Way To Go

The U. S. Congress sets a federal budget every year in the trillions of dollars.  Few people know how much money that is so here is a breakdown of the 2011 budget:

 U.S. income:            $2,170,000,000,000
 Federal budget:       $3,820,000,000,000
 New debt:                 $1,650,000,000,000
 National debt:        $14,271,000,000,000
 Recent budget cut:       $ 38,500,000,000      (about 1 percent of the budget)

It's easy to get lost with the big numbers so let's remove eight zeros from these numbers and pretend this is the household budget for the fictitious Jones family.
 Total Jones family income                                     $21,700

Amount of money the Jones family spent:             $38,200
Amount of new debt added to the credit card:     $16,500
Outstanding balance on the credit card:             $142,710
Amount cut from the budget:                                       $385

Hope that this helps put all of the White House and Congress' hard work into perspective. 

Today's BLS Unemployment Report

Years ago, while an undergraduate accounting student, I read a cartoon that has stuck with me all these years.  A corporate controller was standing the president’s office.  The president had just asked, “What is net income going to be this year?”  The controller responded, “Well sir, what would you like it to be?”

I was reminded of that cartoon while analyzing the latest job report this morning.  The Bureau of Labor Statistics BLS press release stated:  "Total nonfarm payroll employment rose by 117,000 in July, and the unemployment rate was little changed at 9.1 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care, retail trade, manufacturing, and mining. Government employment continued to trend down.

So I decided to dig a little deeper.  First, I wanted to know Now, how we got to a  9.1% unemployment level with 117,000 jobs being added.  The  first apparent statistical sleight of hand was a reduction in  workforce number by 193,000  http://www.bls.gov/news.release/empsit.a.htm.  Clearly, without that reduction in the workforce number the  unemployment rate would have gone the wrong way.

When you read down to line 4 (Table A) again, you see the absolute number of people working was down a further 38,000 for the month.  Those people must be missing in action. 

The CES Birth/Death Model for July showed a decrease of 18,000 jobs (try to mentally reconcile that with the 117,000 job gain in the BLS press release), including 10,000 more manufacturing jobs lost and 15,000 in trader, transportation, and utilities.  You will find that table at http://www.bls.gov/web/empsit/cesbd.htm.   Look at the “2011 Net Birth/Death Adjustment, not seasonally adjusted (in thousands)” table, July column, last row)

I still stick with www.shadowstats.com when I want to know that the real unemployment rate is.  The Shadow Statistics unemployment rate is at about 22%.  Look around you.  Do a reality check.  What seems more real the 9.1% unemployment rate reported by the BLS or Shadow Statistics 22%?

I always tell my students to do reality checks on their numbers.  Do they feel right?  Do they past the sniff test?  If they smell like crap then they probably are, no matter what the person trying to sell you the numbers says.

California Tax Amnesty

Back in March the California legislature passed a law giving taxpayers who underreported their California income tax liabilities through the use of abusive tax avoidance transactions (ATAT) or offshore financial arrangements (OFA) the ability to obtain a waiver of most penalties if they amend their returns for 2010 and all prior years in which there is underreported income. Taxpayers will be required to pay all tax and interest that is owed.

The Voluntary Compliance Initiative 2 (VCI 2) (http://www.ftb.ca.gov/Voluntary_Compliance_Initiative_2/index.shtml) program will be available to taxpayers with California liabilities from August 1 through October 31, 2011. After October 31, taxpayers who are found to have unreported liabilities through the use of ATAT or OFA will face the full range of penalties and interest, and may be subject to criminal prosecution. Furthermore, the eight-year statute of limitations will be extended to 12 years for assessing additional tax and penalties.

If you are a California taxpayers and you wish to take advantage of the penalty waiver then you must :

1.    Sign a participation agreement.

2.    Complete and sign an amended return reversing the ATAT or including the income from the OFA.

3.    Pay all tax and interest.

4.    Submit all of the above to the Franchise Tax Board (FTB) by October 31.

The participation agreement will be available on the FTB's web site on August 1. All other required forms are currently available.

Senator Sanders and the Fed Audit

Senator Bernie Sanders (thank you Vermont) has issued a major statement on how the Federal Reserve Bank engineered $16 trillion to bail out U. S. banks and also foreign banks.  You can see his full report at http://tiny.cc/40u57 .

