For income-seekers, municipal bonds may be worth a look Is college right around the corner? Making the best of a capital loss Choose the beneficiary of your retirement plan carefully Taxing the Travel Squad
For income-seekers, municipal bonds may be worth a look Municipal bonds (often referred to as “munis”) can be attractive to income-seeking investors because they provide an income stream exempt from federal and, in certain cases, state and local income taxes. Like other fixed-income investments, munis involve risk. But as part of a broadly diversified portfolio, they can offer you an effective way to increase your after-tax earnings.
Invest in state and local projects
Municipal bonds are debt securities issued by state and local governments — or entities on their behalf — to generate funds for various public needs. Examples include toll roads, schools and hospitals, as well as general use bonds of cities, counties and states. For investors, the main selling point of munis is that their income is exempt from federal income taxes. What’s more, if you live in the state in which the bonds are issued — or if you buy bonds issued by U.S. territories, such as Puerto Rico or Guam — the securities’ interest payments may also be exempt from state and local taxes. One federal exception is that not all municipal bond income is exempt from the alternative minimum tax.
Beneficial for affluent investors Municipal bonds may be appropriate for investors looking to manage their tax exposure and traditionally have been of greatest use for upper-income taxpayers. In general, the higher your combined federal, state and local income tax rate, the more valuable munis become. (See “Comparing apples to apples” on page 3.) Consider that the top federal income tax rate is 39.6% and high-net-worth individuals face an
additional 3.8% Medicare tax on net investment income. The bite is even greater for residents of high-tax states. In California, for example, the top state tax bracket is now 13.3%, meaning that, for every dollar earned over $1 million, you’d potentially face a combined income tax rate of more than 55%.
Consider the risks As with any fixed-income product, municipal bonds are vulnerable to rising interest rates. Investors saw this first hand in the spring and summer of 2013, when munis across the board experienced big price declines. However, these recent declines followed several years of gains thanks to historically low interest rates.
Comparing apples to apples Because they’re tax-free, municipal bonds generally offer lower yields than comparable taxable bonds. That said, when you consider how taxes affect municipal vs. taxable bonds, you may find that municipal bonds provide the better deal. To compare taxable and tax-free bonds, calculate the latter’s tax-equivalent, or before-tax, yield by dividing the tax-free yield by 1 minus your tax rate. For example, let’s say your municipal bond fund has a tax-exempt yield of 4%, and you’re comparing it to a taxable fund yielding 5.75%. If you’re in the top federal tax bracket of 39.6%, you’d have a before-tax yield of 6.62% — well above the 5.75% provided by the taxable fund. (Bear in mind that this doesn’t consider state and local taxes or the 3.8% net investment income tax.) But what if you’re in the 25% federal tax bracket? In this case, your tax-equivalent yield would be 5.33%, making taxable bonds your more attractive option. The takeaway? Your tax rate matters significantly when you decide whether tax-free investments make sense for you. Municipal bonds also face credit risk — the risk that a bond issuer won’t be able to repay its debts. Even the mere idea of a default can cause bond prices to drop. Last year, widely publicized credit problems, such as Detroit’s bankruptcy filing and Puerto Rico’s credit rating downgrade, weighed on nearly the entire municipal bond market. Even securities that seemed highly creditworthy lost value, because investors were worried about the potential for additional bad news.
Although credit risk is a real challenge — especially when dealing with lower-rated municipal bonds — it’s worth noting that munis have historically defaulted much less than comparable corporate bonds. According to credit rating agency Moody’s Investor Service, just 0.13% of municipal bond issuers defaulted on their debt between 1970 and 2012, compared to 11.17% of corporate bond issuers. And for bonds rated Aaa and Aa — the
This doesn’t mean that corporate bonds are necessarily a worse investment. Many corporate bonds offer higher yields as compensation for the increased default potential and higher taxes. But it does suggest that the credit challenges faced by a few states and municipalities in recent years aren’t necessarily representative of the risks involved with tax-exempt debt.
Individual bonds vs. mutual funds Even though you can buy individual bonds directly from municipal issuers, most investors find it more efficient to gain exposure to this asset class through mutual funds. The latter provide a few significant advantages — for example, they’re more liquid and generally provide better diversification than most investors can achieve on their own buying individual bonds. Your financial advisor can be a valuable resource as you determine whether municipal bonds make sense for your situation and, if so, how best to incorporate them into your portfolio. n
Municipal bonds may be appropriate for investors looking to manage their tax exposure.
top two credit ratings — just 0.01% of municipal bond issuers defaulted during that time, compared to 1.34% of similarly rated corporate bonds.
