Wise Bread (Mark P. Cussen)

An Inheritor’s trust can solve many estate planning problems

Mark P. Cussen — Fri, 18 Apr 2008 03:33:14 +0000

A large number of wealthy Americans today are worried about what will happen to their estates after they are gone. Although many different types of trusts have been designed to help alleviate this problem, a new type of trust, called the “inheritor’s trust” has a level of flexibility that is unmatched by other estate planning vehicles. This type of trust is a dynastic trust, similar to many other types of dynastic trusts, except that this trust is a “stand alone” trust that allows for changes in investment strategies, as long as the beneficiary is willing to discuss the situation with his or her grantors.

This type of trust can provide substantial benefits for those seeking long-term, multigenerational planning, such as the type designed to avoid the generation-skipping transfer tax. It can also protect against divorce, creditors and estate taxes. Any parent that is currently gifting assets to their children on any kind of regular basis should seriously consider establishing one of these trusts. The key difference between this type of trust and other trusts is that the beneficiaries must be willing to talk openly with their grantors regarding how they want the money invested or handled.

In order to establish an inheritor’s trust, an empty, irrevocable dynasty trust must be established first. The inheritor is more often than not the trustee, and must usually choose a close friend or confidant to be the distribution trustee. This trustee has absolute control over what kind of distributions is made from income and principal. However, this transference to a third-party trustee is exactly what makes the assets of the trust so secure from creditors. Beneficiaries have absolutely no legal right to force any kind of distribution from the trust, which renders creditors unable to force any type of distribution from the trust as well. It is important to select the correct state to create the trust in, as the validity of these trusts will vary according to state law.

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Be sure you qualify for the home-sale exclusion before you sell

Mark P. Cussen — Thu, 17 Apr 2008 21:28:16 +0000

By Mark P. Cussen

In 1997, American homeowners received one of the largest tax breaks in U.S. history. The Taxpayer Relief Act granted homeowners the privilege of excluding the gain on the sale of their homes within broad limits. The old rules merely allowed homeowners over the age of 55 to defer the gain on the sale of their homes by rolling it into the purchase of a new residence. Furthermore, this deferral was only available once per homeowner. But the new law has effectively swept those limitations away. Now homeowners who qualify can use this exclusion again and again. Obviously, this act has saved countless homeowners thousands of dollars in taxes, and also provided a real shot in the arm to the real estate industry.

But there are certain provisions that must be met in order to qualify for this special exclusion. The first condition is simply that the house being sold must be your primary residence, and not a vacation home or rental property. This condition is actually broken down into two parts:

1. The ownership test- the sellers must have owned the residence for two out of the last five years prior to the sale of the residence. For example, if the sellers rented the house for four years and then bought it a year before the sale, then they do not qualify for the exclusion.

2. The use test - the sellers must have actually lived in the residence for at least two out of the previous five years prior to the date of the sale. The two years do not have to be contiguous; they can be chronologically broken up in any way, as long as the total time spent in the residence is equal to at least two years.

Furthermore, the actual amount of the exclusion does have a limit. Single taxpayers can exclude up to $250,000 on the gain of their residences, while joint filers can exclude twice that amount, up to $500,000. But this money does not have to be used to purchase another residence; it can now be used for whatever the seller wishes. About the only other real limitation for this exclusion is that it can only be used by taxpayers once every two years.

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Try Brokered CDs for Higher Rates

Mark P. Cussen — Wed, 09 Apr 2008 18:56:52 +0000

By Mark P. Cussen

Thanks to the FDIC, millions of Americans are able to sleep peacefully at night, knowing that their savings are protected by government-backed insurance. Since the thirties, certificates of deposit have become synonymous with safety of principal. Bank customers who shop for CDs concern themselves only with the rates and terms that are available.

Unfortunately, the safety that comes with FDIC insurance comes with a price. Will Rogers once said, “It’s not the return on my money that concerns me, it’s the return of my money.” This famous saying exemplifies the attitude of many bank customers. While CDs are among the safest types of investments available, their rate of return is correspondingly low. If interest rates are around 5%, then that is about what you can expect a short term CD to pay. While longer term and jumbo CDs can pay slightly more, it is very difficult to see much real growth from them over time.

