Bond-Fund Risks—Do you know the perils?


Weighing the Risks of Bond Funds

Most portfolio allocations call for a mix of stocks (equities) and bonds (fixed income). The underlying theory is that stocks may deliver substantial results over the long term, whereas bonds contribute interest income and lower volatility.

As we’ve seen in recent years, stocks can be extremely risky but have recovered from periodic setbacks. Bonds offer low yields in today’s environment. Therefore, one main reason for holding bonds is to dampen overall portfolio swings, holding down losses when stocks sag. This may help keep investors in the stock market and allow them to benefit in the next cyclical move to the upside.

Although bonds have not been as volatile as stocks, they do have risks. Understanding the possible perils may help you adjust your portfolio so that any fixed-income holdings are aligned with your risk tolerance.


Safety in numbers

Today, many people invest in the bond market via funds. Individual bonds may be difficult for non-professionals to analyze, and the trading prices for small transactions in the fixed-income market might be relatively high.

When you invest through a fund, experienced portfolio managers make the buy and sell decisions. Often, these managers are supported by a research team. In addition, a bond fund may hold dozens or even hundreds of different issues, reducing investors’ exposure to weakness in any one bond. Trading prices can be more favorable for bond funds than those for individual investors.

Investing in bond funds can reduce your fixed-income risk, but there still are possible pitfalls to consider.


Credit risk

Buying a bond is essentially making a loan. Your greatest risk is that the borrower will fail to make scheduled interest payments or fail to return the loan amount at maturity. In times of overall economic weakness or specific issuer problems, perceived credit risk may increase. Then, the price of some or even most of the bonds held by a fund might drop, reducing the value of investors’ shares. In the case of an actual default, the price decline can be severe.


Interest rate risk

Rising interest rates generally push down bond prices, even without significant credit risk. That’s because higher interest rates mean that lower-yielding bonds are less attractive. Prices will drop to bring yields in line.

Example: Mark Tucker invests $10,000 in bonds issued by ABC Corp., which is in excellent financial condition. The bonds yield 3%, so Mark will collect $300 (3% of $10,000) in interest each year until the bond pays back his $10,000 at maturity.

What if interest rates rise to 4%? Investors can then receive $400 a year on a similar $10,000 investment. In this scenario, no one will pay Mark $10,000 for bonds yielding $300 a year. If he wants to sell his bonds, he might have to drop the price to $7,500.

A buyer acquiring bonds yielding $300 a year for $7,500 would be getting a 4% return, the going rate in this example. As you can see, a 33.3% increase in interest rates (3% to 4%) leads to a 25% drop ($10,000 to $7,500) in bond values. This is a simplified illustration, but it demonstrates the concept that rising yields will devalue existing bonds.


Reducing the risks

The aforementioned risks can be mitigated by an adept selection of bond funds. To reduce credit risk, look for funds holding bonds from creditworthy issuers.

For instance, bonds issued by the U.S. Treasury have scant risk of default. Corporate bonds are rated by private agencies and those from financially sound companies are considered “investment grade.” Standard & Poor’s, one such agency, gives AAA, AA, A, or BBB ratings to companies considered to have low credit risk.

Bonds with lower ratings or no ratings at all are judged to have more credit risk. The term “junk bonds” may be applied to such issues, although they also may be known as “high yield” bonds because they must offer relatively robust payouts to attract investors. Online, you can see the ratings of the bonds held by various funds. A fund with average credit quality of AA, for example, would generally have little credit risk.

As for interest rate risk, that’s largely determined by whether the bonds in the fund are long- or short-term. In the previous example, suppose Mark buys bonds that mature in one year. An interest rate rise might not drive down the bond price very much. In a year, Mark can redeem his 3% bonds and reinvest in 4% bonds, assuming interest rates hold steady.

Conversely, suppose Mark’s bonds won’t mature for 20 years. A buyer would receive his or her $300 annual payout for decades, locking in that scant return. That prospect could reduce the bonds’ market value a great deal. For risk reduction, Mark should look for funds with relatively short maturity bonds.


Revealing rates

The bottom line is that high-quality short maturity bonds typically have less risk than lower quality long-term bonds. Bond funds holding lower quality or longer-term bonds will have higher yields. Thus, looking at a bond fund’s yield is a key indicator of the risks involved.

As of this writing, U.S. Treasury bonds maturing in the two- to five-year range yield around 2%. Therefore, any bond fund with yields significantly higher than 2% might be taking on meaningful credit risk, interest rate risk, or both. Lower-yielding funds may be relatively safe from share price deterioration.





