Playing Defense as Stock Prices Soar


As of this writing, major U.S. stock market indexes are at or near record highs. This bullish run might continue…or it might end with a severe slide. Here are some strategies to consider.

Stay the course

Many investors will prefer to keep their current stock market positions. For nearly a century, every stock market reversal has been followed by a recovery. Even the severe shock of late 2008 through early 2009 has led to new peaks, less than a decade later.

What’s more, holding onto stocks and stock funds won’t trigger any tax on capital gains.

Move into cash

Investors who are truly nervous about pricey stocks can sell some or all of those holdings, then put the sales proceeds into vehicles that historically have been safe havens, such as bank accounts and money market funds. This would reduce or eliminate the risk of steep losses from a market crash. In both the 2000–2002 and the 2007–2009 bear markets, the S&P 500 Index of large-company stocks fell about 50%. After a loss of that magnitude, investors need a 100% rebound, just to regain their portfolio value.

However, cash equivalents have negligible yields right now, so investors would essentially be treading water in bank accounts and money funds. Timing the market has proven to be extremely difficult, so investors who go to cash risk missing out on future gains as well as possible losses. In addition, investors who sell appreciated equities held in taxable accounts will owe capital gains tax, which could be substantial.

Move into bonds

Aside from cash, bonds have long been considered a lower risk counterweight to stocks. According to Morningstar’s Ibbotson subsidiary, large-company U.S. stocks have suffered double-digit losses in five different calendar years since the 1970s. In 2008, that loss was 37%.

Long-term government bonds, on the other hand, have had fewer down years. The only year they lost more than 9% was 2009, when a drop of 15% was reported. That 2009 loss, though, came after a 26% gain in 2008, when stocks tanked. Therefore, Treasury bonds can be a useful hedge against stock market losses.

Yields on the 10-year Treasury are currently around 2.6%, so long-term Treasury bond funds may pay about 2%: not great, but more than the payout from cash equivalents. Intermediate-term Treasury funds will have lower yields but also less exposure to stock market volatility.

Investors in high tax states may have another reason to favor Treasury bonds and Treasury funds because the interest from these investments is exempt from state and local income tax. To benefit from the tax break, you must hold Treasuries in a taxable account.

Treasuries certainly can be held in a tax-deferred account such as a 401(k) or an IRA, and many investors do so. However, the state and local income tax break might be lost because withdrawals from tax-favored retirement plans may be fully taxable. (Some states offer tax exemption to distributions from retirement plans, often up to certain amounts.)

Individual circumstances

All of these strategies have advantages and drawbacks, so you should proceed with caution. Very generally, buy and hold strategies might appeal to workers who are some years from retirement. A market drop may turn out to be a buying opportunity, especially for those who are investing periodically through contributions to 401(k) and similar plans. On the other hand, trimming stocks might be prudent for people in or near retirement. Investment opportunities at low stock prices may be reduced, and a market skid can be particularly dangerous for retirees who are tapping their portfolio for spending money.

Treasury bond interest

  • Interest income from Treasury bills, notes, and bonds is subject to federal income tax.
  • That interest is exempt from state and local income taxes.
  • If you invest in a bond fund that holds only U.S. Treasuries, you will owe federal income tax on the interest income but no state or local income tax on that interest.
  • Although the bonds held in a bond fund pay interest, the fund will pay dividends to the fund’s investors. Those dividend payments will be taxed at the federal level as interest income, at ordinary income rates.

Defined Benefit Plans for Small Companies


Traditional defined benefit plans, structured to provide a lifelong pension, have become rare in the private sector. They’re still the norm for public sector employers; some large companies continue to offer plans.

Ironically, these plans might be a good fit for extremely small companies. A possible prospect could be a business or professional practice with one or two principals who are perhaps 5–10 years from retirement, with a few employees who are younger and modestly compensated.

Key difference

Most private sector retirement plans today are defined contribution plans. That is, the amounts that can be contributed to the plan are set by law, with a maximum of $60,000 (counting employee and employer inputs) in 2017, or $54,000 for those under age 50. The amount of the eventual retirement fund will depend on how much is contributed and how well the selected investments perform.

Defined benefit plans, as the name indicates, operate by setting a target benefit: the amount of a pension a given employee will receive in retirement. That benefit is determined by an employee’s age, compensation, and years of service with the company. Such plans might permit annual contributions well over $120,000 to the principal’s account, in certain circumstances. With few years to retirement, it will be necessary to build an adequate fund quickly, with large annual cash flows into the plan.

Those contributions can be tax-deductible for the employer and not taxable to the employee until money is received in retirement. Much smaller amounts might have to be contributed to the accounts of younger employees, who have many years to build up a retirement fund. What’s more, the money in the principal’s account eventually may be rolled over into an IRA, tax-free, for ongoing control over investment decisions and distributions.

Note: Even if your company already has a defined contribution plan such as a 401(k), it may be able to establish a defined benefit plan as well.