However, there is another option available for those seeking higher rates on their guaranteed investments. Unbeknownst to many CD buyers, many brokerage and investment firms offer CDs that are every bit as safe and secure as those found in banks. While these CDs do differ from their cousins in the banking system in some respects, they are still FDIC insured up to $100,000 per CD owner. Furthermore, this type of CD generally pays a higher rate than bank CDs, and they often contain other features, such as put or call options that allow either the buyer or the issuer to redeem the certificate prematurely without penalty. For example, a brokered CD with a 20-year maturity could be “puttable” at a premium, such as $105, after five years, if the buyer so desires. That means that five years from now, if rates have gone up and the buyer wishes to move the money in this CD to another one, then he or she will receive $1,050 in return for each thousand dollars that was originally invested. Therefore, a $100,000 CD holder will see a return of $105,000 on the principal-in addition to the five years of interest the holder received. Call features give the issuer the same privilege. Brokered CDs can also be bought and sold in the secondary market like any other type of bond. However, the FDIC guarantee will only apply for investors that either hold their certificates to maturity or redeem them in a put or call transaction. If the certificate is sold prematurely in the secondary market, then the owner may receive more or less than his original investment, depending on market conditions. But those who hold their CDs to maturity or call will be safe.

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Rising bank fees are costing you-big time

Mark P. Cussen — Tue, 08 Apr 2008 21:46:59 +0000

By Mark P. Cussen

Have you had to pay a bounced-check charge lately? Have you noticed that the fee for this is much higher than it used to be? Have you also noticed that your bank is no longer providing many courtesy services that it used to? If so, you’re not alone. Millions of Americans are paying higher fees across the board at their local banks, in the form of higher credit card rates, ATM and cash advance fees, and even fees for deposit slips or to talk to a teller.

A recent study conducted by the U.S. Public Research Interest Group of over 500 banks and 40 credit unions showed that customers who failed to meet monthly minimum deposit requirements paid an average of $228 per year in underlimit fees. The average fees collected were $266 at large banks, $191 at small banks and $101 at credit unions. (In all fairness, the study did also show that the percentage of banks that offered totally free checking had increased from 17.5% in 1999 to 29% in 2005.

Credit and debit card fees are also increasing. When you draw money out of another bank’s ATM, the fees for this are now often half-again as much as they were even a few years ago, both from the bank being drawn on and the bank of the ATM machine. Cash advance fees from credit cards are also increasing, both in dollar amount and percentagewise. Other miscellaneous services, such as balance-transfer fees, foreign exchange fees and even account research fees also cost more than they used to. If you need a copy of a check or past statement, a fee of $5 or even $10 can be assessed to you.

Fortunately, there are several alternatives available for those who wish to avoid these fees. Internet banking is starting to make its presence felt. A full range of FDIC insured bank products is now available online, and the lower overhead required from these online institutions usually translates into higher rates and lower fees for its customers (check out www.everbank.com). Many brokerage and investment firms also offer checking and money market accounts with free features such as automatic bill pay and other banking services.

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Should Your Life Insurance Beneficiaries Be Revocable?

Mark P. Cussen — Mon, 07 Apr 2008 06:11:27 +0000

By Mark P. Cussen

For millions of Americans, life insurance provides protection, access to tax-free emergency funds and other benefits as well. But policyowners are often unaware of the rules pertaining to the designation of their beneficiaries. These designations can be either revocable or irrevocable, and the ramifications of both choices need to be understood.

In most cases, the standard beneficiary option is going to be revocable, because most policyowners want the option of being able to change who they name as beneficiary if they desire. This obviously allows for flexibility in estate planning, and can also provide leverage to policyowners with unreliable beneficiaries, as it allows the insured to effectively disinherit the beneficiary if he or she becomes unreliable. This leaves the beneficiary without any tangible rights or interests in the policy, only the future expectancy of receiving the policy proceeds. Only upon the death of the insured does the beneficiary’s interest become tangible.

