Sigcat Software Showcase 1992/SIGCat Software Showcase 1992 - CD-ROM Strategies.ISO/research/docs/spring89.txt

Text File | 1992-03-02 | 15.6 KB | 313 lines

Tofias
Fleishman
Shapiro                                              Spring
& Co., P.C.                                          1989

Certified Public Accountants

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


PERSONAL FINANCIAL PLANNING QUARTERLY


PLANNING FOR EDUCATION COSTS: TAX STRATEGIES AND INVESTMENT VEHICLES

The Tax Reform Act of 1986 severely limited parents' ability to
shift income to children to be taxed at lower rates. The change, which
applies only to the income of children under age 14, stipulates that a
child's unearned income (interest, dividends, capital gains, rents,
trust income and the like) in excess of $1,000 annually will be taxed at
the higher of the parents' or the child's rate.

Beginning in 1989, children whose only income is $5,000 or less of
interest or dividends will no longer have to file a separate tax return.
This will relieve the paperwork burden of parents, who may elect, in
such instances, to report a child's unearned income on their tax return
if the child made no estimated tax payments and is not subject to
back-up withholding on interest or dividend income. Starting in 1989,
however, persons for whom a dependency exemption may be claimed on a
parent's tax return will no longer include full-time students who reach
age 24 by year-end and have earned income greater than the exemption
amount (currently $2,000).

Tax Planning - Most tax planning techniques for education funding
involve avoiding or minimizing the taxation of income to parents. This
may be achieved through:

     1. Limiting investment income on assets earned by children under 14
        to $1,000 (per child).
     2. Deferring the recognition of income until after a child reaches
        age 14.
     3. Transferring the taxation of investment income earned by a
        child's assets to a trust.
     4. Generating tax-free earned income for a child, when possible.

Limiting Investment Income - Investment assets owned by children
are usually held with an adult custodian, often a parent, under either
the Uniform Gifts to Minors Act (UGMA) or the Uniform Transfer to Minors
Act (UTMA). Custodial accounts may easily be set up with a bank or
brokerage house. The first $1,000 of investment income earned by the
account will be taxed to the child, and after being offset by a $500
standard deduction, will result in a tax liability of $75.00 under
current law. Taxable investment income may be limited by restricting
other account assets to tax-exempt securities, such as municipal bonds

or non-dividend paying growth common stock or mutual funds. Under UTMA,
which has been adopted by more than thirty states, the custodial account
may also contain such non-income-producing assets as undeveloped land or
collectibles.

Deferring Income Recognition - Growth stock, which may include that
of a closely held family corporation, will often generate no taxable
income until its sale (after the child attains age 14). The same is true
of tangible assets held for appreciation.

Series EE Savings Bonds allow the owner to elect to defer taxation
on accrued interest until the bonds are cashed in or mature, which may
be after their owner reaches age 14.

The 1988 Tax Act (TAMRA) created a limited opportunity to
completely avoid payment of taxes on accrued interest of Series EE
Savings Bonds used to pay qualified higher education expenses. The
requirements are:

   1. The Series EE bonds must be issued after December 31, 1989.
   2. The purchaser must be age 24 or older and hold the bonds in his
      or her own name or with a spouse. The exclusion is not transferable to
      another party.
   3. Qualified higher education expenses include tuition and fees net
      of scholarships and other tuition-reduction assistance. The expenses
      must be incurred by the taxpayer, a spouse or dependent during the year
      the bonds are redeemed. Excludable interest is limited to the amount of
      the qualified higher education expenses.
   4. The deduction is ratably phased out for persons having modified
      adjusted gross incomes between $60,000 and $90,000 on joint tax returns
      and between $40,000 and $55,000 on returns of single taxpayers and heads
      of households. (These ranges will be indexed for inflation after 1990.)
      Married individuals filing separate tax returns are not eligible for the
      exclusion.

In addition to tax deferral, and possible tax avoidance, Series EE
bonds offer safety, a variable interest rate tied to 85% of the average
five-year Treasury note rate (with a guaranteed 607o minimum if the
bonds are held five years).

Zero coupon Treasury bonds may be an appropriate investment vehicle
for college savings in a custodial account. These bonds, which are
purchased at a deep discount, accrue interest on which tax must be paid
each year until their maturity. However, because of compounding, the
interest builds relatively slowly in the early years, and much of it may
accrue after the child reaches age 14.

