/$10 million for individuals/couples, up from $1 million/$2 million. And if $5–$10 million isn’t enough, the tax rate on lifetime gifting amounts beyond that was set at 35%, rather than the scheduled 55% rate.

It’s important to note that the annual gift tax exclusion, which is separate from the aforementioned lifetime caps, remains only $13,000 per donor per year. Even so, as this helpful Wall Street Journal article notes, taken together, the new estate and gift rates are the most generous since 1931. In other words, for wealthy individuals or couples seeking gifting opportunities, there may be no time like the present for some careful planning with a knowledgeable estate tax planning team. While the favorable conditions may last beyond 2012, they may not.

Need additional advice? Give us a call. Considering and effectively implementing multi-generational wealth management strategies is core to our services.

Interested in how and where your Federal tax dollars are spent?  See http://www.whitehouse.gov/taxreceipt.  You enter your 2010 tax payments and the website provides a breakdown of (approximately) where your tax dollars are going.

One of the ways we help clients maximize their investment returns is by remaining vigilant for tax-loss harvesting opportunities during market declines. Like a silver lining in cloudy conditions, tax-loss harvesting can save you a significant amount of your own silver when the tax bills come due. On the other hand, like any good tool, in the wrong hands, it can cause harm instead of good. Let’s take a look.

An Advantageous Overview

First, what is tax-loss harvesting? It’s a technique for generating a legitimate capital loss on paper that you can use to offset current or future taxable capital gains … without actually losing the money permanently.

How does it work? Well, that’s where your fee-only financial advisor can be helpful, because the devil’s in the details. But, big picture, you sell a holding for which you’ve experienced a capital loss, temporarily purchase a similar but substantively different holding for no less than 31 days, and then buy back your original holding. After all the buying and selling dust has settled, it’s as if you never sold anything, and your investment position is unchanged. But you’ve got a legitimate capital loss you can use to reduce your capital gains taxes. (This is assuming all the trading is going on within your taxable accounts – losses in IRAs aren’t tax deductible.)

If your head’s swimming by now, an illustration might help. Imagine you hold a mutual fund of U.S. large-cap growth stocks that have been doing poorly this year, so your original $100,000 investment is now worth only $80,000 on paper. Here’s the harvest:

·         Sell the fund, and you’ve just realized a $20,000 capital loss.

·         Use the $80,000 sale proceeds to buy, say, an S&P 500 Index fund for just over a month, so you’re not out of the market entirely.

·         Hold the replacement fund for at least 31 days. When the time is up, you can sell it and buy back the original fund.

Afterward, you're still holding the same carefully selected long-term investments you had to begin with, but you've produced some income tax savings for nothing more than the cost of a couple of trades.

The “Gotchas”

Before you start running with harvesting scissors, be aware that there are some unpleasant traps for the unwary.

One trap can and should be avoided; that’s the “wash sale rule,” which the IRS uses to determine whether your tax loss is legitimate. Two main clauses of this rule dictate: (1) how long your interim period must be (thus the 31-day wait), and (2) what types of replacement holdings you can purchase during your interim period. The replacement holding can be similar, but not “substantially identical,” and believe me, there’s a fine line between these definitions. Violate the wash sale rule, and you’ve just spent good money making pointless trades, plus you’ve annoyed the IRS. That’s never a good idea!

Another trap is beyond anyone’s control: the whims of our unpredictable markets. In our illustration above, we assumed that prices for both original and replacement funds cooperated nicely by remaining level during the 31-day waiting period. In that case, you receive the full benefit of your harvesting efforts. But what if the market doesn’t play so nice? What if the value of your original fund soars over that month, while the value of the replacement fund dips? When you unwind the trade after 31 days, you could have a loss. The replacement fund must be chosen with care to maximize the chance that its performance will be similar to the original fund.

And keep in mind that if the market soars during the 31 days, when you unwind the tax-loss harvesting transaction, you may incur a nasty short-term capital gain when you sell the replacement investment and buy back your original holding. The resulting gain could wipe out the advantage of the loss, or worst-case, incur more taxes than you would have had to begin with.