Generally, there are three situations where irrevocable life insurance beneficiaries are elected by the insured. The first instance pertains to estate planning, where making an irrevocable beneficiary election will reduce the value of the policyowner’s taxable estate by the amount of the policy death benefit. Business buy-sell agreements constitute another use of this practice. In this situation, each partner in the business must have the assurance of the other partners that they will be privy to the appropriate portion of the deceased partner’s death benefit proceeds. The receipt of these proceeds will then allow them to buy a proportional share of the deceased partner’s interest in the business. The final instance where irrevocable election of a life insurance policy may be appropriate is to satisfy creditors, who may not be willing to extend credit to the policyowner without assurance of repayment in the event of the policyowner’s death. For example, a lending institution may not be willing to make a loan to a small business owner unless he or she is willing to take out a life insurance policy that irrevocably names the lender as the beneficiary. This assures the lender that they will recoup their loan proceeds upon the death of the policyowner.

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Bonded life settlements give policyholders new options

Mark P. Cussen — Mon, 07 Apr 2008 05:25:31 +0000

By Mark P. Cussen

Several years ago, life insurance policyowners began to hear about a new kind of product called viaticals. These arrangements had several disadvantages and received much bad publicity in the media. Then a new generation of life insurance settlements came along and, while considered to be better than viaticals, still were eyed dubiously by much of the investing public.

But there is now a new kind of bonded life settlement that may be simpler and more profitable than its predecessors are. This settlement involves three separate parties: the insured, the investor and a bonding and reinsurance company. This type of transaction begins with an insured over the age of 65 whom has a large permanent or convertible term life policy. If the insured no longer wants or needs the policy and would prefer to receive cash instead, then a bonded settlement may be the best possible alternative. An agent or broker will then pair the insured with an investor and a reinsurance company. The investor will make a lump-sum investment, such as $500,000, of which $400,000 may go to the insured, and $50,000 will go to both the agent and the reinsurance company.

One of the primary benefits of this arrangement is that the insured will most likely receive more cash this way than would be possible by simply accessing the policy’s cash value. But the investor also wins in this scenario, because he or she will be guaranteed payment of the policy’s death benefit. The reinsurance company will do a medical evaluation of the insured and make an actuarially based estimate of his or her remaining lifespan. Then, once the investor has made the initial investment, the insured signs the policy over to the company, which will initially receive the face value upon the death of the insured. However, the company will guarantee payment of the full death benefit to the investor by the estimated date of death, regardless of whether the insured is still living. Therefore, the investor does not have to wait for the insured to die in order to receive his or her return on capital. For example, if the reinsurance company estimates that the insured will live for another 7 years, then it will guarantee payment of the full death benefit to the investor at that time, even if the insured lives for another 10 years. The company will, of course, guarantee this payment by purchasing a bond on the policy for protection. Therefore, all parties are effectively guaranteed to receive their portion of the transaction with no risk to anyone.

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An Introduction to Unit Investment Trusts

Mark P. Cussen — Mon, 28 Jan 2008 23:37:53 +0000

By Mark P. Cussen

For millions of investors looking for higher returns and portfolio diversification, there is no better investment than a mutual fund. Their combination of professional management, liquidity and reduced volatility makes them ideal vehicles for virtually any type of investment objective. However, some investors follow simpler investment strategies that do not require active portfolio management, and are therefore unwilling to pay the high sales charges and ongoing management fees assessed by many funds.

Fortunately, there is an alternative for those in this category. Unit investment trusts (UITs) provide diversification similar to mutual funds, but without the internal portfolio turnover. A unit investment trust is simply a set portfolio of securities that have been selected according to either a specific set of characteristics or perhaps a specific investment strategy. Each unit of the trust represents an undivided interest in each of the securities held within the trust. Each trust will hold the securities for a set term and then mature. Upon maturity, the securities in the trust are reset according to the trust’s objective if necessary. The process is then repeated.

One of the most common examples of this is the “Dogs of the Dow” strategy. The ten highest dividend-yielding stocks from the Dow Jones index are purchased within the UIT and held for 13 months. Then the stocks within the trust are readjusted according to this strategy, and a new trust is issued for another 13 months.