Proceed with care 

Before jumping into a defined benefit plan, business owners should consider the drawbacks. These plans can be extremely expensive to administer. You must hire an actuary or a third-party administrator to calculate how much to contribute annually. What’s more, your company must continue to make the required payments to the plan, even in a down year, and underfunding might trigger IRS penalties. Other rules and regulations apply to defined benefit plans.

In addition, some defined benefit plans may be structured so that employees who don’t work for a specified number of years forfeit their benefits. This can create incentives for the company’s principals to hire short-term workers. Hiring individuals who become long-term employees probably will be better for the firm, in terms of business results, but these workers eventually may be entitled to large payouts from the plan.

Overall, there is more to a small-company defined benefit plan than large tax-deductible contributions for business owners. If you think such a plan could work for you, HLB Gross Collins, P.C. can go over the numbers with you and explain the requirements that your company would face.

Long-term Care Coverage Combo Plans


If you or a loved one ever need help with daily living activities, you will discover that custodial care can be expensive. That’s true whether the care is provided at home, in an assisted living facility, or in a nursing home, and it’s especially true if care is needed for many years.

Long-term care (LTC) insurance is available, but insurance companies have learned that these costs can be steep. Premium increases for LTC insurance are in the news (for example, some press reports tell of cases where premiums have tripled in the last three years), and some insurance companies have dropped out of this business. Consumers face the prospect of paying thousands of dollars a year, every year, and never getting any benefit at all if it turns out that custodial care is not needed.

Sure things 

Some people might prefer another path to LTC coverage, such as a hybrid or “combo” product. These come in two varieties: a combination with a life insurance policy or with a deferred annuity. Here, a consumer buys a product that will deliver a death benefit (life insurance) or future cash flow (deferred annuity). With a combo product, the consumer can obtain a rider that will offer a payout if the covered individual needs LTC.

Example 1: Ted Moore has an insurance policy on his life, payable to his son Paul. Ted’s policy has an LTC rider. So, if Ted needs LTC, that insurance policy will provide a benefit to help pay those bills. Regardless if Ted needs care and collects an LTC benefit, his life insurance policy will pay a death benefit to Paul at the time of Ted’s death.

Generally, in this situation, Ted would receive an “accelerated death benefit” to pay for care. When someone receives such a payout, the amount of the lifetime benefit is subtracted from the death benefit that eventually will be paid to beneficiaries. Typically, a combo life insurance product would be some form of whole life or universal life, rather than term life insurance.

Example 2: Rita Smith decides to invest in a deferred annuity, attracted by that particular product’s features, which include guaranteed withdrawals. Like Ted in the previous example, she has an LTC rider for this annuity. In retirement, Rita can receive cash flow from the deferred annuity, and the LTC rider will provide money to pay for care, if needed. Depending on how Rita handles the annuity, there also may be a payout to beneficiaries she has named at the time of her death.

The common aspect of those two tactics is the absence of a “use it or lose it” drawback. With standalone LTC insurance, the money spent could wind up generating no return. With either life insurance or a deferred annuity, there will be a payout to someone at some point. The extra LTC coverage is another benefit that possibly will come in handy.

Acquiring LTC coverage in this manner usually avoids the threat of future premium increases. As another attraction, existing life insurance policies or annuities might be exchanged, tax-free, for a new contract that includes an LTC rider.

Added expense

The attractions of LTC combo products, however, come with negatives as well. The underlying problem here includes the potentially disastrous costs of LTC, and this problem can’t be escaped by switching from one type of insurance to another. There often is a cost to adding an LTC rider to an insurance policy or a deferred annuity. These combo products may require a substantial outlay, which must be paid upfront or within relatively few years.

In addition, tax advantages may be lost with combo products. With most standalone LTC insurance policies, certain amounts of your premium count as a medical expense, which can potentially be deducted. That’s not the case with a rider to a life insurance policy or to a deferred annuity.

As of 2017, people age 40 and younger can include LTC premiums up to $410 as a medical expense; that amount scales up as premium payers age, maxing out at $5,110 for those 70 and older. Those outlays are added to other medical expenses and the amount that exceeds 10% of adjusted gross income can be taken as an itemized deduction.

Putting needs first

Combo products vary widely, and so do individuals’ concerns on this issue. However, generally, people who only want LTC insurance might be best-served with standalone coverage, working with an insurance professional to hold down premiums. That said, if you are interested in life insurance such as whole life or universal life, it may be worth exploring the idea of adding LTC coverage, perhaps for an added fee. The same may be true if you are seriously considering a deferred annuity.

After Tax Dollars in Traditional IRAs


Workers under age 70½ can deduct contributions to a traditional IRA, as long as they are not covered by an employer’s retirement plan. The same is true for those workers’ spouses.

If these taxpayers are covered by an employer plan, they may or may not be able to deduct IRA contributions, depending on the taxpayer’s income. However, all eligible workers and spouses can make nondeductible contributions to a traditional IRA, regardless of income. Inside a traditional IRA, any investment earnings will be untaxed.

Dealing with distributions 

Problems can arise for people who hold nondeductible dollars in their IRAs when they take distributions. Unless they’re careful, they may pay tax twice on the same dollars.