Senator Sanders writes, "The first top-to-bottom audit of the Federal Reserve uncovered eye-popping new details about how the U.S. provided a whopping $16 trillion in secret loans to bail out American and foreign banks and businesses during the worst economic crisis since the Great Depression. An amendment by Sen. Bernie Sanders to the Wall Street reform law passed one year ago this week directed the Government Accountability Office to conduct the study.

He further writes that, "As a result of this audit, we now know that the Federal Reserve provided more than $16 trillion in total financial assistance to some of the largest financial institutions and corporations in the United States and throughout the world,"  He notes that, "This is a clear case of socialism for the rich and rugged, you're-on-your-own individualism for everyone else."  (emphasis mine).

According to the GAO report  the Federal Reserve Bank unilaterally provided trillions of dollars in financial assistance to foreign banks and corporations from South Korea to Scotland.  Sanders comments that,  "No agency of the United States government should be allowed to bailout a foreign bank or corporation without the direct approval of Congress and the president".

The GAO also determined that the Federal Reserve Bank lacks a comprehensive system to deal with conflicts of interest, despite the serious potential for abuse. Not only that but,  according to the report, the Fed provided conflict of interest waivers to employees and private contractors so they could keep investments in the same financial institutions and corporations that received emergency loans.

One potential conflict of interest examples was  the CEO of JP Morgan Chase who served on the New York Fed's Board of Directors at the same time that his bank received more than $390 billion in financial assistance from the Fed.  That’s over a third of a trillion dollars!  In addition JP Morgan Chase served as one of the clearing banks for the Fed's emergency lending programs.

The GAO report noted that that on September 19, 2008, William Dudley, who is now the New York Fed president, was granted a waiver to let him keep investments in AIG and General Electric at the same time AIG and GE were given bailout funds.  Just another disturbing finding.

According to the GAP audit one reason the Fed did not make Dudley sell his holdings was that it might have created the appearance of a conflict of interest.  Really?  Senator Sanders concludes that,  "No one who works for a firm receiving direct financial assistance from the Fed should be allowed to sit on the Fed's board of directors or be employed by the Fed.”

The GAO report suggests that “. . . opportunities exist to strengthen polices and processes to manage emergency assistance . . ."  What an understatement.

I expect that Congress, ever on the corporate dole, will find a ways to weasel and waffle its way out of accepting any responsibility for the findings in the GAO report.  In addition the Federal Reserve Bank, which is not Federal at all but is privately owned, has no real responsibility to the American public will most likely ignore the findings of the report.  Nevertheless, I thought that you should know . . .

Time to Cut My Budget

I'm going to cut my spending  . . . I hope you will participate and do your part too.

With all the concern about the Federal debt limit, spending cuts, and tax increases I got to thinking and remembered that back in April of 2009 the President ordered the Cabinet to cut $100 million from the $3.5 trillion federal budget.  I felt bad because I hadn’t done my part.  I’ve been spending at my normal level ever since he made the request.

I was so impressed by this requested sacrifice that I have decided to stop sitting around and do the same thing with my personal budget.  Shared sacrifice is the current buzz word.   I spend about $2000 a month on groceries, household expenses, medicine, utilities, etc, but it's time to get out the budget-cutting axe, go through my expenses, and cut back.

I decided to cut my spending at exactly the same ratio, 1/35,000 of my total budget.  That’s the least that I can do.  After doing the math, it looks like instead of spending $2000 a month; I'm going to have to cut that number by six cents. Yes, I'm going to have to get by with $1999.94, but that's what sacrifice is all about. I'll just have to do without some things that are, frankly, luxuries.

I hope that you will do your part too.

What's With the Federal Debt?

Will the U.S. default on the national debt?  All of the political hype and spin may have left you spinning, wondering about what is going to happen to the U.S. if (when) we default on the national debt.  Not to worry.  In spite of what you may have heard the Federal debt really isn’t a big problem.

First, a couple of definitions.  The national debt represents the money that the government has borrowed and upon which it must make interest payments.  The deficit is the difference between what the government spends and what it takes in.   You borrow money to buy a car . . . the loan is debt.  You spend more than you make . . . that’s a deficit.  The Federal debt is about $14.3 trillion.  The Federal deficit was $1.4 trillion last year[i]

Defaulting on the national debt would mean that we quit making interest payments on the bonds that have been sold to the investors in U.S. debt.  The bond holders include pension funds, individual investors and countries like China.  China, incidentally, has been the largest investor in U.S. bonds for some time.  More about that in another blog.