Is college right around the corner? How to prepare your finances for big expenses If your children are teenagers, you’ll likely be facing big college bills in the near future. If you’ve been diligently saving for these costs over the years, you may be in the enviable position of being able to maintain your lifestyle while writing tuition checks. But what if you aren’t so prepared? After all, when you consider tuition, room and board, travel, and other expenses, even affluent families can start to feel the pinch. Although there’s no substitute for a head start on college savings, there are several options to consider when it comes to meeting college costs head on.
Research scholarship opportunities
The best way to pay for college is with someone else’s money. Whether for academic success, athletic ability or community service, every
dollar your child receives in scholarships is a dollar you won’t have to pay out of pocket. Of course, receiving scholarships requires not only significant achievement — that’s up to your child — but also significant research time and effort. The good news is that millions of dollars’ worth of private scholarship funds are available. Your child’s school may provide assistance, and online search tools such as Fastweb.com can help match your child to other appropriate scholarships.
Save taxes where you can Implementing tax-saving strategies can help you accomplish some of your college funding goals. If you’re self-employed, for example, consider hiring your child part time. It’s a win-win-win situation — you can deduct your child’s wages
(lowering your taxable income), get help with your business needs and provide some spending money for college. Another option is to make annual gifts to your children. You can gift up to $14,000 per year per child ($28,000 for married couples splitting gifts) free of gift taxes and without tapping your lifetime exemption. With this strategy, you can reduce your taxable income as well as your taxable estate. But think twice about this strategy if your child is hoping to qualify for financial aid, because children’s assets are more heavily weighted in colleges’ financial aid decisions.
as a 529 plan, albeit at some additional risk. Ask your financial advisor about this strategy.
Remember retirement With college expenses looming, it’s easy to lose sight of the need to save for retirement. As you consider how to balance these two important objectives, keep this in mind: While your child may have access to private or public student loans, no one will step in later to cover your retirement expenses.
As your child approaches college age, it’s generally prudent to shift a portion of your portfolio into conservative investments that tend to retain more of their value.
Adjust your portfolio As your child approaches college age, it’s generally prudent to shift a portion of your portfolio into conservative investments that tend to retain more of their value. That way, an unexpected shift in market conditions will be less likely to pose a major financial challenge to you at just the wrong time. If you’re fortunate enough to have greater-thanaverage financial flexibility, you may be able to handle the risk of an equity-heavy portfolio for longer. This strategy allows your assets additional time to grow tax-free — assuming your savings are held in a tax-advantaged vehicle, such
No time like the present Even if you haven’t been disciplined about saving for your children’s college education costs, it’s never too late. Because college attendance generally takes place over four or more years, you can continue to address your financial needs even after your children have started their education. The most important thing is to get started, saving what you can, as soon as you can. n
Depending on whether you have a “glass half empty” or “glass half full” mindset, you might consider incurring a capital loss to be an unfortunate part of investing or an opportunity to lower tax liability and reposition your portfolio, respectively. While no investor wishes to
experience a capital loss, being able to save some taxes can ease the sting.
On the bright side A capital loss occurs when you sell a security for less than your “basis,” generally the original
Making the best of a capital loss
purchase price. You can use capital losses to offset any capital gains you realize in that same tax year, even if one is short term and the other is long term. When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately) and carry the remainder forward to future years until it’s used up.
company’s chief competitor is more attractively valued and has better growth prospects. Your solution is now simple and straightforward — you simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you’ve added to your portfolio a stock you believe has more potential or less risk.
In with the new, out with the old Years ago, investors realized it was often beneficial to sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses in situations where an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.
Waiting 30 days to repurchase a security you’ve sold might be fine in some situations, but there may be times when you’d rather not be forced to sit on the sidelines for a month. Likewise, you might hesitate to double up on a position in which you have a loss and then wait 31 days to sell the original stake — a strategy that also avoids a wash sale violation because the purchase occurs more than 30 days before the sale.
If you purchased shares of a security at different times, give some thought to which lot can be sold most advantageously.
The same strategy can be applied to mutual funds. In that case, your financial advisor can help you identify a mutual fund or exchangetraded fund with a similar investment sector, strategy and size.
