Worcester Jewish Chronicle, March 24, 2004

Getting Your Financial House In Order Is A Must

William E. Philbrick, CPA, MST, CVA, CFF

Ever tear your bedroom apart looking for that birth certificate; sure you had safely stashed it in your sock drawer? Or pulled an all-nighter organizing your tax records after spending the previous three days looking for documents and receipts? If you have, this information will help you gain control of your financial house.

Whether you are a pack rat, saving every piece of paper in the first draw or shoe box you find or the laissez faire filer, who saves some and discards some, depending on your mood, you’ll be left scrambling when you actually need to find an important document.

The time and effort to organize your financial records pays off in more ways than less frustration. First, organized records will make your tax preparation easier and less time consuming. Complete tax records will help remind you of deductions you might otherwise overlook and they come in handy if the IRS questions your return, helping to avoid interest, penalties, or additional taxes. Second, good records will give you a better handle on your overall financial situation and help your CPA identify financial and tax-planning opportunities. Lastly, should you die or become incapacitated, a well-organized records system will ease the burden on your loved ones by providing a road map to your financial affairs.

To get started, begin at your local office supply store and pick up the items you need to start your filing system such as hanging files and manila folders, as well as a container to keep them in. If you prefer to keep electronic records, many software systems allow you to download electronic statements. You can help on space by scanning documents onto your computer. Make sure to keep a backup file in case your computer is ever damaged or destroyed. Don’t forget to get a quality paper shredder, more identity theft occurred last year from non-online sources than from the Internet. Discarded documents in the trash are prime sources for personal information.

You should divide your records into three categories. First are “current” files that you will be adding to through the year. Be sure they are located in a convenient location. Now find a spot for “dead” files. This is information you need to keep but won’t have to access often. A safe out of the way space, which is dry, will work for this purpose. The third category is your safe-deposit box. It is where you will keep documents that are costly or difficult to replace, like wills, deeds and car titles.

Now you need to sort that pile. What do you keep and what do you discard? While your personal circumstances will dictate your needs, consider six universal subject areas- taxes, banking, investments, retirement plans, insurance policies and your home for starters.

Starting with taxes, maintain a current file for this year’s return. Include all your income information and backup documentation for deductions, including receipts and cancelled checks. Add your past year’s return to this file. All other returns and related documents can be moved to the “dead” storage area. Plan to keep the prior year returns for six to ten years to be safe you are beyond the period the IRS has to question your return.

Banking records can take up a large part of your system. Keep separate files for each account for the current year and compare them to your 1099s at the end of the year. If they agree, discard the statements. After a year, you can discard cancelled checks except for those that support tax deductions and tax payments. Pull these and put them with your current tax file. Also keep cancelled checks that relate to a home purchase, capital improvements to your home, investments, and non-deductible IRA contributions.

Investment records files need to be maintained so you will have the documentation to establish your cost basis. Failure to do this could result in double tax. For example, reinvested dividends are currently taxable, but add to your cost basis when you sell.

Plan on holding your investment records a minimum of three years after the sale.

Set up a separate file for each retirement plan that you have. Each file should include enrollment papers, statements, a list of beneficiary designations and contact information.

This information will be very important if you have IRAs, which have contributions, which were made with pre-tax and post-tax income. You can avoid being taxed on the non-deductible contributions when you start to withdraw, if you maintain these files.

Your insurance record keeping is fairly simple. Make a file for each policy with the policy number, insurance company name, your agent’s name, what is covered and any beneficiaries. Imagine the ease of filing a claim with all these details at your fingertips.

If you own a home, set up a file on the purchase of your home. Next add a file on all improvements and additions. While there is a $250,000 exclusion on the sale gain, double if you are married. Don’t count on that to excuse keeping the records, as inflation can drive up prices and what Congress has given, Congress can take away.

Also set up an inventory file on your belongings. Include brand, model and serial numbers, purchase prices and replacement costs for big-ticket items. Photos or videos of your property are invaluable in the event of an insurance claim. Make copies of the inventory list, photos and video for your safe deposit box in case your home is damaged or burglarized.

If you don’t have a safe deposit box, rent one. It should contain personal records such as birth and marriage certificates, as well as adoption, citizenship and divorce papers. You also should have your proof of ownership for major possessions such as real estate, autos, boats, as well as stock or bond certificates. Again, while these can all be replaced, but not without a lot of time and effort.

You should also store your signed, original will in your safe deposit box. But you should also keep a copy at home and an additional copy with your attorney. Old originals and copies should be destroyed if you make any changes to avoid any confusion after your death.