According to the U.S. Department of Treasury the average monthly interest payment on the Federal debt over the last fiscal year has been about $22.9 billion[ii]  .  That seems like a lot of money.  However, that is a drop in the bucket compared to the revenue received by the Federal government. 

Total Federal revenue for 2011 is expected to be about $2.2 trillion or $180 billion per month (and most of that comes from you and me . . . individual taxpayers)[iii].  So do the math.  If the government takes in $180 billion per month and spends $22.9 million on interest payments on the debt, then it only has $157.1 billion left (or $1.9 trillion annually) to cover other operating expenses.  We ought be able to get by on $1,900,000,000,000. 

The Federal government easily has sufficient funds to cover the Federal debt . . . there is no danger of technical default on the debt.  The hype about raising the debt ceiling isn’t about covering the debt, it’s a cover story to provide an excuse to raise taxes and rake in more money to fund run-away Federal spending.  So what is the problem?  Spending.

Is raising taxes on the “rich” a viable solution?  Will it solve the “debt crisis”.  Assume that rather than taxing the “rich” the government decided to take all of the wealth of the American billionaires.  Sounds like a plan, no?  That would bring in about $1.3 trillion[iv].  Sorry, even if the government took all of their wealth, not just a tax on their annual income, it wouldn’t come close to eliminating the Federal debt.

The problem is easy to identify, and so is the solution.  It’s just that no one in Washington really wants to talk about it.  The problem:  as a country we spend more than we make.  The solution:  spend less.  Families have to do that.  Why shouldn’t we expect our government to do the same?

Just my opinion.

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[i] http://www.washingtonpost.com/wp-dyn/content/article/2010/07/23/AR2010072304101.html

[ii] http://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

[iii] http://www.usgovernmentrevenue.com/#usgs302a

[iv] http://www.moneycontrol.com/news/business/interesting-numbers-forbes-rich-list_446045.html

Tax Deductible Vacation?

The rules for travel-related tax deductions are complicated. If you want to avoid a visit from an IRS auditor then check these tips before you book your flight.

1. Transportation cost: The cost of transportation is fully deductible both ways if the trip is primarily for business and within the U.S.  On the other hand international trips must be at least 75 percent business to write off your plane ticket. (If it is less than 75 business then you can only deduct the percentage related to business.)

2. Cruises rule:  A business-related cruise has to be aboard a U.S. registered ship  and the cruise must avoid foreign ports . . . follow that rule or your cruise will not be deductible. The maximum cruise deduction is  is $2,000 per year regardless of the length or frequency of travel.  Moreover, you have to file a detailed written statement with the tax return about the cruise.

3. Work and play is OK:  Your deductible business trip doesn’t have to start and end with business.  You can take a few extra days on either end of the business trip and it won't disqualify your business travel deductions. Make sure, however, that  the primary purpose of the trip is business.  Document the business purpose and expenses and don't deduct any expenses related to the non-business part of your stay.

4. Take the family too . . . just don’t deduct them:  You can take your family with you but you can't deduct expenses for anyone who isn't involved in the business of the trip.  Unless your family members are partners or employees don’t deduct their expenses.  You can  find overlap expenses, expenses that you would have to pay for yourself anyway.  For example if you are driving (your car or a rental) it doesn’t matter who is in the car with you.  Your car expenses was a necessary expense to get you to the business objective of the trip so it is deductible.  If everyone shares a single hotel room, it's deductible too. However, any fees for added occupants or an upgrade to a larger room to accommodate the family, however, will not be covered so be sure and document the single occupancy rate at the hotel.

5. Food is 50%  but that’s not a diet:  Your meals and those of your business associates are deductible at 50 cents on the dollar while on deductible business trips.

 6.  Looking for work?    You can deduct that too.  According to the IRS, "You may deduct travel expenses, including meals and lodging, you had in looking for a new job in your present trade or business. You may not deduct these expenses if you had them while looking for work in a new trade or business or while looking for work for the first time. If you are unemployed and there is a substantial break between the time of your past work and looking for new work, you may not deduct these expenses, even if the new work is in the same trade or business as your previous work."

7. Be reasonable. The IRS expects that your business expenses "reasonable based on the facts and circumstances."  The business travel expense category is NOT the place to de extravagant; that is unless you want to raise a red flag in an IRS auditor’s office.