Because they are not actively managed, UITs do not generate capital gains or losses of any kind, except at maturity. Gains and/or losses realized from UITs will virtually always be long-term, assuming that the term of the trust is more than a year (I personally have never seen one with a shorter term.) They can pass through interest and dividends periodically, depending upon the investment objective of the trust. Like mutual funds, there are many different types of UITs that meet various investment objectives, such as growth, income, or sector exposure.

UITs also generally cost less to invest in than actively managed investments. Although most UITs do have a nominal sales charge, they generally have no annual expense fees of any kind, due to their passive management. Even their initial fees tend to be fairly low. Many of the trusts that follow the “Dogs of the Dow” strategy have an entrance fee of around 1%. To find out more about UITs, consult your financial advisor.

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Beware of Taxable Social Security Income

Mark P. Cussen — Mon, 28 Jan 2008 21:42:04 +0000

By Mark P. Cussen

Retired taxpayers who begin taking distributions from their retirement accounts often discover that a portion of their Social Security income has suddenly become taxable. Filers who have realized substantial capital gains or converted their retirement assets to Roth IRAs must be prepared for the additional tax of their Social Security income above and beyond what they will pay for their other transactions.

When Social Security began back in the thirties, it was originally slated as tax-free income. However, over the years Congress has enacted legislation that has eroded this tax-free status. The general parameters for the current taxation of social security are broken down as follows:

Income levels requiring taxation of social security income:

Single	$25,000 - $34,000
Married Filing Jointly	$32,000 - $44,000

Once your income respective to your filing status reaches these levels, then 50 to 85 percent of your Social Security income can become taxable. This can quickly have a substantial impact upon your tax return, as many Americans receive up to $25,000 of social security benefits per year. Furthermore, very few recipients have any tax withheld from this income, as most believe that they will not be taxed on it. But even a modest pension income can make a large amount of your social security benefits taxable.

For example, if you are single and you draw $15,000 a year from a company pension, and you also receive $16,500 in social security benefits, then that will effectively subject close to 85% of your benefits to taxation. Mathematically, that comes out to around $14,000, resulting in a possible tax bill somewhere between $1,400- $2,000. And, of course, if you have additional investment income of any kind from bonds, CDs or mutual funds, then that will increase your taxable Social Security income as well.

The good news is that, for many Americans, there are ways to either eliminate or greatly reduce their tax bills. One of the key methods to achieving this is by moving taxable income-producing assets into tax-deferred vehicles such as fixed annuities. This effectively allows the taxpayer to only pay tax on the actual taxable portion of each distribution, and not on the interest that is still compounding within the annuity. With taxable CDs or other fixed income investments, all interest is taxable, whether it is paid out or not. This income can therefore also increase the taxation on your social security benefits.

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Exchange-Traded Funds Provide a More Liquid Form of Diversification

Mark P. Cussen — Sun, 27 Jan 2008 23:22:23 +0000

By Mark P. Cussen

Over the last few years, a new breed of mutual fund has become available to investors seeking liquidity and lower costs. These funds, called exchange-traded funds (ETFs), trade on the major exchanges and behave just like stocks, except that they offer the same type of diversification and professional management available in traditional funds. Over 350 different exchange-traded funds are now available, and the number is continuing to grow.

These funds can be useful for investors seeking to reap capital losses at year-end. For example, assume that you have stock in a certain technology company. The stock price has dropped precipitously since you got in, but you feel that this is only temporary. However, you would like to realize a capital loss on the stock while it is trading in its current range. But you must watch out for the “wash sale” rule as dictated by the IRS prohibits the repurchase of any stock sold for a loss for at least 31 days following the sale. Therefore, an ideal solution could be to sell the stock and buy shares of the appropriate corresponding exchange-traded technology fund. Even if this fund actually has your former stock as one of its core holdings, it is still considered a separate security by the IRS and the SEC. Therefore the wash sale rules will not apply.

Furthermore, you now have diversification within the technology sector, while retaining the same liquidity as before. Since numerous studies have shown that the majority of return on equity is due to asset class as opposed to individual stock selection, it is possible that you will realize a similar rate of growth from your new fund holding while reducing your overall risk. The proliferation of exchange-traded funds now allows you to realize a loss with one fund and then jump into another if you desire.

