Sigcat Software Showcase 1992/SIGCat Software Showcase 1992 - CD-ROM Strategies.ISO/research/docs/fall87.txt

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Tofias
Fleishman
Shapiro                                              Fall
& Co., P.C.                                          1987

Certified Public Accountants

205 Broadway, Cambridge, MA 02139 ■ [phone] ■ 66 Pearl Street,
Portland, ME 04101 ■ [phone]


PERSONAL FINANCIAL PLANNING QUARTERLY


SHOULD YOU BUY OR LEASE YOUR NEXT NEW CAR?

The 1986 Tax Reform Act made buying a new car more expensive by phasing
out the deductibility of interest expense and eliminating the sales tax
deduction. Is leasing a car for personal use now the better deal? The
answer is far from simple. Factors to consider include personal
preferences, the automobile desired and the terms which can be
negotiated.


Personal Preferences.

Those who always pay cash for an auto and dislike any type of monthly
payment will not enjoy leasing. The same is true of persons who pride
themselves on the economy of driving a car long after payments cease.
Leasing is best suited to the driver who finances his or her auto and
trades for a new model as soon as the old one is paid for.


The Car.

Probably the most attractive feature of leasing is the fact that the
monthly payment is usually lower than it would be if the car were
purchased. How much lower depends on the car's residual value at the end
of the lease term. Lease payments will be lowest for models having high
residual values, including many higher priced domestic and foreign
autos. The sum of the lease payments will equal the car's market value
new less its residual value (plus the equivalent of an interest charge).
You pay only for the portion of the car's value depreciated during the
lease term.


Specific Terms.

Even when a model's residual value is so low that financing it would
result in lower monthly payments than leasing, the required down payment
and up-front sales tax may represent an opportunity cost which argues
for leasing. (However, leasing requires a security deposit and some
leases require a down payment called a "capital cost reduction"). To
compare costs in a specific situation, first calculate the cost of
purchasing the car using the following formula.

Cost of Purchasing--This equals down payment plus sales tax plus
earnings foregone on the total of these during the financing period
(your "opportunity cost") plus the sum of all monthly payments less any
tax savings attributable to interest deductions and less the car's
residual value at the end of the financing period.

The cost of purchasing should be compared with the sum total of lease
payments during the lease term. The numbers may be so close that
changing the earnings rate assumed in calculating opportunity cost will
tip the scales one way or the other. For this reason, it is important
that a realistic assumption be made in selecting the factor used.


Other Leasing Considerations.

If the calculation indicates that leasing may offer an advantage in
your situation, be sure to consider carefully the other decisions you
must make in negotiating your lease. First, you may choose either an
open- or closed-end lease. With an open-end lease, you may obtain a
lower monthly payment but will bear the risk that the residual value has
been set too high. If so, you will be called upon to pay any shortfall
in the resale price at the end of the lease term. With a closed-end
lease, the dealer guarantees the residual. You are responsible only for
staying within the negotiated mileage allowance (which should, if
possible, be sufficiently high at the outset) and maintaining the car in
reasonably good condition. You can reduce your monthly lease payments by
lengthening the lease term, but be realistic about your needs. Terminating
the lease early will almost certainly require the payment of additional cash,
since you must pay the cost of depreciation, which takes place most rapidly
early in the vehicle's life. Finally, it is generally desirable for the
contract to have an option allowing you to purchase the car at the end of the
lease term. While involving no commitment or risk on the part of the lessee,
such an option may permit an opportunity to profit should the
automobile depreciate less than anticipated.


INTEREST EXPENSE: WHEN IS IT DEDUCTIBLE?

The 1986 Tax Reform Act provides that certain allocation procedures be
employed to characterize interest as belonging to one of the five
following categories:

Personal Interest, which is no longer deductible except under
transition rules allowing a deduction of 65% in 1987, 40% in 1988, 20%
in 1989 and 10% in 1990;

Qualified residence interest, which remains fully deductible;

Investment interest, deductible only to the extent of investment income,
except for transition rules similar to those for personal interest (any
excess is carried forward);

Passive activity interest, deductible only to the extent of income
derived from passive sources with the excess carried forward;

Business interest, which is fully deductible.


