Tax Time Again!!

Yes, we know it’s only August; however, now is a good time to review your 2013 tax status and (if necessary) do some preliminary planning. As you know, we at Paragon Financial Advisors do not prepare taxes and we advise you to consult your tax professional to ensure any suggestions made here are applicable to your particular circumstances. That being said, there are some items that may be worthy of your consideration.  This list is, of course, not inclusive of all items that might be beneficial to you.

Tax Free Income-SEC football at Texas A&M is about to start. As you know, hotel/lodging arrangements for football weekends are at a premium. Did you know you can rent your home for less than 15 days a year and the rental income is tax free? Often known as the “Masters’ Provision” because homeowners used it to rent their homes for the Masters Golf Tournament in Augusta, Ga., this tax benefit might prove useful to families willing to rent their home for home game weekends. However, be sure and visit with your property owner’s association and/or insurance company for possible conflicts or prohibitions before doing such a rental.

Required Minimum Distributions from and IRA- Congress has extended the provision allowing a maximum of $100,000 of a required minimum distribution (for account holders older than 70 ½) to be made directly from an IRA to the charitable organization with no tax consequences. The donor does not receive a charitable donation for the amount donated; however, the amount donated is not counted in taxable income. With the health care tax increases becoming effective in 2013, reducing taxable income can be very advantageous. Be sure to make arrangements well enough in advance to allow the charity to receive payment prior to the end of year; we recommend that you initiate such transfers no later than mid-November.

Capital Gains/Loss Harvesting- The stock market is at all time high levels. However, many people have losses carried forward from 2008. Review your portfolio gain and loss positions (selling gains to offset losses) so you can realize some of your current market gains with no tax consequences.

Charitable Donations-As you consider your end of the year donations, consider gifting appreciated assets (stocks) to the charity in lieu of cash. You can gift the stock and get credit for donations at current market value regardless of your cost basis. You do not have to pay capital gains on the stock as you would if you sold the stock and gave cash to the charity.

“Step-up”  in Basis at Death- While considering tax harvesting provisions, keep in mind that appreciated assets receive a “step-up” in basis at the first death of a spouse in community property states (or at death of the owner in separate property states). If a couple bought stock at $25 per share originally and the stock is now valued at $125 per share, sale of the stock would incur taxes on a gain of $100 per share (at ordinary income or capital gains rates depending on how long the stock had been owned). Transferring the stock to children would mean the original cost ($25 per share) would be passed to the children subjecting any subsequent gain on sale above that basis to income taxes. However, at the death of the first spouse, the stock value is “stepped up” to the market value as of the date of death and taxes on gains to that point are not calculated. Obviously this is not a preferred method of tax planning, but in those cases where medical/age conditions apply, one should be aware of it.

Estate Tax Exemption Portability- One provision of the 2013 tax changes was the exemption of $5 million per person exemption from estate or gift taxes. Therefore, a couple could shelter $10 million from estate taxes. That amount was indexed for inflation; the 2013 exemption amount is $5.25 million per individual. In addition, that exclusion amount is “portable” i.e. a deceased spouse’s estate can transfer to the surviving spouse any unused portion of that estate/gift exemption. However, an estate tax return must be filed to take advantage of this portability benefit.

As tax rates increase and deductions decrease, tax planning becomes even more critical. We, at Paragon Financial Advisors, will work with you and your chosen tax professional to integrate tax benefits into your financial planning. Please do not hesitate to call us for review of your account.

Variable Annuities

Those of you with whom we have discussed variable annuities know that we at Paragon Financial Advisors are not fans of variable annuities. Our basic reasoning has been that variable annuities usually have high fees (for the insurance costs in addition to fund management expenses), required holding periods to avoid significant redemption penalties, and thus lower investment returns to you (the annuity holder). They also turn gains on investments that could potentially taxed as capital gains into gains taxed as ordinary income.

 The Wednesday, March 13, 2013 Houston Chronicle carried an excellent article by nationally syndicated personal finance writer Scott Burns. We would highly recommend you read the entire article at his website that can be found HERE . To pique your interest, we will quote some of his comments here to give you a general flavor of his opinion of variable annuities and with which we completely agree.

“According to the Morningstar variable annuity database, a typical VA contract carries insurance costs of 1 percent to 1.25 percent.”

 “…the fee burden becomes punitive in a low rate period. Over the last five years…the Vanguard Total Market Index (a proxy for all U.S. stocks) returned 2.18 percent a year. So … with an insurance expense of 1.1 percent a year, the cost of the insurance wrapper was 50 percent of your return.”

“…it would have been a bit worse if you had invested in the Vanguard 500 Index (a proxy for domestic large cap stocks) because … its return over the last five years was 1.57 percent, indicating a 1 percent insurance wrapper cost would have taken 64 percent of the return.”

 “The return from a variable annuity is taxed, upon withdrawal, at ordinary income rates.”

“Much of the return from a broad index fund … will be taxed at the capital gains rate. …now 20 percent, up from 15 percent last year.”

Mr. Burns is a proponent of indexing and he also discusses the performance issues associated with variable annuities vs. indexing. Anyone considering the purchase of a variable annuity will find this discussion a worth while read.