Sigcat Software Showcase 1992/SIGCat Software Showcase 1992 - CD-ROM Strategies.ISO/research/docs/summer87.txt

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

Certified Public Accountants 1987

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


  PERSONAL FINANCIAL PLANNING QUARTERLY


THE ALTERNATIVE MINIMUM TAX MORE IMPACT THAN EVER

The significance of the alternative minimum tax for individual tax
planning has been increased by:

   1) A narrowing of the spread between
      regular and alternative tax rates;

   2) The designation of several new tax
      preference items; and

   3) The phasing out of the exemption amount above
      certain income levels.

Since its inception, the purpose of the alternative minimum tax has
been to ensure that everyone pays some significant share of income
taxes. The rules governing the tax require that items of tax
"Preference" (such as the formerly available exclusion on long-term
capital gains and the use of accelerated depreciation) be added back to
adjusted gross income and that certain itemized deductions be disallowed
in calculating the alternative minimum tax. After subtracting an
exemption amount ($40,000 for joint returns, $30,000 for singles) from
the resulting tax base, the alternative minimum tax rate, now 21%, is
applied. The tax resulting from this computation is compared to the tax
calculated under the regular rules, and the larger amount must be paid
by the taxpayer.

The preference items most likely to trigger the alternative minimum tax
for individuals under the 1986 law are:

    ■  Net Losses from "Passive" Investments
       Transition rules allow a percentage ranging from 65% to 10% of such
       losses from pre October 22,1986 investments to be deducted in 1987
       through 1990. The deductible amount is a preference item and must be
       added back to income.
    ■  Consumer Interest Deductions
       The deductibility of consumer interest expense is also phased out
       between 1987 and 1990. In the interim, any deductible amount is a
       preference item and not deductible for alternative minimum tax
       purposes.

    ■  Interest on Home Refinancing or Home Equity Loans
       Home mortgage interest on first and second homes is deductible for
       regular tax up to the cost of the home plus improvements. In addition,
       interest on proceeds used for educational or medical expenses may be
       deducted. Under the alternative minimum tax rules, however, deductible
       interest is generally limited to the amount of the original mortgage.

    ■  Charitable Gifts of Appreciated Property
       Under the regular tax the full fair market value of such property is
       deductible. The difference between fair market value and cost must be
       added back to income in calculating the alternative minimum tax.

    ■  Incentive Stock Options
       The difference between the exercise price and the fair market value of
       the stock at the time of exercise is a preference item.

    ■  Tax-Exempt Interest from Private-Activity Municipal Bonds
       For bonds issued after August 7, 1986, such interest is subject to the
       alternative minimum tax.

    ■  Accelerated Depreciation
       The excess of accelerated over straight line depreciation is a
       preference item. However, the 1986 tax law distinguishes between
       preference items which merely defer taxes, such as accelerated
       depreciation, and those which permanently lower them. Credits are
       established which are generally equivalent to the amount of alternative
       minimum tax resulting from a deferral type preference item. These
       credits may be carried forward and offset regular, but not alternative
       minimum, tax liability in subsequent years.

Under the new rules, the alternative minimum tax exemption amount is
phased out at alternative minimum tax income levels above $150,000 for
joint returns and $112,500 for singles. There is a reduction of 25 cents
for each dollar of additional income.

Sound tax planning requires anticipating whether or not you will be
subject to the regular or alternative minimum tax. When the alternative
minimum tax applies, taxable income should be accelerated, if possible,
to take advantage of the 21% rate. State and local taxes are not
deductible, and payment should be postponed to the extent feasible.
Charitable contributions provide less tax benefit than under the regular
tax, and gifts of appreciated property should be avoided altogether.


THE NON-DEDUCTIBLE IRA: A GOOD INVESTMENT?

Under the Tax Reform Act of 1986, a person who is an "active
participant" in a qualified retirement plan (or whose spouse is an
active participant in such a plan) and whose adjusted gross income
exceeds $50,000 ($35,000 if unmarried) will, beginning in 1987, be
unable to deduct any contribution made to an Individual Retirement
Account. Affected individuals may continue to contribute up to $2,000
($2,250 for a spousal account) on an after-tax basis. The earnings on
the account will compound tax deferred and be taxed upon withdrawal
along with any deductible contributions made under prior law. The
pro-rata portion of any withdrawal representing non-deductible
contributions will be tax free.