Look Before You Leap

Thus it’s important to be thoroughly familiar with wash sale rules, as well as acutely aware of the level of risks involved in any particular harvest. While we’re on regular look-out for tax-loss harvesting opportunities for our clients — and this year was no exception — we certainly don’t execute them every time. First, we consider the magnitude of the opportunity in relation to its transaction costs, available investment alternatives and other factors. Only when the circumstances seem comfortably in our clients’ favor do we leap.

It’s no news that our military personnel put themselves in harm’s way every day they serve our country. Sometimes they pay the highest price in our defense. Their families pay the price too.

Now the New York Attorney General’s office alleges that insurance companies MetLife and Prudential prey on our fallen heroes’ families by holding onto the death benefits from their life insurance policies.

Most of us assume that, if we die, our life insurance policy will pay off in the form of a check delivered to our family. Instead, these insurers put the service member’s death proceeds into an interest-bearing corporate account, delivering a book of drafts (similar to checks) to the policy beneficiary. The insurer argues this arrangement is a win-win: The account pays a modest interest rate, and the beneficiary can use the drafts like checks. The insurer profits from a portion of the interest if the account stays put.

Some military families feel they have been taken advantage of at the very time when they are most vulnerable.

My bet is that the insurers are mystified as to why military families (and the New York Attorney General) are so upset. After all, the family can write a check on the balance. And it does earn interest. Where’s the beef?

The beefs are two. First, unlike most bank accounts, the insurer’s corporate accounts are not FDIC-insured. That’s a big deal if the insurer goes out of business. Second, the military families miss a tax opportunity by leaving the death proceeds in the insurance company account: For up to one year after receipt, they are entitled to put all or part of the proceeds into a Roth IRA or Coverdell education account, where the proceeds can grow tax-free to fund retirement or education.

MetLife and Prudential informed the beneficiaries that the money could be withdrawn from their accounts, but reports say that the insurers stayed mum about the right to transfer the balance to a tax-sheltered account. The insurers had no legal obligation to brief the family on the Roth IRA opportunity, but surely the families of our fallen service members deserve more consideration. I can understand why the AG is upset.

If you’re a beneficiary of one of these insurer’s accounts, what should you do? According to CPA Sheri Allshouse in Houston, if you want to contribute part or all of the proceeds to a Roth IRA but the one-year deadline has passed, it’s probably simply too late. Nevertheless, she says, there have been cases in which the IRS has shown some leniency in late transfers between Traditional IRAs and Roth IRAs. Talk with your CPA before you conclude that there’s no hope.

In addition, Houston CPA Laura Conway warns that the Roth IRA rollover is available only for life insurance proceeds from Servicemembers' Group Life Insurance (SGLI) and military death gratuity policies, both programs sponsored by the Veterans Administration. Other life insurance benefits are not eligible.

Given the tough financial times we’ve all lived through recently, you may be concerned that your account is not FDIC-insured. Two thoughts here. First, rating agency Standard & Poors assigns a relatively strong AA- rating for financial stability to both MetLife and Prudential, implying that these insurers are unlikely to go belly-up anytime soon.

But you may still prefer to have an FDIC-insured account, and if so you’ll need to transfer your balance to a bank. Be careful that you don’t go from the frying pan to the fire: With some exceptions, FDIC insurance generally covers only the first $250,000 you have at the bank. These days lots of banks aren’t nearly as financially strong as some of the major life insurance carriers, so if you transfer money to one or more banks, be sure to keep the amount at each bank under the FDIC-insured limit. You can use the FDIC’s calculator to determine exactly how much of your bank account is FDIC-insured. And remember that not all banks are members of FDIC. Click here to be sure the bank is a member.

Don’t hesitate to call on us if you have any questions or if we can help in any way.

Taxes can encourage people to make spending or investment decisions for tax reasons instead of economic reasons.  Sometimes this is intentional.  To illustrate, the excise tax on cigarettes is partly intended to discourage smoking, and it does have that effect.  But many taxes have unintended economic effects.  For example, while income from an employer is subject to income tax, most employer healthcare benefits are not.  This may encourage employers to give raises in the form of healthcare benefits.  One solution:  tax employer healthcare benefits.  I’m not a big fan of taxes, but this is one that would make sense.