May 2013 Archives

Case 1 of 2 on a trustee's duty to diversify.

farmland.jpgThe pleasantly named Baker Boyer National Bank held some liquid assets and 846 acres of farmland in a trust for the benefit of successive generations of the Garver family. The bank put the $194,000 of liquid assets into municipal bonds. This was during the period 1973 to 1982, when interest rates rose to record levels. This caused the bonds to decrease in value. They were ultimately sold at a loss of $63,750 (ouch!).

The Garvers sued the bank for failing to diversify the trust's holdings, and the trial court awarded the family $22,950 in damages. These were computed by comparing the municipal bond outcome, with what would have occurred if 40% of the portfolio had been in stocks. The bank appealed.

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Observations on doing Lars's tax return (4 of 4); retirement plan contributions.

2d admitting to hospital.jpgLars is putting about $30,000 a year into his retirement plan at the CPA firm. Actually it isn't just Lars's; it's earned income therefore his and Kyra's community property. His account has grown to about a million and a half. This would have seemed like a great amount when Lars started work. Now it's not even their largest asset; they have more than that in real estate, thanks mostly to the smarts and generosity of his childless Uncle Nils.

Some of the retirement plan is Roth, meaning Lars doesn't get to deduct that portion going into the plan, but it isn't taxable when it comes out. His account is invested in stocks, bonds, and REITs. The plan permits Lars and the other participants to direct their own allocations. Lars likes watching the numbers and has an especially good feeling about this holding generally. Why?

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Observations on doing Lars's tax return (3 of probably 4); the self-employment tax, Social Security, and Medicare.

form se.jpgAnother thing that strikes Lars as he prepares and reflects on his 2012 personal income tax return, is the amount of self-employment tax. He pays this because, as a partner in a CPA firm, he gets a share of the partnership's net income rather than a salary, so there is no Social Security tax deducted from his draws (paychecks). For him the SE tax is about $20,000 for the year, roughly half the amount of income tax he's paying.

At 55, Lars is ten years or so away from drawing Social Security, and has been paying SE tax for a long time. He has not factored Social Security income into his retirement planning, although as the time gets closer and the system remains in place he becomes a little more confident he'll actually receive some. But it doesn't seem like a great bargain, paying today's equivalent of a $20,000 a year for decades in hopes of his and Kyra's getting $30,000-plus for -- well, maybe decades, maybe it isn't so bad.

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Observations on doing Lars's tax return (2 of maybe 4); retirement plan investing.

graph.jpgSeeing the reduced tax on his capital gains and dividends, Lars feels confirmed in favoring stocks over bonds. There is part of his portfolio that doesn't show up in his income tax return, though, at least not yet: his retirement plan.

Some of it actually never will: the Roth portion. Lars's firm has a 401(k) plan, and he has some of his account in Roth status, meaning he pays the tax on the income as it goes in, but neither the future income and gain on these contributions, nor the distributions when they come out, will be taxed. Lars likes this idea.

Even the non-Roth portion of the retirement plan that will be taxed when it comes out, gets tax-free growth in the meantime. This takes away one of Lars's reasons for not liking bonds, the taxation of interest income at ordinary rates.

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Observations on doing Lars's tax return (1 of maybe 4); why would anyone have bonds now?

pencil + paper.jpgLars is a professional tax preparer. Actually at this advanced stage of his career as a CPA, he is much more reviewer than preparer; the less senior accountants in his office do the return assembly. He has a couple of peculiarities in the way he does his own return. First, he extends it so he can go over it with some deliberation. Tax season is a crush every year.

And Lars does his return by hand, at least initially. This is so he can see how the income and tax ingredients really go together. After he's done that, he does indeed run it through their software and, since the results are always at least a little different, he learns something from that too.

One thing he notices this year is the tax calculation on dividends and capital gains. These have a maximum rate of 15%, about half that on ordinary income like earned income and interest. The policy reasons for this benefit, Lars recalls, are to soften the double taxation of dividends (taxed both at the corporate and the shareholder level, theoretically at least), and to encourage people to invest. Invest in equities, at least. Not bonds.

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