This change in the rules raises a question as to whether funding an IRA
is still worthwhile. The answer is "Yes" for persons who view the
account as a vehicle for accumulating retirement assets and who
anticipate no interim need to withdraw funds. It is clear that over time
the tax deferral of earnings has significant value, although the actual
dollar benefit will vary with marginal tax rates and the number of years
of deferral. Moreover, the Individual Retirement Account offers greater
investment flexibility at lower cost than its most similar competitor,
the tax-deferred annuity.

For those whose primary motivation has been immediate tax benefits, the
situation is different. Penalties on early withdrawal and other
disadvantages associated with the IRA may not be adequately compensated
by the tax deferral of earnings. Certainly the following should be
considered in the decision.

    ■  A 10% penalty is imposed on funds withdrawn from an IRA before age 59
       1/2 for reasons other than death or disability. The penalty is in
       addition to any other tax due.
    ■  Current individual marginal tax brackets may be lower than those in
       effect upon withdrawal.
    ■  Persons who already have IRA balances accumulated on a before-tax
       basis face a tax on the immediate or early withdrawal of any
       non-deductible contribution due to its aggregation with deductible
       contributions.
    ■  Losses occurring within an IRA, whether funded with deductible or
       non-deductible contributions, are not tax deductible.
    ■  The new law adds an upper limit on the amount which may be withdrawn
       without penalty from an IRA each year.
    ■  The new law increases the complexity of bookkeeping chores
       necessary to the IRA.



CLOSED END FUNDS AN EXPLANATION

Most mutual funds are "open end" funds. They issue an unlimited number
of shares as money is received from investors. Conversely, they redeem
shares as necessary to return in cash the net asset value of shares
owned at the request of the investor. In order to redeem their own
shares, open end mutual funds must either keep a cash reserve or sell
securities as required.

A "closed end" fund issues only a limited number of shares to raise
funds for investment at its inception and does not redeem its own
shares. Instead, a current shareholder who wishes to convert to cash can
do so only by selling his or her shares to another investor through a
brokerage firm at whatever price the market dictates. Only in very rare
instances would the price be equivalent to the fund's net asset value
(of securities held by the fund). Closed end funds usually sell at a
discount to net asset value, although they may sell at a premium.

In terms of performance, the open end structure would seem to be at a
disadvantage because of the tendency for money to flow in when the
market is up (and few bargains are available) and to be withdrawn when
stock prices have dropped. Neither the holding of cash in a rising market
nor the selling of securities into a falling market is likely to enhance
the fund manager's performance.

Considering the advantage enjoyed by managers of closed end funds, the
historical tendency of the funds to trade at a discount runs counter to
expectation. Contributory factors may include the large number of
initial public offerings of closed end funds during recent years and
their attendant heavy marketing, which may have reduced demand in the
secondary markets. In addition, high management fees and other expenses
tend to depress share prices.

The discounted price may be the best reason to buy a closed end fund.
Prices may easily be 20% or more below net asset value, which creates a
form of leverage. If a fund performs well, benefits may be realized
both from an increase in the net asset value and from a narrowing of the
discount. Moreover, if the market falls, the discount may tend to
cushion a fund's price decline somewhat, especially if the discount is
very deep.


VACATION HOME OR RENTAL PROPERTY?

The new tax law requires owners of vacation homes to select between
alternative rules for deducting expenses by choosing to characterize the
property either as a second residence or as a rental property.

If the owner's annual personal use of the property exceeds the greater
of 14 days (excluding days required for maintenance) or 10% of the
number of rental days, the vacation home will be considered a second
residence. All mortgage interest up to the cost of the home plus
improvements will be deductible, as well as real estate taxes. However,
other expenses such as fees, utilities, maintenance and depreciation
will be deductible only to the extent of rental income, and a pro-rata
portion of mortgage interest and real estate taxes must first be claimed
against such income.

If the owner's personal use of the vacation home is limited to less
than 14 days per year (or 10% of rental use), the property will be
considered rental property. All expenses related to the property will
be deductible, but any resulting loss will be considered a "passive"
loss and available to offset only passive income, not earned or
investment income. (If the property was placed in service prior to
October 22, 1986, transition rules allow the use of passive losses to
shelter other income as follows: 65% in 1987, 40% in 1988, 20% in 1989
and 10% in 1990.)