What the New Tax Cuts and Jobs Act Means for Manufacturers


The 2017 Tax Cuts and Jobs Act (the “Act”) has overwhelmed many on an individual and business level with the unending question: what will I really be paying in taxes and what is my most advantageous strategy to implement in 2018? The focus of individuals and businesses should not solely be on the next year but must include a long-range viewpoint considering the future years’ impact on strategic planning.

In particular, for the manufacturing and distribution community, there are several changes, both beneficial and not, that should be considered. See below for a summary of the larger scope of tax code updates in the Act:

DPAD (Domestic Production Activities Deduction)/Section 199
DPAD consisted of a tax incentive to manufacturers that manufactured property in the United States. The DPAD tax incentive was repealed in the final Act, which while a negative overall, is expected to be recouped with the significant reduction in the overall corporate tax rates. This is effective beginning for years after December 31, 2017.

Corporate Tax Rate & Corporate Alternative Minimum Tax (AMT)
The corporate tax rate was reduced from 35% to 21%. This is a significant win for many companies, including manufacturers. Additionally, the Corporate AMT was repealed. This is effective beginning for tax years after December 31, 2017.

Pass-Through Tax Treatment/Section 199A
Historically, many manufacturers have chosen the pass-through structure.  Previously, owners of S Corporations, partnerships and sole proprietorships (i.e. – Pass-Through entities) paid taxes at an individual rate, with a maximum tax rate of 39.6%. Under the Act, a new deduction of up to 20% of qualified pass-through earnings of the business to the individual owners’ tax returns was introduced.  The deduction is limited based on certain wage and/or fixed asset criteria as well as overall taxable income and the trade or business of the company.   The deduction is effective for tax years beginning after December 31, 2017.

Section 1031 Like-Kind Exchanges
Under the new Act, like-kind exchanges were not impacted for real estate/real property. However, they were eliminated for all personal property assets, such as vehicles, large equipment, certain intangibles, etc. You can still benefit from a like-kind exchange of personal property if you entered into the exchange before the December 31, 2017 year end by meeting certain requirements.

Interest Deductibility
Under the new Act, there are new limitations for deductibility of interest expense for companies with average gross receipts over $25 million. This change can be of concern to manufacturers and distributors with significant financing arrangements supporting their operations. Under the Act, a cap on interest deductions was implemented to include the sum of a company’s interest income; 30% of the adjusted taxable income with certain limitations considered; and the company’s floorplan financing interest for the year. Interest not allowed in a current year can be carried forward for an indefinite period by the company (or its owners if a pass-through entity). This is effective for tax years beginning after December 31, 2017.

Research & Development Deduction
The Act implemented procedures to reduce immediate deduction of research and development (“R&D”) costs by amortizing these R&D costs over a five year period and a fifteen year period for foreign R&D costs. Additionally, clarification was provided that all costs associated with the development of software should be considered R&D costs. This is effective for tax years beginning after December 31, 2021.

Research & Development Tax Credit
The R&D tax credit was preserved under the Act, which retained an important tax credit that provides ongoing incentives for qualified R&D costs to manufacturers.

Net Operating Losses
Under the Act, the net operating losses (“NOL”) of a company are generally limited to 80% of the company’s taxable income in years beginning after December 31, 2017, and no NOL carrybacks will be allowed. This change to the NOL carryback rules can be a significant concern for some companies, including manufacturers, which have relied on the ability to apply NOLs available to prior years’ operating taxable profits, and recover tax refunds.

Capital Expenditures Treatment
The Act allows for expensing of 100% of certain business property (including used property) acquired and placed in service after September 27, 2017 and before January 1, 2023 (or January 1, 2024 for certain longer production period property and certain other business property). This expensing is phased-out at 20% per year through tax years ending in 2023 through 2026.

Additionally, under Internal Revenue Code (“IRC”) Section 179, the maximum amount a taxpayer may expense increased to $1,000,000 for qualifying assets placed in service, for taxable years beginning before January 1, 2023, and increases the phase-out threshold for qualifying asset expenditures to $2,500,000 for taxable years beginning before January 1, 2023. Included in the capital expenditures treatment revisions are also increased limitations on the depreciation deduction for business-use vehicles acquired and placed in service after December 31, 2017 and before January 1, 2023.

Both the bonus depreciation and Section 179 increased limits are a great incentive for manufacturers and distributors to expand infrastructure and invest in the growth of their business.

Taxation of Foreign Income
The tax law prior to the Act treated earnings of foreign subsidiaries of United States (“U.S.”) multinational corporations as not being taxed until the income was repatriated (i.e.-paid as a dividend) in the U.S. Under the new Act, the U.S. moves away from a worldwide taxation of U.S. corporations towards a territorial tax system, in which dividends received from foreign subsidiaries are not subject to regular U.S. tax.  The new participation exemption system provides a deduction of 100% of the dividends received from specified foreign corporations by U.S. shareholders, which are C-corporations. What does this mean for manufacturers? This system is viewed to positively impact manufacturers with foreign operations, which are often located in lower-tax jurisdictions. Taxing earnings only once in the country they are earned allows for available capital to move more easily between the various locations, or to be brought back and re-invested in the U.S.