Transferring Income - A child's trust, as provided for in IRS Code
Section 2503 (c), may produce tax savings by limiting taxation to 15% on
the first $5,000 of income retained by the trust each year. (Any amount
retained above $5,000 will be taxed at 28% under current law.)

The child is the trust beneficiary, and a parent or someone else
may serve as Trustee. Trust income may either be used for the child's
benefit, although not to fulfill legal parental obligations, or
accumulated until the trust terminates. The child must be given the

option to withdraw principal and accumulated income at age 21. However,
should the child decline to accept distribution within some reasonable
specified period of time, the trust may continue until some later
designated age.

Gifts to a minor's trust qualify for the annual $10,000 gift tax
exclusion amount. There will, however, be legal fees for establishing
the trust and possibly other costs, since an annual trust tax return
must be filed.

Generating Earned Income - Income earned by a child will be taxed
at the child's rate and is tax free up to $3,000, which will be indexed
for inflation beginning in 1989. In addition, if a child under age 18 is
employed by a parent, there is no obligation to pay Social Security tax
on his or her behalf. Where the parent's business is a sole
proprietorship, the 13.02% self-employment tax avoided on income
transferred from the parent to the child may, under certain
circumstances, represent an additional savings. Wages paid to a child
should, of course, be commensurate with the job and the amount of time
expended. Other considerations - Planning to fund higher education may
be complicated by rules governing financial aid. Both the parents' and
child's assets are included in the calculation of need, but a larger
portion, generally 35%, of a child's available assets is expected to be
contributed toward college expenses. In addition, parents give up
control of assets owned by children. These disadvantages may, however,
be offset by both income and estate tax savings.


INSURANCE FOR LONG-TERM HEALTH CARE

One of the greatest fears of many older persons is the prospect of
a debilitating or progressive illness requiring long-term custodial
care. In addition to physical pain, the cost of care for such an illness
can easily wipe out a life-time of savings, leaving Medicaid, a
government welfare program for the poor, to pick up the remaining
expenses. In the past, Medicaid rules required that nursing home
patients and their spouses be virtually impoverished before benefits
could be received. The recently enacted Medicare catastrophic health
care provisions require state Medicaid plans to allow spouses to retain
a minimum $800 in monthly income and from $12,000 to $60,000 in assets,
plus the couple's home if occupied by the spouse.

In response to this concern, a new form of health insurance policy
covering the cost of long-term care has begun to evolve. Many of the
earliest policies contained restrictions severely limiting benefits.
Most of the others are quite expensive (several hundred to several
thousand dollars a year), with premium cost increasing with the age of
the insured at purchase. Because the potential cumulative premium costs
may be substantial, long-term care insurance should be purchased only
when there are significant financial assets to preserve. As with other
types of insurance, costs can be reduced by selecting a longer waiting
period before benefits begin. The number of days' care which a person
may wish to self-insure will vary with available assets. Protection should
be purchased against potentially disastrous financial losses.

In evaluating a long-term-care policy, check the following provisions:

Daily Benefit. A good policy may pay up to $120 per day for nursing
home care and may contain a rider increasing the benefit annually by
some set percentage.

Maximum Benefit Period. Took for a policy which covers nursing home
care or home health care for an unlimited number of days. (Five to seven
years should be a minimum.)

Home-Care Benefit. Coverage should be provided for the cost of
custodial care at home, with a benefit of up to $100 per day.

Premium Amount and Renewability. The policy premium should remain
constant over time, and the company should guarantee to renew coverage
as long as the premium is paid.

Type of Institutional Care Provided. It is essential that the
policy cover all types of nursing home care - skilled care, intermediate
care and, especially, custodial care under the same terms and with the
same daily benefit.

Prior-Hospitalization and Prior-Skilled Nursing Rules. It is
important that the policy contain no provision requiring a prior stay in
a hospital or skilled-nursing-care facility before custodial care is
covered. Such a provision has restricted the availability of benefits in
numerous instances.

Pre-Existing Condition Rules. Coverage for pre-existing conditions
should be provided after a waiting period of no more than six months.

Alzheimer's Disease. The policy should provide coverage for care of
Alzheimer's patients or those with mental illness. Alzheimer's
frequently results in a need for custodial care.