An exception exists for persons with adjusted gross income less than
$150,000. If the owner actively manages the property, up to $25,000 in
losses may be written off against other income. The allowance gradually
declines and is phased out above $100,000 AGI.

Unutilized passive losses are suspended and available either to offset
future passive income from operations or on the disposition of the
property.

Whether it is more advantageous to characterize the property as a
personal or rental residence depends on a number of factors including
the owner's income level and the amount of mortgage interest,
depreciation and other expenses, including any planned maintenance.
Written calculations will be helpful in decision making. Rental status
may prove to be preferable where rental losses are substantial and at
least partially deductible. After 1987, personal use may become more
desirable for higher income individuals due to the tightening of
restrictions on the deductibility of passive losses.


TAX PLANNING AFTER DEATH

Planning to minimize estate taxes does not end with the preparation of
wills and other necessary legal documents during one's lifetime. The
importance of appointing a well qualified Executor is highlighted by
the complexity of planning which can only be accomplished after death.
Decisions may be necessary in a number of areas including the following:

    ■  The Q-Tip Election:
       A Q-Tip trust allows a married person to leave a substantial interest
       in property to the surviving spouse, obtain the marital deduction for
       the property in the first estate and still control who will receive the
       property upon the spouse's death. If the Q-Tip election is properly
       made on the estate tax return, the entire value of assets subject to the
       election will be included in the surviving spouse's estate for tax
       purposes.

    ■  Qualified Disclaimers:
       Sometimes unforeseen events make it desirable to amend a testator's
       written plan for disposition of property after the testator is deceased.
       One means of accomplishing this is through the use of qualified
       disclaimers by the named beneficiaries. Since individuals are unlikely
       to disclaim a bequest except to obtain some greater benefit, the Executor
       may find it necessary to assist the beneficiaries in understanding the
       ramifications of a disclaimer or refusal to disclaim. He or she must also
       see that any disclaimer meets the requirements to be qualified.

    ■  Valuation Date Decision:
       The Executor must timely elect whether estate assets are to be valued
       for estate tax purposes as of the date of death or the alternate
       valuation date six months after the date of death. Especially when
       assets which fluctuate in value are part of the estate, this decision
       may result in significant estate tax savings. The decision is
       complicated by interaction with the resulting tax basis of assets and
       potential income tax liability of the beneficiaries.

    ■  Expenses of Estate Administration
       A decision to deduct these expenses from either federal estate tax or
       the estate's income tax must be based on which is financially most
       advantageous.

    ■  Estate's Year End
       The Executor may choose either a fiscal or calendar year end for the
       estate. A sound choice may achieve significant income tax savings and
       deferral of liability.

    ■  Split Gifts
       When the decedent and surviving spouse made substantial gifts shortly
       before death, the Executor may join the surviving spouse in consenting
       to split the pre-death gifts in order to obtain the maximum gift tax
       exclusion.

    ■  Final Income Tax Return
       A federal income tax return must be filed to reflect the decedent's
       income in the short tax year ending with the date of death. The Executor
       must decide, based on available tax savings, whether to file this
       return separately or jointly with the surviving spouse s income for the
       entire calendar year.


COLLATERALIZED MORTGAGE OBLIGATIONS AN IMPROVEMENT ON GNMA'S

Investors have looked favorably at the attractive yields of pooled
Ginnie Maes and other mortgage backed securities. However, some other
features of these securities have been annoying. First, they distribute
(pass through) a combination of interest and principal, both from
amortization of the pooled mortgage loans and from early mortgage
payoffs. The investor who does not wish to impair principal must take
care to track and systematically reinvest the returned capital. Second,
the length of time before the mortgages are paid off is unpredictable. A
drop in the interest rate will dramatically speed the process as
homeowners refinance their mortgages. Since, under such circumstances,
the principal returned to the investors must be reinvested in a lower
interest rate environment, the value of mortgage backed securities may
be discounted for uncertainty of return.

Collateralized Mortgage Obligations are a variation on mortgage pass
throughs. Instead of passing through interest and principal payments
from homeowners directly to investors, CMOs use the pass through
securities as collateral to create a series of bonds of varying expected
lives. The shortest bonds receive any principal payments until they are
completely paid off, then the next series and so on. This enables the
longer series to receive payments of interest only for some roughly
predictable number of years.

CMOs are not directly guaranteed by any government agency. However,
their collateralization by the guaranteed mortgages provides a
relatively high degree of security.

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.