Advantageous times Fortunately, there may be another alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Let’s assume you own stock in a networking equipment company that has lost value since you purchased it. After researching the industry, you discover that the
If you purchased shares of a security at different times, give some thought to which lot can be sold most advantageously. The IRS allows investors to choose among several methods of designating lots when selling securities, and those methods sometimes produce radically different results.
If you’re buying mutual funds, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability. At the same time, bear in mind that prior dividends paid and reinvested in mutual funds you own were taxed, and therefore increase your tax basis in the fund.
Seek professional advice Given the volatile financial markets of the past few years, investors know that sometimes they must sell securities that are worth less than when they purchased them. If you incur a capital loss, discuss with your financial advisor your options to use it to reduce your taxes and reposition your portfolio. Your advisor can help determine if the tax strategies discussed make sense for you. n
Choose the beneficiary of your retirement plan carefully If you’ve been fortunate enough to live into your golden years without tapping much or any of your retirement savings beyond required minimum distributions (RMDs), you have the opportunity to share perhaps considerable tax-deferred (or, in the case of Roth accounts, tax-free) wealth with a family member on your death. However, it’s important to understand how the beneficiary you choose to inherit your IRA, 401(k) plan or other retirement account can affect the income and estate tax consequences. For non-Roth accounts, there are three factors to consider that can affect the beneficiary’s income tax liability: 1) how long the beneficiary will be able to defer distributions, 2) how large any RMDs will be, and 3) the beneficiary’s likely income tax bracket.
It’s also important to consider the estate tax consequences. It may be advantageous to name your spouse as beneficiary because transfers to your spouse are estate-tax-free — as long as he or she is a U.S. citizen. The downside is that the IRA or other plan will increase the size of your spouse’s taxable estate, which may result in increased estate tax liability on his or her death. If you name a beneficiary other than your spouse, the retirement plan generally will be included in your estate. Whether it will cause any estate tax liability will depend on a variety of factors, such as the size of the plan, the size of your total estate and the estate tax exemption available for the year of your death. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC, 530 Fifth Avenue, 14th Floor, New York, NY 10036, 212.536.6000. Fee based financial planning services are offered through Lenox Advisors, Inc., a registered Investment Advisory Firm, and are not offered or sponsored by MML Investors Services, LLC. Lenox Advisors, Inc. is not a subsidiary of or affiliated with MML Investors Services, LLC. Lenox Advisors, Inc. is a wholly owned subsidiary of National Financial Partners Corp. (NFP). NFP is not an affiliate of subsidiary of MML Investors Services, LLC. CRN201603-179868 This publication was developed by a third-party publisher and distributed with the understanding that the publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters and recommend you consult with a professional attorney, accountant, tax professional, financial advisor or other appropriate industry professional. The hypothetical examples used are for illustrative purposes only and not intended to represent the value or performance of any specific product or to predict or guarantee actual results, which will vary. ©2014 PFPma14
In most cases, annual RMDs must begin shortly after inheriting a retirement plan. The amount of the RMD depends on the age of your oldest beneficiary and the size of the account. Generally, the younger your beneficiaries, the better. Why? Because the RMDs will be smaller, allowing more opportunity for continued tax-deferred (or tax-free) growth.