Once you have gotten this far, one remaining step needs to be taken. This is the preparation of a personal financial review. Use a three ring binder and include a list of all your assets and liabilities. Include the account numbers, names and phone numbers of contacts. Then prepare a list of important documents, such as wills, power of attorney, and insurance policies, noting where they are located. Be sure to include the bank and location of your safe deposit box. Add the names of all your financial advisors, including your attorney and CPA. Once this is complete give copies to your next-of-kin, attorney, CPA and trustees, if any. Your CPA will use this information to make tax-planning recommendations, which could have been missed without it.

Once you have tamed the paper tiger, keep it under control by making it a weekly habit to go through your paperwork. Pay your bills and file any documents that you need to retain in the appropriate files. Once a year, give your system an overhaul. Discard any unneeded documents and files and move the old tax returns to the dead storage area.

Remember clutter is the enemy. Discarding unneeded paperwork is key to maintaining an organized financial record keeping system under control.

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William E. Philbrick, CPA, MST, CVA, CFF is a Senior Vice President and Director of Taxes and Forensic Services with Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached at wphilbrick@GRK&B.com.

The Advocate and Greenwich Time, Sunday, June 15, 2003

Rethinking Investment Choices Under the New Tax Act

Julie Jason

You are probably wondering whether you need to change your investment decisions because of new reduced taxes on corporate dividend distributions.

As we discussed last week, the Jobs and Growth Tax Relief Reconciliation Act of 2003, which was signed into law May 28, lowers taxes on corporate dividends received in 2003 through 2008. The act also lowers long-term capital gains to a maximum of 15 percent (5 percent for taxpayers in lower tax brackets) for stock sales after May 5.

Here is a ranking of income-producing investments based strictly on the effect of taxes, prepared with the help of tax experts Evan Snapper of Ernst & Young and William Philbrick of Greenberg, Rosenblatt, Kull & Bitsoli PC of Worcester, Mass.

The list is in the order of best tax efficiency to worst. The ranking will not tell you which investments you should buy, since that decision is not based solely on taxes. As the saying goes, "Don’t let the tail wag the dog."

As you are considering the list, think about whether you should hold some of your less-tax-efficient investments (ranking 4 or below) in a tax-deferred account, such as an individual retirement account, instead of a taxable account.

1.Tax-free municipal bonds: When the new tax act was proposed, income taxes on corporate dividends were to be completely eliminated, which would have made dividend-paying stocks not only the most tax-efficient, but also potentially more desirable to investors than municipal bonds. Since Congress reduced, but did not eliminate income taxes on dividends, municipal bonds remain the most tax-efficient income-producing investment.
2. Income-producing investments held in Roth Individual Retirement Account: You can withdraw dividends and interest (and principal and gains) from a Roth IRA completely free of federal and state income taxes, assuming you are over 59½ and have held your Roth for more than five years.

Because you can invest stocks and bonds in a Roth IRA, you might rank a Roth as the best all-round investment vehicle for flexibility and tax efficiency. It is ranked second here only because of tax penalties for early withdrawal (before age 59½) and the five-year holding period. 
3. Dividend-paying stocks: Dividends paid by domestic stocks or stock mutual funds investing in domestic stocks are now taxed at a rate of 5 percent or 15 percent, depending on your tax bracket.

4. Government bonds and government bond mutual funds and unit trusts: Interest from U.S. government and agency bonds, notes and bills is taxed at ordinary income tax rates. 

Government bond interest is exempt from state income taxes. Dividends paid by bond mutual funds are taxed at ordinary income-tax rates.

If your ordinary income-tax rate is higher than 15 percent (or 5 percent), then the top three choices on this list will be more tax-efficient for you than the rest. 

Who falls into that category? If you are single and you make more than $28,400, married filing jointly making more than $56,800, or filing as a head of household and making more than $38,500, your ordinary income tax rate will be higher than 15 percent – as high as 35 percent for the top bracket. 

5. All the instruments whose distributions are taxed at ordinary income tax rates on both the federal and state tax levels: These are savings accounts, bank certificates of deposit, corporate bonds and corporate bond mutual funds and unit trusts, immediate and tax-deferred annuities, and tax-deferred accounts such as traditional IRAs, 401(k)s and the like.

Note that some annuity and traditional IRA distributions or withdrawals may not be fully taxable. For example, there is an adjustment for nondeductible IRA contributions or a return of principal used to purchase a nonqualified annuity.

Capital Gains Taxes

In addition to taxes on distributions such as interest and dividends, you also have to consider whether there is a tax on the sales of the asset.

If you sell a stock or a municipal, government, or corporate bond at a profit, the gain will be taxed at the new long-term capital gains tax rate of 5 percent or 15 percent. 

