Newsletter from
Steve Richardson & Company, Certified Public Accountants

October 21, 2019

To Our Clients and Friends:

Stubborn-Super-Steve!

Much to my physician’s consternation, I’m not an “outstanding patient”. I’m well now, but I’ve been sick for ten hard days. My Physician told me that if I didn’t rest, I would “relapse”. Frankly, I didn’t believe him. What should have been a five-day illness turned into a ten-day illness because I failed to follow good professional advice.

I thought that the “rest” part of recovery doesn’t apply to Mr. Stubborn Super-Steve. Boy-Howdy was I wrong! Good professional advice is important. I will try to be a better patient but Mr. Stubborn Super-Steve will very likely show-up again as it has so many times in the past.

It is important to follow good professional advice!

We have a few CPA Firm clients a bit like Mr. Stubborn Super-Steve. Thankfully, not too many. Most of our clients are “outstanding”! That phrase, “outstanding clients” may need to be defined; an “outstanding client” is one who acts upon our advice and pays their bills on time. When our clients follow our advice, it does pay off!

We do more than tax returns. We look at retirement planning, cash flow issues, investment management, employee and personnel, and other issues as they present themselves.

Right now, we (our clients and their CPA Firm) need to do a bit of year-end tax planning.

2019 and 2020 Tax Planning

With year-end approaching, now’s the time to take steps to cut your 2019 tax bill. Here are some relatively foolproof year-end tax planning strategies to consider, assuming next year’s general election doesn’t result in retroactive tax changes that could affect your 2020 tax year.

Year-end Planning Moves for Individuals

Here are some strategies that may lower your individual income tax bill for 2019.

• Game Generous Standard Deduction Allowances. For 2019, the standard deduction amounts are $12,200 for singles and those who use married filing separate status, $24,400 for married joint filing couples, and $18,350 for heads of household. If your total annual itemizable deductions for 2019 will be close to your standard deduction amount, consider making additional expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation.
  • Charitable Deductions. Deferring and doubling up on charitable donations, in alternating tax years, is actually easy to do with minimal planning. There are venerable well established organizations set up to assist donors. One of my favorites is the National Christian Foundation.
• Carefully Manage Investment Gains and Losses in Taxable Accounts. If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2019 is only 15% for most folks, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.
  • With the instability of the looming 2020 elections, I recommend accelerating your capital gains into 2019 while we have tax law clarity and favorable tax rates.
• Take Advantage of 0% Tax Rate on Investment Income. For 2019, singles can take advantage of the 0% income tax rate on long-term capital gains and qualified dividends from securities held in taxable brokerage firm accounts if their taxable income is $39,375 or less. For heads of household and joint filers, that limit is increased to $52,750 and $78,750, respectively. While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If so, consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. However, if you give securities to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates.
• Give away Winner Shares or Sell Loser Shares and Give away the Resulting Cash. Don’t give away loser shares (currently worth less than what you paid for them) to relatives. Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, you can give the sales proceeds to your relative. On the other hand, you should give away winner shares to relatives. These principles also apply to donations to IRS-approved charities.
  • If you gift stock, never gift a stock that is worth less than you paid for it!
  • Gifting stock that has an appreciated in value to charity or to a relative can be a very good tax planning strategy.
• Convert Traditional IRAs into Roth Accounts. The best profile for the Roth conversion strategy is when you expect to be in the same or higher tax bracket during your retirement years. The current tax hit from a conversion done this year may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings.
  • This is one of my favorite ways to take full advantage of the lower Trump Tax Rates. I have assisted clients in moving a bunch of IRAs into ROTH accounts at minimal tax costs.
• Take Advantage of Principal Residence Gain Exclusion Break. Home prices are on the upswing in many areas. More good news: Gains of up to $500,000 on the sale of a principal residence are completely federal-income-tax-free for qualifying married couples who file joint returns ($250,000 for qualifying unmarried individuals and married individuals who file separate returns). To qualify for the gain exclusion break, you normally must have owned and used the home as your principal residence for a total of at least two years during the five-year period ending on the sale date.
• Don’t Overlook Estate Planning. Thanks to the Tax Cuts and Jobs Act (TCJA), the unified federal estate and gift tax exemption for 2019 is a historically huge $11.4 million, or effectively $22.8 million for married couples. Even though these big exemptions may mean you’re not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules.
  • I should write an article on estate planning. Way too many people believe that with the estate and gift tax exemptions being $11.4 million (or $22.8 million) for married couples that estate planning is no longer necessary. Not-True!
  • Good estate planning has never been about cutting the estate taxes.
  • Good estate planning has always been about smoothing the transition of even modest wealth and assets over subsequent generations and to insure the survivability of “legacy businesses”.
  • Good estate planning is being a blessing to your children and to your children’s children.
  • People with modest wealth can accomplish a lot with simple estate planning!

Year-end Planning Moves for Small Businesses

If you own a business, consider the following strategies to minimize your tax bill for 2019.