INSIGHTS FROM AN INVERTED YIELD CURVE

Under normal circumstances, the yield curve, a graphic depiction of
interest rates versus bond maturities, is an upward sloping line. Such a
curve indicates that as maturities lengthen, interest ratios rise. The
increasing yields represent a premium paid to investors in compensation
for the increased risk of longer maturities.

Lately, however, the yield curve has become inverted and is
characterized by a downward sloping line for maturities greater than
about two years. An inverted yield curve may be caused by the Federal
Reserve pushing short term rates up to counteract perceived inflationary
pressures in the economy. Since the market doesn't anticipate inflation
as a problem over the long-term, long-term rates are unaffected.

The danger is that if the short-term cost of credit is pushed too
high, businesses and individuals may cut back on spending to an extent
that produces a recession. In the past this has occurred so frequently
that many financial professionals now view an inverted yield curve as a
forerunner of recession.

Investors can benefit from high short-term rates through money
market funds, which offer low risk and liquidity and currently pay
yields competitive with those of long-term bonds. Since interest rates
fall during a recession, it may be wise to diversify by placing some
funds in longer term interest bearing securities.

An inverted yield curve is considered negative for the stock
market, both because of competition from interest bearing securities and
the threat of recession. Once short-term rates peak and begin to
decline, however, the stage is set for enhanced stock market
performance.


HOUSEHOLD EMPLOYEE OBLIGATIONS

Employing household help increases your tax-related paperwork and
financial obligations, if the domestic helper is considered an employee.
An employer is responsible for withholding and paying Social Security
(FICA) taxes for any employee receiving at least $50 in quarterly
compensation. The combined tax amount is 15.02% of the employees
compensation up to $48,000 in 1989. The employer may either pay the
entire amount and report the employee's share as additional taxable
income on form W-2 or withhold the employee's (7.51%) share and add
7.51%.

The tax must be paid and reported on federal Form 942 on a
quarterly basis. If federal income tax is withheld from the employee's
wages, it may be reported on the same form. The first 1989 payment is
due May 1.

An employer is also responsible for paying federal (FUTA) and state
unemployment taxes for any employee receiving compensation of $1,000 in
any calendar quarter of the current or previous year. FUTA taxes are at a
net rate of .008 of the first $7,000 of wages. The FUTA form 940 must be
filed by January 31 of the following year, although deposits may be
required for any quarter during which the liability exceeds $100.

Hiring a cleaning service or independent contractor to provide
housecleaning, yard work, or dependent care avoids these tax reporting
responsibilities.


STOCK INDEX FUNDS

In 1988, the total return on the Standard & Poor's 500-stock Index
was 16.6070. Most mutual fund managers did not do as well, although a
few achieved far greater returns. One reason for the managers' lagging
performance is transactions costs incurred in the buying and selling of
securities. Such trading is generally integral to their management of
the fund.

A pure stock index fund simply buys the securities which make up
the relevant index (often the S & P 500) and holds them indefinitely.
This eliminates most costs. Thus, index funds offer an opportunity to
nearly match the performance of the index (not all costs can be
eliminated).

Although simply matching the performance of the S & P 500 index
provides a return which is "above average" for fund managers, many index
funds attempt to improve on the index's performance by trading options
or altering the portfolio mix. The more actively managed the portfolio,
the greater the reliance on the fund manager's abilities and the risk
that his performance will lag behind the index. Transactions costs also
begin to increase, and the initial purpose of the index may be defeated.

STOCK MARKET FOLKLORE: MYTHS WHICH MAY OR MAY NOT BE TRUE

   1. The Weekend Effect. The market tends to go down on Monday, up on
      Friday. (Corollary: Buy on Monday - sell on Friday.)
   2. The January Effect. The markets' performance in January sets the
      tone for the rest of the year. Also, small capitalization stock tend to
      do well during early January.
   3. The Presidential Cycle. Stocks (and the economy) tend to do
      better during the last two years of a president's term than during the
      first two years.
   4. End of Month. Stock performance tends to be best during the last
      trading day of the month and the first three trading days of the next
      month.
   5. Holiday Effect. The market tends to rise during the last trading
      day, preceding a holiday. The ranking for positive returns is as
      follows: Labor Day, Memorial Day, Thanksgiving, New Year's Day,
      Christmas, Good Friday and the fourth of July.

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.