And when should you swap? The obvious answer is when you have capital gains or other income that you would like to declare a loss against. A loss can be declared against the amount of any gain received, plus $3,000 of ordinary income per year.

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Deduct Those Home Office Expenses

Mark P. Cussen — Mon, 21 Jan 2008 18:32:06 +0000

By Mark P. Cussen

More and more employers are now allowing their employees to work from the comfort of their own homes. While this is convenient for many workers, it also allows them to take a tax deduction for their home office expenses. This article will examine the specific costs that count as home office expenses, as well as the criteria that must be met in order to deduct them.

Exclusively and regularly used for business?

The first question that must be asked about any home office in order for it's expenses to be deductible is, is the workspace used exclusively and regularly for business? The answer to both of these questions must be yes before any deduction can be taken.

If the workspace is used for both business and personal use, then it is not deductible. Furthermore, the space must be used on a regular basis for business purposes; a space that is used only a few times a year will not be considered a home office by the IRS, even if the space is not used for anything else.

These criteria will effectively disqualify many filers who try to claim this deduction but are unable to substantiate regular and exclusive home office use. It should be noted that it is not necessary to partition off the workspace in order to deduct it (although this may be helpful in the event you are audited.) A simple desk in the corner of a room can qualify as a workspace, provided you count only a reasonable amount of space around the desk when computing square footage.

An exception to the exclusive-use test applies to filers who provide day-care services for children or any type of adult dependents. In this case, the exclusive use test is applied differently, because obviously those receiving care are only there during the day. Therefore home daycare expenses are computed by apportioning out not only the square-footage of the home versus the area used for daycare but also the number of hours the area is used for daycare versus the number of hours in the year (8,760). Utility rooms such as laundry and storage rooms may be deductible under certain conditions as well.

For your employer's convenience?

The second major test that must be met is whether your home office is solely for your convenience or the convenience of your employer. If your employer has provided a place for you to do business at its own location, then you cannot simply set up a home office for your own convenience and deduct its expenses. Your employer has to decide that you must work from home before your expenses become deductible.

There cannot be an alternative location available, at least on a regular, continuous basis. Both employees and independent contractors may have to prove this to the IRS via expense receipts and/or documentation from their employers stating that there is no workplace provided to them outside their homes.

Finally, filers with more than one home-based business must take care when claiming the home office deduction, because each of their different lines of business must meet the above criteria, on a standalone basis. If one line fails, then all others fail as well. It's an all-or-nothing proposition.

Calculating your deductions

Once all of the above conditions have been met, IRS form 8829 must be completed in order to compute the actual amount of deductible home-office expenses.

The first step in computing expenses is to determine the amount of square footage of the workplace and divide that by the total square footage of the home. For example, if your home office is a 15’ by 15’ room, and your home has a total of 1,600 square feet, then you will divide 225 by 1,600 to get 0.14. This decimal represents the percentage of your total home expenses that can be allocated toward the home office deduction.

Then you must list all of the expenses that pertain to your entire home, such as mortgage interest, real estate taxes, insurance, utilities and depreciation for the year under the section titled “indirect expenses” of form 8829. Expenses that are incurred solely for the benefit of the office space are then listed under the “direct expense” section of the form. The indirect expenses are totaled and multiplied by the percentage derived earlier, while the direct expenses are also totaled and added to the indirect expenses.

A final test that must be met here is the income test, which mandates that the total deductible expenses cannot exceed the income derived from the business for which the deductions have been taken. For example, if total deductions come to $1,200 and only $950 of income has been earned from the business, then only $950 of deductions can be taken for that year. However, the remainder can be carried forward to a future year and deducted when business income exceeds expenses. (NOTE: this summary of how expenses are calculated is only intended as an overview: for complete instructions on this matter, see the instructions for form 8829 on the IRS website at www.irs.gov.)

This final number is then carried to either the Schedule C for self-employed filers or form 2106 and then to Schedule A for employees. The latter group must also be able to itemize deductions, and then home office deductions are aggregated with all other unreimbursed employee expenses and must exceed a 2% AGI threshold in order to be deductible.

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