8. Document everything:   Travel tends to rack up lots of incidental costs like seminar and conference fees, taxi fares, Internet access fees, phone calls, tips, laundry charges. All of these expenses that are in any way business-related can be deducted.  Again, document all of them.

9. One more time:  Document everything.  Keep meticulous records if you travel for business: not just receipts, but anything that might help prove your business purpose.  This includes things like itineraries, agendas, and programs.  Travel expense deductions are rife with abuse.  This means increased odds of the IRS asking you to justify your deductions.  Don’t worry about it . . . just document everything.

New IRS Cost-basis Regulations for Investments

The Emergency Economic Stabilization Act of 2008 included new provisions requiring that all financial institutions the report adjusted cost basis (in addition to gross proceeds) of covered securities and whether the related gain or loss is long-term or short-term beginning with the 2011 tax year.  These new IRS regulations are designed to help taxpayers accurately report gains and losses on investments in covered securities. 

 Transactions involving non-covered securities will continue to be reported as they have in the past, meaning that only gross proceeds (no detailed cost basis)will be reported to the IRS on the sales of these securities. It will still be the investor’s responsibility to report the proper cost basis on non-covered securities.

Covered securities are any securities that are purchased or acquired on or after the legislation effective dates.  Non-covered securities are those purchased or acquired before the effective dates.

Different securities will become covered in different years:

·         Equities.  Equity securities, investments in common stock for example,  are covered securities if they are purchased or acquired on or after Jan. 1, 2011.

·         Mutual funds and dividend reinvestment plan (DRIP) shares. These types of investments are covered if they are purchased or acquired on or after Jan. 1, 2012.

·         Other specified securities, including fixed income and options. Investments in this category will be covered if purchased or acquired on or after Jan. 1, 2013.

Tax Lot Relief Methods

To help you manage the tax consequences of your trading activities, different and new “tax lot relief methods” available. A tax lot relief method is a way of computing the realized gain or loss for an asset sold in a taxable transaction.  It determines which lot of a security as well as its associated cost basis and holding period are used in computing the gain or loss.

          Some of the more common tax lot relief methods include:

·         First In First Out

·         Last In First Out

·         Highest In First Out

·         Lowest Cost First Out

·         Highest Cost Short Term

·         Highest Cost Long Term

·         Lowest Cost Long Term

·         Lowest Cost Short Term

·         Minimum Loss Minimum Gain

If you have invested in equity securities since January 1, 2011 then I suggest that you visit with your tax and investment advisors to determine the best tax lot relief method to use when you compute the gain or loss on investing activities for 2011. 

Recharaterize your Roth Conversion?

2010 may be remembered as the year of Roth conversions.  Remember that after-tax dollars are invested in a Roth IRA while pre-tax dollars go into a traditional IRA.  The advantage of a Roth IRA is the withdrawals from the account are tax free.  The Internal Revenue Code (IRC) permits Roth conversions, the transfer for funds from a traditional IRA to a Roth IRA.  However, it also requires that taxes be paid on the funds converted.  Usually the converted funds are taxed in the year of the conversion.  For example if you did a Roth conversion in 2009 then the funds transferred from the traditional IRA to the Roth IRA would have been taxed on your 2009 tax return.

Things were different in 2010.  The IRC, for 2010 only, allowed the taxes on the converted funds to be taxed over two years (2011 and 2012).  While this didn't reduce the total tax bite, it did spread the taxes out over two years making the taxes a little easier to pay.

Many taxpayers experienced “sticker shock” when they saw their 2010 tax returns on April 18^th this year and have started to have second thoughts about the conversion. 

All is not lost.  If you are in that boat then you have until October 17, 2011 to recharacterize (undo) your Roth conversion.  Before you make that decision there are a couple of important considerations.

First, the two year tax deal is lost forever if the Roth conversion in recharacterized.  The two-year payment option was only available for 2010 conversions.  We’re not in Kansas anymore (unless you happen to live there) and 2010 ended about six months ago.

Second, only the funds that with converted from a traditional IRA to a Roth IRA can be recharacterized.  That seems obvious, no?  But some people held out funds during the conversion to pay the taxes on the conversion.  Assume that a client withdrew $200,000 from a traditional IRA and converted $170,000 into a Roth IRA, withholding $30,000 for the tax bill on the conversion.  In a recharacterization only $170,000 can be converted back into the traditional IRA, taxes will have to be paid on the $30,000 that didn’t find it’s way into the Roth IRA.