The cost to transition to the participation exemption system is a mandatory transition tax imposed on accumulated foreign earnings from certain foreign corporations.  The tax is 15.5% for earnings held in cash and cash equivalents and 8% for earnings held in other liquid assets. The deemed distribution provision affects all U.S. persons and taxpayers will need to make the first installment of the tax due by April 18, 2018 (the due date of 2017 tax returns for calendar year C-corporations and individuals) and they may elect to pay the tax in installments over the next eight years.

As part of the international reform, the Act repealed the foreign tax credit for exempt dividends and modified certain Subpart F provisions. The Act also introduced a category of income called Global Intangible Low Taxed Income (“GILTI”), which will be taxed in the year it is earned, as well as the Foreign Derived Intangible income that will be taxed at lower beneficial rates. Finally, a new base erosion anti-abuse (“BEAT”) minimum tax will apply to certain companies with gross receipts greater than $500 million, whom which make cross-border payments to related foreign entities.

What Next?
There are many positive impacts the new Act provides to manufacturers. We are beginning to peel away the layers of understanding and impact this will have at the federal level for companies, and continuing to be proactive in what the states will be implementing in conjunction with the Act.

To understand the implication of these changes, considering the complexity of the new reform and the individuality of each company’s strategic planning and financial position, be proactive and please contact your qualified tax advisor.

Scam Alert: IRS Urges Taxpayers to Watch Out for Erroneous Refunds

The Internal Revenue Service today warned taxpayers of a quickly growing scam involving erroneous tax refunds being deposited into their bank accounts. The IRS also offered a step-by-step explanation for how to return the funds and avoid being scammed.

Following up on a Security Summit alert issued Feb. 2, the IRS issued this additional warning about the new scheme after discovering more tax practitioners’ computer files have been breached. In addition, the number of potential taxpayer victims jumped from a few hundred to several thousand in just days. The IRS Criminal Investigation division continues its investigation into the scope and breadth of this scheme.

These criminals have a new twist on an old scam. After stealing client data from tax professionals and filing fraudulent tax returns, these criminals use the taxpayers’ real bank accounts for the deposit.

Thieves are then using various tactics to reclaim the refund from the taxpayers, and their versions of the scam may continue to evolve.

Different Versions of the Scam

In one version of the scam, criminals posing as debt collection agency officials acting on behalf of the IRS contacted the taxpayers to say a refund was deposited in error, and they asked the taxpayers to forward the money to their collection agency.

In another version, the taxpayer who received the erroneous refund gets an automated call with a recorded voice saying he is from the IRS and threatens the taxpayer with criminal fraud charges, an arrest warrant and a “blacklisting” of their Social Security Number. The recorded voice gives the taxpayer a case number and a telephone number to call to return the refund.

As it did last week, the IRS repeated its call for tax professionals to step up security of sensitive client tax and financial files files.

The IRS urged taxpayers to follow established procedures for returning an erroneous refund to the agency. The IRS also encouraged taxpayers to discuss the issue with their financial institutions because there may be a need to close bank accounts. Taxpayers receiving erroneous refunds also should contact their tax preparers immediately.

Because this is a peak season for filing tax returns, taxpayers who file electronically may find that their tax return will reject because a return bearing their Social Security number is already on file. If that’s the case, taxpayers should follow the steps outlined in the Taxpayer Guide to Identity Theft. Taxpayers unable to file electronically should mail a paper tax return along with Form 14039, Identity Theft Affidavit, stating they were victims of a tax preparer data breach.

Here are the official ways to return an erroneous refund to the IRS.

Taxpayers who receive the refunds should follow the steps outlined by Tax Topic Number 161 – Returning an Erroneous Refund. The tax topic contains full details, including mailing addresses should there be a need to return paper checks. By law, interest may accrue on erroneous refunds.