• Establish a Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.
• Take Advantage of Generous Depreciation Tax Breaks. 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar year 2019. That means your business might be able to write off the entire cost of some or all of your 2019 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end.
• Cash in on Generous Section 179 Deduction Rules. For qualifying property placed in service in tax years beginning in 2019, the maximum Section 179 deduction is $1.02 million. The Section 179 deduction phase-out threshold amount is $2.55 million.
• Time Business Income and Deductions for Tax Savings. If your business is conducted via a pass-through entity, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. On the other hand, if you expect to be in a higher tax bracket in 2020, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2020.
• Maximize the Deduction for Pass-through Business Income. For 2019, the deduction for Qualified Business Income (QBI) can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income. Because of the various limitations on the QBI deduction, tax planning moves (or non-moves) can have the side effect of increasing or decreasing your allowable QBI deduction.
• Watch out for Business Interest Expense Limit. Thanks to an unfavorable TCJA change, a taxpayer’s deduction for business interest expense for the year is limited to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest paid by certain vehicle dealers. Fortunately, many businesses are exempt from this limit. We can help you determine if an exemption applies.
• Claim 100% Gain Exclusion for Qualified Small Business Stock. There is a 100% federal income tax gain exclusion privilege for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after 9/27/10. QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Contact us if you think you own stock that could qualify.

This letter only covers some of the year-end tax planning moves that could potentially benefit you, your loved ones, and your business. Please contact us if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers the best tax results for your particular circumstances.

Best regards,

Steve Richardson, CPA

The Kirkwood Letter

Newsletter from
Steve Richardson & Company, Certified Public Accountants

September 30, 2019

The Kirkwood Letter

With permission and for fun reasons, I am titling this letter the “Kirkwood” letter in honor of a client couple that showed good initiative in including me in a family discussion about investment options related to modest and irregular gifts of cash from grandparents to their infant children.  I was honored to be included in that discussion.  The amounts of money involved are “modest” and most young couples would inappropriately jump to the conclusion that there is no good investment option with “modest” and “irregular” funds.  There are in fact a number of excellent investment options that fit this cash flow scenario. 

The investment strategy we discussed and settled on for this family is additional unscheduled mortgage payments.  This strategy fits the Kirkwood family perfectly.  It also fits with my philosophy that parents need to be in a position of financial strength before they try to help their children financially.

With college educations skyrocketing in costs, family financial strength is more important than ever.  The plan is simple but unexpectedly powerful!

This investment strategy builds upon an indisputable financial principal: good financial behavior, over long time horizons, will always pay off.  Few investment are more long-term that a house and a mortgage.

Please take the few minutes necessary to read this short memo.  This investment strategy is deceptively simple but do not under estimate its effectiveness. 

Why Accelerated Mortgage Pay-Down Is a Good Investment Strategy

The notion of paying down one’s home mortgage balance faster than required is not a new idea. However, even those who are well schooled in personal finance may be surprised to discover how powerful this idea can be. This release prepares you to raise the issue and explain it to clients who might be interested. Before getting started, please note the following key points:

•   The accelerated mortgage pay-down idea can only work for clients who have positive cash flow and/or available cash. It is not for folks who are struggling to pay their monthly bills.

•   The idea is only appropriate for clients who are looking for a very conservative, risk-free way to invest some surplus funds. Obviously, clients who want to earn (and believe they can earn) 8% to 10% annually are not going to be very excited about the idea of expending cash to earn 3.5% or 4% (or whatever their exact mortgage interest rate may be) by paying off their home mortgage early.

•   Finally, the idea is far more powerful when the client intends to continue pumping the monthly accelerated mortgage pay-down amount into a retirement account after the mortgage has been paid off.

With these thoughts in mind, here is a more detailed analysis in the form of sample scenarios.

Sample Scenario: Accelerated Pay-down Strategy Makes Good Financial Planning Sense

Phil, your 45-year-old client, is in good financial shape. He has cash on hand and positive monthly cash flow after paying his bills. Even better, he expects to be in the same position for the foreseeable future. Assume Phil has a $400,000 balance on a recently refinanced 30-year first mortgage on his home that charges 4% interest. (We know the current rates are lower for qualified borrowers, but that may not last forever. Plus, we want to keep things simple to illustrate the points we will make in this release.)

Phil’s monthly payment for principal and interest is only $1,910, but he has a whopping 30 years to go before the mortgage will be paid off (if he sticks to the prescribed monthly payment schedule). That means Phil will be a wizened 75 years old when the mortgage is finally extinguished.

Being 75 years old before your mortgage is paid off probably does not sound so great to most folks. Collecting a guaranteed, risk-free 3.5% or 4% (or whatever rate applies) return by paying down one’s mortgage quicker (thus avoiding the interest that would otherwise be charged on the principal that is paid off early) probably sounds like a solid investment idea to many homeowners. After all, the stock market is looking rather frothy, and fixed income investments are currently paying pitiful interest rates.