Example 1: Marge Barnes has $100,000 in her traditional IRA on February 15, 2017. Over the years, she has made deductible and nondeductible contributions. Assume that $25,000 came from nondeductible contributions, $45,000 came from deductible contributions, and $30,000 came from investment earnings inside Marge’s IRA.

Now Marge wants to take a $20,000 distribution from her IRA. She might report $20,000 of taxable income from that distribution; indeed, Marge’s IRA custodian may report a $20,000 distribution to the IRS. However, Marge would be making a mistake, resulting in a tax overpayment.

Cream in the coffee 

To the IRS, a taxpayer’s IRA money must be stirred together to include pre-tax and after-tax dollars. Any distribution is considered to be proportionate. If Marge were to pay tax on a full $20,000 distribution, she would effectively be paying tax twice on the after-tax dollars included in this distribution.

Example 2: After hearing about this rule, Marge calculates that her $25,000 of after-tax money (her nondeductible contributions) was 25% of her $100,000 IRA on the date of the distribution. Thus, 25% of the $20,000 ($5,000) represented after-tax dollars, so Marge reports the $15,000 remainder of the distribution as a taxable withdrawal of pre-tax dollars. Again, this would be incorrect.

Year-end calculation 

Tax rules require an IRA’s after-tax contributions to be compared with the year-end IRA balance, plus distributions during the year, to calculate the ratio of pre-tax and after-tax dollars involved in a distribution.

Example 3: Assume that Marge’s IRA holds $90,000 on December 31, 2017. Her $100,000 IRA was reduced by the $20,000 distribution in February, but increased by subsequent contributions and investment earnings. Therefore, Marge’s IRA balance for this calculation is $110,000 (the $90,000 at year-end plus the $20,000 distribution). This assumes no other distributions in 2017.

Accordingly, Marge divides her $110,000 IRA balance into the $25,000 of after-tax money used in this example. The result¾22.7%¾is the portion of her distribution representing after-tax dollars. Of Marge’s $20,000 distribution, $4,540 (22.7%) is a tax-free return of after-tax dollars, and the balance ($15,460) is reported as taxable income. Marge reduces the after-tax dollars in her IRA by that $4,540, from $25,000 to $20,460, so the tax on future IRA distributions can be computed.

Form 8606

As you can see, paying the correct amount of tax on distributions from IRAs with after-tax dollars can be complicated. Without knowledge of the rules, an IRA owner may overpay tax by reporting already-taxed dollars as income. However, keeping track of after-tax and pre-tax dollars may not be simple, especially for taxpayers with multiple IRAs and multiple transactions during that year.

The best way to deal with this issue is to track pre-tax and after-tax IRA money by filing IRS Form 8606 with your federal income tax return each year that your IRA holds after-tax dollars. Our office can help prepare Form 8606 for you, when it’s indicated, and, thus, prevent this type of double taxation. 

Deducting IRA Contributions 

  • Single filers who are covered by a retirement plan at work cannot deduct traditional IRA contributions for 2016 with modified adjusted gross income (MAGI) of $71,000 or more in 2016 ($72,000 for 2017 IRAs).
  • On joint tax returns, covered workers are shut out from deductible IRA contributions with MAGI of $118,000 or more for 2016 ($119,000 for 2017).
  • A spouse who is not covered by a retirement plan at work and files jointly with a covered worker can deduct IRA contributions as long as joint MAGI is less than $194,000 for 2016 ($196,000 for 2017).
  • Other income limits apply to contributions to Roth IRAs in which contributions are never deductible, but future distributions may be tax-free.

Alert About Form W-2 Scam Targeting HR Departments

The Internal Revenue Service, state tax agencies, and the tax industry today renewed their warning about an email scam that uses a corporate officer’s name to request employee Forms W-2 from company payroll or human resources departments.

This week, the IRS already has received new notifications that the email scam is making its way across the nation for a second time. The IRS urges company payroll officials to double check any executive-level or unusual requests for lists of Forms W-2 or Social Security number.

The W-2 scam first appeared last year. Cybercriminals tricked payroll and human resource officials into disclosing employee names, SSNs and income information. The thieves then attempted to file fraudulent tax returns for tax refunds.

This phishing variation is known as a “spoofing” e-mail. It will contain, for example, the actual name of the company chief executive officer. In this variation, the “CEO” sends an email to a company payroll office or human resource employee and requests a list of employees and information including SSNs.

The following are some of the details that may be contained in the emails:

  • Kindly send me the individual 2016 W-2 (PDF) and earnings summary of all W-2 of our company staff for a quick review.
  • Can you send me the updated list of employees with full details (Name, Social Security Number, Date of Birth, Home Address, Salary)?
  • I want you to send me the list of W-2 copy of employees wage and tax statement for 2016, I need them in PDF file type, you can send it as an attachment. Kindly prepare the lists and email them to me asap.

Working together in the Security Summit, the IRS, states and tax industry have made progress in their fight against tax-related identity theft, cybercriminals are using more sophisticated tactics to try to steal even more data that will allow them to impersonate taxpayers.

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