Third, gains or losses on funds in the Roth IRA must be considered in any recharacterization.  Let’s look at gains first.  Assume $200,000 were converted into a Roth IRA and now the taxpayer only has sufficient funds to pay taxes on 70% of the conversion.  That means that 30%, or $60,000, of the original conversion needs to be recharacterized.  Assume also that the converted funds, due to some good investment decisions, now have a $300,000 balance.  The Roth fund has earned $100,000 of tax-free investment income.  However, the writers of the tax code took this into account.  Sorry.  If 30% of the converted funds are transferred back to a traditional IRA then 30% of the gain on the Roth IRA must also be converted back as well.  That means that rather than recharacterizing $60,000 the taxpayer will have to recharacterize $90,000 ($60,000 from the original Roth conversion plus $30,000 from the investment gain).

Now, what if the Roth IRA had a loss?  Assume the same set of facts as above, except that the Roth IRA had losses and the account balance has declined to $140,000.  Unless funds are recharacterized the taxpayer will still have to pay taxes on the full conversion amount of $200,000.  To recharacterize 30 percent as above the taxpayer will recharacterize $60,000 (30% of $200,000) but only transfer $42,000 (30% of $140,000) back to the traditional IRA.  If the taxpayer recharacterized and transferred back $42,000 then taxes would be due on $158,000 ($200,000 - $42,000). 

Don’t you just love taxes!

Email me with tax or investment questions and I'll consider them for future blogs.

Up the Creek

Don't ever want to be up the creek without a paddle.  Not literally nor figuratively.  Here I am in my new Father's Day present on the James River; thanks to my dear wife.  Pretty cool and lots of fun. 

In these troubled financial times it is always good to keep your head clear and above water.

Evaluating Credit Card Offers

Have you ever received an invitation to transfer your high-balance, high-interest rate credit card to a new card with zero percent interest for a year?  Is it a good deal or not?  Like many things in life, it depends. 

I was just asked that by a client who had a $10,000 balance on his credit card, was paying 14% interest and making monthly payments of $250.  The offer that he received in the mail was for 0% on transferred balances for a year, followed by 18% interest after that.

You can go to http://www.creditcards.com/calculators/ and run some simulations on your own.  However, let’s take a look at what we did.  First, we computed the payoff for his current card using the “payoff calculator”.  If he continues to make $250 per month payments and cuts the card up or at least doesn’t use it until it is paid off then he will pay the balance of in 55 months, that’s about four and one-half years, and will pay $3,549 in interest.

Next we looked how much he would have to pay per month at 0% interest.  Remember to take advantage of the low, zero percent, interest; he would have to pay the entire balance off in 12 months of less.  $10,000 divided by 12 months is about $833 per month.  He couldn’t do that.  In fact, paying $250 per month was his maximum payment.

If he converted to the new credit card and paid $250 per month for a year with zero interest  then he would reduce his balance by $3,000.  All of every payment for a year would reduce his account balance.  That way, after a year, when the higher interest rate kicked in his unpaid balance would be $7,000.  Back to the payoff calculator for another look.  Again assuming that he doesn’t use the card, makes the $250 per month payment, and accepts the new 18 percent interest rate he will pay the card off in 37 more months and will pay $2,147 in interest.

The following table summarizes his options.

	Keep the 14% Card	Pay off in 1 Year	Transfer Balance
Interest Rate	14%	0%	18%
Monthly Payment	$250	$833	$250
Months to Pay Off	55 months	12 months	12 at 0% 37 at 18% 49 months
Interest Paid	$3,549	$0	$2,147
Total Paid	$13,549	$10,000	$12,147

The second option, although the least expensive, was a no brainer.  He couldn’t make the payments.  He will be out of debt 6 months sooner and $1,402 richer if he transfers his balance to the 0 percent credit card.  However, this only works if he doesn’t start using the credit card again, makes $250 payments every month, and is able to keep the interest rate at 18% after the initial zero-interest period.  Being late or missing a payment could cause the interest rate to skyrocket.

Finally, is it always best to transfer credit card balances to zero-interest cards?  Nope.  Every case is unique.  Run the numbers before you make a decision.  Again, http://www.creditcards.com/calculators/ is an easy-to-use tool to help you analyze a credit card offer.