To qualify for the lower rate, you must have owned the instrument for more than one year and the sale must occur after May 5. You may offset losses against gains as before, and losses can be carried forward. The $3,000 annual limit for deducting losses against income has not changed. 

If you withdraw money from a savings account, certificate of deposit, an annuity or tax-deferred account such as a traditional IRA or 401(k), profits or gains are not distinguished from other withdrawals and are taxed at ordinary income-tax rates.

However, withdrawals from annuities may include a return of principal, which would not be taxed. Traditional IRAs may also have been funded with nondeductible monies, which will reduce the amount that is subject to tax.

Watch out for penalties when you take out money from certificates of deposits and annuities. 

Be sure to talk to your tax adviser before making any decisions to realign your investments based on the new tax law.

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Julie Jason encourages readers to send in their 401(k) questions and stories for discussion in the column. Email Julie Jason atJulie.Jason@snet.net or write: Julie Jason, The Advocate and Greenwich Time, PO Box 9307, Stamford, CT 06904. Jason, a money manager who has a juris doctor and master of laws degrees, is the author of "Strategic Investing After 50" (John Wiley & Sons, 2001), "You and Your 401(k): How to Manage Your 401(k) for Maximum Returns" (Simon & Schuster, 1996) and "The 401(k) Plan Handbook" (Prentice Hall, 1997). She is managing director of Jackson, Grant Investment Advisers, Inc. of Stamford.

Recap of the Jobs and Growth Tax Relief Reconciliation Act of 2003

William E. Philbrick, CPA, MST, CVA

You are probably wondering how the new tax law will affect you. Read on to find out how the Jobs and Growth Tax Relief Reconciliation Act of 2003 will:

• Reduce taxes on dividends and capital gains

• Accelerate reductions in tax rates

• Accelerate other tax benefits

• Provide temporary tax relief for businesses

Reduced taxes on dividends and capital gains.

An important component of the new tax law, particularly for investors, is a reduction in taxes on dividends and capital gains. These temporary lower rates can mean considerable tax savings for taxpayers, although they will cease to apply after 2008.

Under the new law, the 10% and 20% rates on adjusted net capital gain are reduced to 5% (zero, in 2008) and 15% respectively, for both regular tax and the alternative minimum tax (AMT). The change applies to sales and exchanges (and installment payments) received after May 5, 2003 and before January 1, 2009. The 5% rate applies to taxpayers whose regular tax bracket is below 25%, while the 15% rate applies to those in tax brackets of 25% or higher. The lower rates apply to sales of capital assets held for more than one year.

Note, however, that there is no cut in the 28% capital gains rate affecting collectibles and certain small business stock, and the 25% rate for gains from depreciation claimed on realty.

Dividends received in tax years beginning after 2002 and before 2009 by an individual shareholder from domestic corporations and certain qualified foreign corporations are taxed at rates of 5% (zero, in 2008) and 15% for both regular tax and AMT purposes. This results in substantial tax savings for dividend recipients; before passage of the new tax law, dividends were taxed as ordinary income at rates of up to 38.6%.

Acceleration of certain previously enacted tax benefits and reductions for individuals.

The new tax law also speeds up previously enacted tax benefits and reductions that were scheduled to be phased-in over the next several years. These accelerated provisions include:

Expansion of the 10% individual income tax rate bracket. The expansion in the width of the 10% rate bracket for single and joint filers that was scheduled to take place in 2008 instead takes place this year. As a result, the 10% tax bracket for 2003 ends at $14,000 (up from $12,000) of taxable income for joint filers and $7,000 (up from $6,000) for single filers and marrieds filing separately. For 2004, both figures will be indexed for inflation. The endpoint of the 10% bracket for heads of household remains unchanged at $12,000. From 2005 through 2007, the endpoint of the 10% bracket will revert to the $12,000/$6,000 levels, but will increase to $14,000/$7,000 for 2008 through 2010.

Reduction in individual income tax rates. The change that will affect the largest number of taxpayers is an immediate reduction of the marginal tax brackets paid by all but the lowest earners. The tax rates above 15% for 2003 and later years are 25%, 28%, 33% and 35%, a decrease from previous rates of 27%, 30%, 35% and 38.6%. Previously, these rate reductions were scheduled to take effect in 2006. After 2010, rates above 15% will revert to 28%, 31%, 36% and 39.6%.

Marriage-penalty relief. The new law reduces so-called marriage penalties (i.e., tax-law provisions that force two-income couples to pay more in taxes each year than single individuals). The basic standard deduction amount for joint returns will be $9,500 for 2003 – double the basic standard deduction for single returns. Under prior law, this was not scheduled to be fully phased-in until 2009. However, beginning in 2005, a joint-return filer’s basic standard deduction will revert to the prior levels (e.g., for 2005, to 174% of a single return filer’s basic standard deduction).