Under the new rules, the characterization of any interest expense
depends on how the loan proceeds are used, not on the security for the
loan. Because of this, interest on margin loans will no longer
necessarily qualify as investment interest. One exception to the rule
is qualified residence interest, which must be secured by a primary or
secondary personal residence.

When funds are borrowed and deposited into an account, any interest
expense paid during the interim period prior to use of the funds will
be characterized as investment interest. After the funds are withdrawn
and used for a specific purpose, the interest expense will be
reclassified based on the type of property purchased. If the loan
proceeds are not commingled with other funds in an account or if the
expenditure is made within fifteen days of their receipt or deposit, the
appropriate characterization of the interest expense will be automatic.

Commingling loan proceeds with each other or with other funds is
hazardous. Regulations issued by the IRS stipulate that in such cases
loan proceeds will be considered to be spent in the order deposited and
before any other funds already held in the account at the time the loan
proceeds were deposited. Where funds are commingled in a single account,
any use of the account for household purchases or day-to-day living
expenses prior to the full utilization of loan proceeds for some other
intended purpose will cause interest on the loan to be categorized as
consumer interest and, therefore, non-deductible, except under
transition rules.

Loan proceeds should always be deposited into an account within fifteen
days of receipt. Otherwise, the funds will be presumed to have been
used for a personal purpose. The same is true of any borrowed funds
withdrawn from an account. If not used within fifteen days or
redeposited, a consumer use will be assumed.

Careful record-keeping, both of the loan proceeds and of interest and
principal repayments, will be essential. Where proceeds of a single loan
have been used for multiple purposes, it will be necessary to allocate
the interest expense among various categories. Also, under such
circumstances, the regulations stipulate that any principal repayments
will be applied in the following order: 1) Personal expenses; 2)
Investment expenses and passive activity expenses; 3) Expenses relative
to activities which were formerly passive; 4) Business expenses. Notice
that, because of this, partial repayment of principal will result in the
need for a new interest expense allocation. Borrowings on a line of
credit will be treated as separate loans if the interest rate has
changed in the interim, and the loans will be considered to be repaid in
the same order that the loan document treats repayments, usually in the
order in which the borrowings occurred. Record-keeping will be
simplified if separate loans are taken and separate accounts maintained
for separate types of expenditure.

AN ESSENTIAL COMPONENT OF RISK MANAGEMENT: INSURANCE AGAINST LOSS OF
INCOME

Protection against income loss resulting from disability is one of the
most frequently overlooked elements of an adequate risk management
program. In this instance, many people fail to consider the odds. The
average forty year old is substantially more likely to be seriously
disabled for a significant length of time before reaching age 65 than to
die The income loss and other costs associated with such a disability can
wreck otherwise well-laid financial plans and prevent the attainment of
necessary resources for retirement.

There may be several reasons why individuals are so frequently
under-insured against catastrophic disability. Many have group coverage
through their employment which they may assume provides more protection
than is actually the case. Others may think they can rely on Social
Security, failing to realize that severe restrictions are associated
with that program. In addition, good disability coverage is relatively
expensive. (Being under-insured can be much more costly, however.)

Ensuring the safety of your financial future requires re-evaluating
your disability coverage if you have not recently done so. Be sure to
verify that the following policy features are appropriate to your
circumstances.

Amount of coverage. Your disability coverage should replace a minimum of
60% of your earned income, and more is better Insurers place
restrictions on the income replacement ratio, so coverage in excess of
70% to 80% is not available.

Definition of disability. A good policy will specify that benefits are
to be paid when you are unable to perform the duties of your "own
occupation." This is an important provision, since many policies provide
for payment of benefits only when the insured is unable to engage in
"any occupation."

Non-cancellable and Guaranteed Renewable. Your policy should include
this provision, which protects you against cancellation of the policy or
a premium increase even if claims are made on the policy or your
circumstances change.

Elimination Period. The elimination period is the length of time you
must be disabled before receiving benefits. Thirty to 180 days is
typical. The longer the elimination period, the less the premium cost.
To determine what is suitable for you, consider the amount of your
emergency reserve fund.

Benefit period. Many policies cut off benefits paid for disability due
to sickness at age 65. The provision that benefits will be paid for
life is more desirable.

Residual Benefits. Policies which provide for residual benefits will pay
benefits for partial disability during either recovery from or onset of
a disabling illness.