Taxing the Travel Squad William L. Abrams, Partner - Abrams Garfinkel Margolis Bergson, LLP
Professional athletes traverse the country, performing on the hallowed grounds of sports’ most storied venues. However, the travel inherent to the industry forces today’s professional athletes to face complex tax laws. In 2009, twenty of the twenty-four states with franchises in at least one major professional sports league (e.g., NFL, NBA, WNBA, NHL and MLB) had laws requiring visiting athletes to pay state income taxes for services performed in the state.1 As the popularity and salaries of major professional athletes grew over the latter part of the 20th century, states became increasingly concerned that they were not receiving a fair portion of taxes on actual income earned. Consequently, states have adopted allocation rules, or “Jock Taxes,” to compensate for the income earned by athletes while playing in nonresidential states. For example, California requires nonresident athletes to specify in their gross income the amount received for services within the state.2 In 2010, California collected more than $70 million in taxes attributable to visiting athletes.3 Historically, the states with “Jock Taxes” have utilized one of two methods, either “duty days” or “games played,” to determine how much an athlete owes. “Duty days” are the aggregate number of days of services commencing on official preseason training and terminating on the last day of competition within a given tax year. Preseason training, regular and postseason game days, practice days, team meeting days, and team travel days all count as duty days. Nonresident income is calculated by using a ratio of the number of duty days spent in the state compared to the total number of duty days in the tax year. The definition of duty days can vary slightly by state, but it is generally applied to anyone connected to the team who performs services within the state, including coaches, managers, and trainers, and also to players on the disabled list. Illinois is one of the states that implemented a duty days methodology for nonresident athletes. This means that whenever the Chicago Cubs have a home stretch of games, every nonresident player, coach, and trainer on both teams must pay taxes on income earned for practice days, meeting days and game days. Under the Illinois rules, however, days for which a team member is not compensated and is not performing services for the team, including days when that member has been suspended without pay or is on the disabled list but unable to rehab, are not treated as in-state duty days, while all days on the disabled list are counted in the aggregate number of duty days in the tax year. The most common alternative to the “duty days” allocation method had been the “games played” method. Under the “games played” apportionment, the ratio is based on the number of games an athlete played in a particular state compared to the total number of games played during the tax year, including preseason and postseason games.
Unlike the “duty days” method, the “games played” apportionment does not account for services rendered on practice days, meeting days and other non-game days.4 Frustrated with the deficiencies of the “games played” method and the inconsistencies of sports taxation across the board, former Kansas City Chiefs owner Lamar Hunt successfully lobbied the Federation of Tax Administrators (FTA) to recommend the abandonment of the “games played” method. The FTA’s subsequent report led to many “games played” states moving to the “duty days” apportionment.5 In the case of athletes like Tiger Woods, who are considered to be non-team athletes (along with tennis players, boxers, and jockeys), income is allocated based on the amount of compensation received for the specific performance or by a ratio of in-state performances to total performances.6 The proper treatment of nonresident athletes’ bonuses has also been a controversial subject. If a bonus is paid for the athlete’s services (either past or future), each state’s allocation rules would apply to the bonus as well. However, in the case of a “signing” bonus, there looms the issue of whether tax allocation rules apply or whether the payment is for an intangible right—that is, the commitment to play for the team—in which case the payment should be automatically allocated to the player’s state of residence without any consideration of services performed in other states. Fortunately, athletes may find relief in state reciprocity laws. For example, Pennsylvania residents are exempt from paying taxes on income earned in Ohio. So, when a Pittsburgh Steelers football player who resides in Pennsylvania travels to Ohio to play the Cincinnati Bengals, that player either won’t be obligated to pay Pennsylvania taxes on income earned in Ohio or will be entitled to a tax credit.7 Challenges for professional athletes extend beyond the field. They, along with their representatives, must be well prepared to face the multiplicity of state taxation. Unless all states agree to a uniform allocation strategy, professional athletes are best suited to hire a seasoned tax representative to capitalize on credits and tackle complex tax laws head on. n Kevin Baxter, The Taxing Life of a Pro Athlete, Los Angeles Times, April 12, 2009. 2 Cal. Code Regs. tit. 18 §17951-5(a)(2). See also 35 Ill. Comp. Stat. 5/1501; Wis. Stat. Ann. §71.02. 3 Teresa Ambord, NFL Players versus the IRS: It’s a Tough Tackle, Accounting Web (October 30, 2013), http://www.accountingweb.com/ article/nfl-players-versus-irs-its-tough-tackle/222629. 4 Prior to Jan. 1, 1995, New York utilized this method. See N.Y. Tax Law §132.22. 5 John Di Mascio, The “Jock Tax”: Fair Play or Unsportsmanlike Conduct. 68 U. Pitt. L. Rev. 953 (2006). 6 See, e.g., Mass. Regs. Code tit. 830, §62.5A.1(6)(e). 7 Teresa Ambord, NFL Players versus the IRS: It’s a Tough Tackle, Accounting Web (October 30, 2013), http://www.accountingweb.com/ article/nfl-players-versus-irs-its-tough-tackle/222629. 1
The information provided is not written or intended as specific tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. We are not authorized to give tax or legal advice. Individuals are encouraged to seek advice from their own tax or legal counsel. The views expressed are those of Abrams Garfinkel Margolis Bergson, LLP and are not necessarily those of Lenox Advisors or MML Investors Services, LLC.