If the erroneous refund was a direct deposit:

  1. Contact the Automated Clearing House (ACH) department of the bank/financial institution where the direct deposit was received and have them return the refund to the IRS.
  2. Call the IRS toll-free at 800-829-1040 (individual) or 800-829-4933 (business) to explain why the direct deposit is being returned.
  3. If the erroneous refund was a paper check and hasn’t been cashed:
  1. Write “Void” in the endorsement section on the back of the check.
  2. Submit the check immediately to the appropriate IRS location listed below. The location is based on the city (possibly abbreviated) on the bottom text line in front of the words TAX REFUND on your refund check.
  3. Don’t staple, bend, or paper clip the check.
  4. Include a note stating, “Return of erroneous refund check because (and give a brief explanation of the reason for returning the refund check).”
  5. The erroneous refund was a paper check and you have cashed it:
  • Submit a personal check, money order, etc., immediately to the appropriate IRS location listed below.
  • If you no longer have access to a copy of the check, call the IRS toll-free at 800-829-1040 (individual) or 800-829-4933 (business) (see telephone and local assistance for hours of operation) and explain to the IRS assistor that you need information to repay a cashed refund check.
  • Write on the check/money order: Payment of Erroneous Refund, the tax period for which the refund was issued, and your taxpayer identification number (social security number, employer identification number, or individual taxpayer identification number).
  • Include a brief explanation of the reason for returning the refund.
  • Repaying an erroneous refund in this manner may result in interest due the IRS.

IRS mailing addresses for returning paper checks

For your paper refund check, here are the IRS mailing addresses to use based on the city (possibly abbreviated). These cities are located on the check’s bottom text line in front of the words TAX REFUND:

  • ANDOVER – Internal Revenue Service, 310 Lowell Street, Andover MA 01810
  • ATLANTA – Internal Revenue Service, 4800 Buford Highway, Chamblee GA 30341
  • AUSTIN – Internal Revenue Service, 3651 South Interregional Highway 35, Austin TX 78741
  • BRKHAVN – Internal Revenue Service, 5000 Corporate Ct., Holtsville NY 11742
  • CNCNATI – Internal Revenue Service, 201 West Rivercenter Blvd., Covington KY 41011
  • FRESNO – Internal Revenue Service, 5045 East Butler Avenue, Fresno CA 93727
  • KANS CY – Internal Revenue Service, 333 W. Pershing Road, Kansas City MO 64108-4302
  • MEMPHIS – Internal Revenue Service, 5333 Getwell Road, Memphis TN 38118
  • OGDEN – Internal Revenue Service, 1973 Rulon White Blvd., Ogden UT 84201
  • PHILA – Internal Revenue Service, 2970 Market St., Philadelphia PA 19104

HLB International Adds New Member in Rwanda

HLB International, one of the leading global accountancy networks with presence in 150 countries, continues its growth with the recent signing of a new member firm in Rwanda, M.N & Associates CPA.

M.N & Associates CPA is based in Kigali, the capital city of Rwanda. Established in 2008, the firm provides and offers expertise in Audit & Assurance, Accounts outsourcing, Taxation as well as Advisory services.

Michael Maina, Partner at M.N & Associates CPA, commented: “ With the firm’s values of uncompromising professionalism in all aspects of our business dealings we are excited to be joining HLB International and connect with member firms. Not only to meet the clients expectations but also to exceed them.”

M.N & Associates CPA, with its cross-border business, will work closely with other HLB members, in particular in Africa and Europe. With extensive experience in the East African region, the firm makes a great addition to our coverage in Africa.

February/March Dates to Remember


February 15  

All businesses. Give annual information statements to recipients of certain payments you made during 2017. Payments that are covered include amounts paid in real estate transactions (Forms 1099-S); amounts paid in broker and barter exchange transactions (Forms 1099-B); and payments to attorneys (Form 1099-MISC, if amounts are reported in box 8 or 14). 

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in January if the monthly rule applies.

Individuals. If you claimed exemption from income tax withholding last year on the Form W-4 you gave your employer, you must file a new Form W-4 to continue your exemption for another year. 


February 16 

Employers. Begin withholding income tax from the pay of any employee who claimed exemption from withholding in 2017 but did not give you a new Form W-4 to continue the exemption for 2018.


February 28

All businesses. File paper versions of most annual information statements (Forms 1098, 1099, and others) for certain payments you made in 2017 (due date is April 2 if you are filing electronically). 


March 15

Partnerships. File a 2017 calendar-year return (Form 1065). Provide each partner with a copy of Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, and so on, or a substitute Schedule K-1. If you want an automatic six-month extension of time to file the return and provide Schedule K-1 or a substitute Schedule K-1, file Form 7004 and then file Form 1065 by September 17.

S corporations. File a 2017 calendar-year income tax return (Form 1120S) and pay any tax due. Provide each shareholder with a copy of Schedule K-1 (Form 1120S), Shareholder’s Share of Income, Deductions, Credits, and so on or a substitute Schedule K-1. If you want an automatic six-month extension of time to file the return, file Form 7004 and deposit what you estimate you owe.

S corporation election. File Form 2553, “Election by a Small Business Corporation,” to choose to be treated as an S corporation beginning with calendar year 2018. If Form 2553 is filed late, S corporation treatment will begin with calendar year 2019.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in February if the monthly rule applies.

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