Cost-of-Living Rider This feature, for which an additional premium will
be charged, provides for adjustment of the monthly disability benefit
to reflect changes in the consumer price index.


1987 YEAR END TAX STRATEGIES

Although tax planning is more difficult than before passage of the Tax
Reform Act, utilizing appropriate strategies can still result in a
reduced tax outlay. The following suggestions apply to individuals
whose income is regular or rising and who will not be subject to the
Alternative Minimum Tax in 1987. If you have invested in limited
partnerships for tax shelter, made charitable gifts of appreciated
property or exercised stock options during 1987, see your personal
financial advisor to determine whether the AMT will apply.

   1. Wherever possible, defer receiving income until 1988, when tax rates
      are scheduled to be lower. Interest income can be postponed by
      purchasing Treasury bills or Certificates of Deposit which mature in
      1988 and credit interest at maturity. Postpone taking capital gains,
      receiving bonuses or exercising stock options. (An exception exists for
      persons who have net long-term capital gains available and who will be
      in the 33% marginal tax bracket in 1988. Taxes on long-term capital
      gains are limited to 28% in 1987.)


   2. Accelerate the payment of deductible items into 1987 when rates are
      higher than they will be in 1988. Take available short-term capital
      losses this year and try to lump "miscellaneous" deductions, such as
      work related expenses and various fees (including those for tax and
      financial planning), into whichever year they are most likely to exceed
      the new floor of 2% of adjusted gross income. Bunch medical expenses
      also, since they must now exceed 7 1/2% of adjusted gross income before
      becoming deductible.

   3. To the extent possible, pay off consumer and other debts generating
      interest expense which will only be 65% deductible in 1987 under the new
      rules. Consider refinancing any debt which cannot be paid off with
      proceeds from a home equity loan.

   4. Keep complete and exact records. The new tax forms are more complex
      than in prior years and call for additional information in a number of
      areas. The rules governing deductibility of interest expense require
      documenting the use of loan proceeds in most cases. Up-to-date records
      of home improvements are now important not only when you sell your home
      but also if you have post August 16, 1986 borrowings against it.
      On-going documentation of all IRA contributions and whether or not they
      are deductible is now required.

   5. Continue to invest in IRAs and 401K plans. Despite new restrictions,
      they continue as good vehicles for retirement savings. A non-deductible
      IRA still provides tax deferred compounding not otherwise available
      without paying a commission. But don't put money that you may need
      before retirement into either plan.

   6. If you plan to invest in mutual funds, check the expense ratio.
      Under the new Tax Act, your taxable income from the fund will be grossed
      up to include the management fee. Funds with low fees are at an
      increased advantage.

   7. Annualize year-to-date withholding and check it against your
      projected 1987 tax liability. Unless at least 90% of your actual 1987
      tax (or 100% of 1986 tax) is withheld by year-end, penalties may be
      incurred. Under-withholding is now more likely to occur than in prior
      years because of lost deductions and the increased value of each
      exemption claimed.


NON-QUALIFIED RETIREMENT PLANS FLEXIBILITY & UNLIMITED BENEFITS

New restrictions and penalties established by the Tax Reform Act have
constricted the potential benefits which can be derived from qualified
retirement plans. The new law also tightened non-discrimination
provisions of such plans. Consequently, non-qualified retirement plans
are receiving increased attention as a means of providing additional
retirement benefits to business owners and key employees. Contributions
to such plans are not immediately deductible to the employer, but
neither are they limited in amount. Moreover, non-qualified plans may
freely discriminate.

If the employee is to escape immediate taxation on the employer's
contribution, his interest in the deferred compensation promised by the
employer must be subject to a "risk of forfeiture." In addition, the
plan must be in place before the compensation is earned and must be
irrevocable, and the benefits must be unavailable until some specific
date of triggering event. The plan cannot be "funded" or secured.
However, it may include a trust account which is reachable by the
employer's general creditors and in which the employee has no vested
interest.

There are no restrictions as to the manner of investment of any funds
held in trust. Earnings credited to the account may be based on actual
performance or some other designated measure, such as an index or
interest rate. Life insurance is often used as a means of funding,
because policy earnings are not currently taxable to the employer.

The technical information contained in this publication is of a general
nature. Consultation with our personnel is recommended before taking
action based upon any of this information.