Impact of Mortgage Interest Deductibility

One argument that may be mounted against the accelerated mortgage pay-down idea is that your client will lose tax deductions because interest charges will go down more rapidly than if he or she sticks to the scheduled monthly payments. This is true, but so what? Consider the following points:

•   The TCJA imposed stricter limitations on home mortgage interest deductions for 2018-2025.

•   The greatly increased standard deduction for 2018-2025 means that many more clients won’t be claiming itemized deductions. Even if they itemize, the larger standard deduction reduces the incremental tax benefit from itemizing.

Impact of Future Inflation or Deflation

While the accelerated mortgage pay-down strategy will yield guaranteed results, it is not foolproof. If we have a period of roaring inflation, paying down a mortgage with a relatively low interest rate earlier than required may no longer make sense. In this situation, it may be better to stop the accelerated pay-down program, allow the mortgage term to stretch out, and pay the remaining balance back with cheaper inflated dollars.

On the other hand, the accelerated pay-down strategy will work great during a period of deflation because the mortgage is being paid down sooner when dollars are cheaper rather than later when dollars are more expensive.

Big Advantage to “Continuing” the Program
after
Mortgage Is Paid Off

The accelerated mortgage pay-down strategy can clearly be beneficial in and of itself because interest charges are avoided, and debt is eliminated from the client’s personal balance sheet. Another advantage is your client can stop and restart the program anytime he or she wants (for example, when inflation or deflation strikes). However, the biggest payoff from following the strategy will probably be reaped by folks who have the cash flow and self-discipline to continue the program even after the mortgage is extinguished. This involves taking the monthly amount that was previously dedicated to the accelerated mortgage pay-down strategy and stuffing it into a retirement savings account (whether taxable or tax-advantaged).

In our sample scenario, let’s say Phil pays $3,500 per month under the accelerated mortgage pay-down program instead of making the scheduled monthly payment of $1,910. He will pay off his $400,000 mortgage balance in about 12 years, at age 57, instead of paying it off in 30 years, at age 75. He will earn a guaranteed 4% rate of return because that is the interest rate he avoids on the accelerated principal payments.

If Phil continues the program after the mortgage is paid off by putting $3,500 a month into a retirement savings account that earns 4% annually for another eight years, he will have accumulated about $395,000 at age 65. This seems like a much better plan than sticking with the status quo and making mortgage payments until age 75.

More Sample Scenarios

Here are some additional illustrations of how the accelerated mortgage pay-down strategy can work.

Faster Pay-Down. Now say 45-year-old Phil pays $4,500 per month under the accelerated mortgage pay-down program instead of making the scheduled monthly payment of $1,910. He will pay off his $400,000 mortgage balance in eight years and ten months, at age 54, instead of paying it off in 30 years, at age 75. He will earn a guaranteed 4% rate of return because that is the interest rate he avoids on the accelerated principal payments.

If Phil continues the program after the mortgage is paid off by putting $4,500 a month into a retirement savings account that earns 4% for another 11 years, he will accumulate about $745,000 by age 65. Sweet! Once again, this seems like a much better plan than sticking with the status quo and making mortgage payments until age 75.

Really Fast Pay-Down. Now say 45-year-old Phil pays $5,000 per month under the accelerated mortgage pay-down program instead of making the scheduled monthly payment of $1,910. He will pay off his $400,000 mortgage balance in about seven years and ten months, at age 53, instead of paying it off in 30 years, at age 75. He will earn a guaranteed 4% rate of return because that is the interest rate he avoids on the accelerated principal payments.

If Phil continues the program after the mortgage is paid off by putting $5,000 a month into a retirement savings account that earns 4% for another 12 years, he will accumulate a little over $920,000 by age 65. Wow! That would be great!

Slower Pay-Down. Let’s now be a bit less ambitious and assume that 45-year-old Phil pays $2,500 per month under the accelerated mortgage pay-down program instead of making the scheduled monthly payment of $1,910. This only requires an additional payment of $590 per month. Under our basic assumptions, Phil should have absolutely no problem doing this. Paying $2,500 per month will allow Phil to pay off his $400,000 mortgage balance in about 19 years and two months, at age 64, instead of paying it off in 30 years, at age 75. He will earn a guaranteed 4% rate of return because that is the interest rate he avoids on the accelerated principal payments.

Older Individual. Finally, let’s now assume Phil is 55 instead of 45. Say Phil pays $4,000 per month under the accelerated mortgage pay-down program instead of making the scheduled monthly payment of $1,910. He will pay off his $400,000 mortgage balance in about ten years and two months, at age 66, instead of paying it off in 30 years, at age 85. He will earn a guaranteed 4% rate of return because that is the interest rate he avoids on the accelerated principal payments. This seems like a much better plan than sticking with the status quo and making mortgage payments until age 85.

Conclusion

You get the idea. With financial software, you can put together sample scenarios for clients who are interested in the accelerated mortgage pay-down concept. It often makes good sense from an overall financial planning perspective, and it delivers a guaranteed, risk-free rate of return. You can’t say that about too many other investment strategies.

Very truly yours,

Steve Richardson, CPA