In addition, in 2003 and 2004 the endpoint of the 15% tax bracket for joint returns will be twice the endpoint of the 15% tax bracket for single returns. Under prior law, this was not scheduled to happen until 2008.

In other words, for 2003, the 15% tax bracket for joint filers applies to taxable income over $14,000 (up from $12,000), but not over $56,800 (up from $47,450). However, for tax years beginning after 2004, the endpoint will, like the basic standard deduction amount, revert to previous levels.

Increase in child tax credit. For 2003, 2004 and 2005, the child tax credit will increase to $1,000 per qualifying dependent child under 17, up from the $600 per qualifying child for 2003 and 2004, and $700 for 2005 as previously provided. After 2005, the child tax credit will fall back to $700 for 2006 through 2008. What’s more, for 2003, the increased amount of the child tax credit will be paid in advance over a period of three weeks, beginning in mid-July. As a result, a typical qualifying family will receive an advance payment check for up to $400 for each qualifying child under age 17 as of the end of 2003.

Note that the income limits related to the child tax credit are unchanged by the Act, which means that the amount of the credit allowable is reduced or eliminated for taxpayers with adjusted gross income (AGI) over certain levels: $75,000 for singles and $110,000 for married couples. However, taxpayers who did not qualify in the past for the child tax credit because of AGI limitations may now qualify for a portion because of the increased credit, even though they will not get an advance payment.

Minimum tax relief to individuals. The tax law also includes some relief from the alternative minimum tax (AMT). For 2003 and 2004, the maximum AMT exemption for joint filers and surviving spouses increases to $58,000 (up from $49,000) and to $40,250 for unmarried taxpayers (up from $35,750), reverting to $45,000 and $33,750 respectively, in 2005.

Tax changes for businesses and corporations.

Two new temporary tax breaks are designed to encourage immediate investments. First, small companies can expense up to $100,000 in new equipment investments through 2005. Second, businesses can depreciate more of their assets sooner through 2004.

The 2003 Jobs and Growth Act vastly liberalizes the expensing election, which permits small businesses to expense (i.e., deduct immediately rather than depreciate over several years) a certain amount of the cost of tangible depreciable personal property purchased and placed in service during the tax year in an active trade or business. All of the following expensing changes are effective for tax years beginning after 2002 and before 2006:

• The maximum annual expensing amount is $100,000, up from $25,000.

• The maximum annual expensing amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $400,000 (up from $200,000).

• The maximum annual expensing amount will be indexed for inflation for tax years beginning after 2003.

• Off-the-shelf computer software is now eligible for expensing.

• Taxpayer revocation of expensing elections will no longer require IRS consent.

• Certain SUVs and autos may qualify for 100% expensing if they meet weight and size requirements.

A second major change affecting businesses is an increase and extension of bonus first-year depreciation. In general, before the 2003 Jobs and Growth Act, a 30% additional first-year depreciation allowance applied to the non-expensed portion of qualified property if: (1) its original use commenced with the taxpayer after September 10, 2001; (2) the asset was acquired by the taxpayer after September 10, 2001 and before September 11, 2004; and (3) it was placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

The Act makes the following changes:

• For 30% bonus first-year depreciation purposes, property can be acquired before 2005.

• 50% bonus first-year depreciation applies to qualified property if (1) its original use commences with the taxpayer after May 5, 2003; (2) the asset is acquired by the taxpayer after May 5, 2003 and before 2005 (there can not be a written binding contract for acquisition in effect before May 6, 2003); and (3) it is placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

• Taxpayers can elect on a class-by-class basis to claim 30% instead of 50% bonus first-year depreciation for qualifying property, or elect not to claim bonus first-year depreciation at all. Two situations in which a taxpayer would likely consider making an election to claim a smaller first-year depreciation, or to elect out of it entirely, are when the taxpayer (1) has net operating losses that are about to expire, or (2) anticipates being in a higher tax bracket in future years.

• Note that there still is no AMT depreciation adjustment for the entire recovery period of qualified property recovered under the bonus first-year depreciation rules.

We’ve described only the highlights of the most important changes in the new law. There are new transition rules and specific definitions, coupled with the various sunset dates, all of which make planning more complex. In addition, we do not expect states to adopt any of the provisions of the new law.

Please be aware that there are several pending tax bills which can and will have a material impact on planning and compliance. It is expected that action will be taken on one or more of these bills in the coming sessions.

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William E. Philbrick, CPA, MST, CVA is a Senior Vice President and Tax Director at Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached atwphilbrick@GRK&B.com.