New Tax Changes: Business

This is a summary of the business provisions of the Stimulus Bill signed into law today by President Obama. See the preceding post for Personal/Individual provisions.

Bonus Depreciation: First year 50% bonus depreciation has been extended through 2009.

Section 179 Expensing: Increased the amount of first year depreciation expensing up to $250,000. Note that a business must be profitable to utilize this provision.

Change in Estimated Taxes: While we will need further clarification, “qualified individuals” (defined as those who have adjusted gross income of less than $500,000 and more than 50% of their income comes from a business with less than 500 employees) can make 2009 estimated tax payments of only 90% of their prior year (2008) liability, rather than 100% of the liability. We are not sure yet how this will interact with the general rule that requires estimated taxes of 110% of the prior year tax for individuals with AGI of greater than $150,000.

There are other, very specific or targeted provisions. The above items should be the ones affecting most businesses.

New Tax Changes: Personal

This is a summary of some items in the 2009 Stimulus Bill which relate to individuals. Most of the items have very specific income phaseouts, so please consult with us as to whether these affect your specific situation.

Home Buyers Credit: For homes purchased between January 1, 2009 to December 1, 2009 a credit of up to $8,000 is available for a taxpayer who has not owned a US principal residence in the prior three years. The amount of the credit is 10% of the purchase price. This replaces the prior law, which provided a $7,500 credit for homes purchased between April 9 to December 31, 2008. That credit must be repaid over 15 years or less.

New Car Sales Tax Deduction: Sales-tax for a new car or truck purchase up to the cost of $49,500 may be deducted “above the line” and not as a Schedule A deduction, so it is more beneficial. This phases out, beginning at adjusted gross income of $125,000 and $250,000, respectively, for single or joint filers. This is effective for vehicles bought on or after the effective date, February 17, 2009.

Work Tax Credit: A temporary credit for 2009 and 2010 of 6.2% of earned income, up to a total credit of $400 for individuals and $800 for joint filers. This is retroactive to the beginning of 2009. The phaseouts for this provision are at $75,000 – $90,000 for individuals and $150,000 – $190,000 for joint filers. These benefits may be received by minor adjustments in federal withholding from paychecks, starting around June, 2009.

Higher Education Tax Credits: For 2009 and 2010, the maximum credit per student increases from $1,800 to $2,500 and the income phaseouts are increased significantly to $80,000 -$90,000 for single filers and $160,000-$180,000 for joint filers. Expenses are expanded to include textbooks.

Section 529 Plan and Computer Purchases: For 2009 and 2010, the cost of computers and related technology can qualify as section 529 plan distributions. Internet access charges and software are also covered, as long as they are not for sports or games.

AMT: As Congress has done in prior years, the AMT exemption has again been temporarily increased. We still anticipate that many taxpayers will continue to be affected by the AMT.

Social Security Tax Credit: Recipients will receive a $250 tax credit. This may be in the form of reduced withholdings or a check.

Energy Tax Credits: Homeowners who add energy-efficient windows, furnaces, heat pumps and air conditioners may be eligible for a tax credit of up to 30% of the costs, up to a total of $1,500. In the future, tax credits of up to $7,500 will be available for plug-in hybrids and battery power electric cars. These vehicles are not yet available.

Required Minimum Distributions: More Guidance

As discussed in my post dated January 29, 2009, no required minimum distributions will be required in 2009 for most individuals older than 70 1/2. Minimum required distributions will resume again in 2010.

The waiver of distributions for 2009 applies to recipients from IRA’s, 401(k)s and 403(b)s. However, the exception for no 2009 distributions does not apply to distributions from defined benefit plans, which must take required minimum distributions in 2009.

Beneficiaries of inherited IRAs who are subject to the 5 year rule are also exempt from required distributions in 2009, so they will get 6 years (this applies primarily to non-spouses who receive inherited retirement funds).

The Case for our Investment Philosophy

While reviewing a prospective client’s current portfolio, which we consider like a medical “second opinion,” we again found real world evidence of the strength of our investment philosophy. (Note that we do not currently manage this part of the portfolio and this is only an example, but one that we have seen time and again).

The person’s broker subdivided the account to be managed into three asset categories (large value, large growth and small growth). Beyond the fact that there are many other asset classes that should have been included, the portfolio commentary for 2008 provides very interesting reading. The broker hired or allocated the money into 3 separate funds. Each of the funds then hired 2 or 3 sub-advisors, to actually do the investing.

So this broker of a major brokerage firm, utilizing their vast resources, selected 3 managers. The 3 managers, again assuming used intensive research, each selected multiple sub-advisors. With all this research and diligence, all 3 funds failed to outperform their respective benchmark.

Over a longer time period, the results for this portfolio was no better, as the person’s portfolio failed to beat the broker’s benchmarks over the past one year, 3 years, 5 years or since inception in the 1990s, failing to beat their benchmark by 3-5% each year (as annualized).

While this is only one limited example, it provides further real-world evidence which academic research continues to show: that it is very difficult for active managers to beat their respective benchmarks, particularly over long periods of time.

Thus, by designing a portfolio with the objective of obtaining benchmark returns with far less in fees, investors have a greater likelihood to outperform active managers, over time. For more information on how we design such a portfolio, or to have us perform a “second opinion” on your portfolio, please contact us.

The detailed commentary:

For the large value asset class, the firm wrote: “The Fund outperformed its benchmark, the Russell 1000 Value Index, in the fourth quarter, but underperformed it for the full year.” In mid-December, the Fund replaced one of the 3 sub-advisors that it had hired to manage the fund. (See more about this in my post dated January 28, 2009).

For the large growth asset class, “compared to the Fund’s benchmark,…the Fund underperformed during the quarter, as well as for the full calendar year…The portfolio continues to be subadvised by three active managers…The three sub-advisors ended the year underperforming the benchmark.”

For the small growth asset class, “the Fund’s negative return was accompanied by relative underperformance versus the Fund’s benchmark…for both the quarter and the year overall. The Fund is sub-advised by two active managers…” The active fund sub-advisors decided to overweight the portfolio in 3 sectors. “However, the stocks in which the sub-advisors invested underperformed stocks in the sector as a whole. Energy stocks within the small cap growth universe declined by nearly 50% during the quarter. The Fund’s holdings in this sector underperformed the benchmark’s sector return.” This means the Fund’s energy sector picks did even worse than the benchmark’s 50% loss.

Snowball….Well Worth the Time

I highly recommend this book, Snowball, by Alice Schroeder, which documents Warren Buffett’s life, including both his personal and business life. It is very long, but very worthwhile reading. Buffet is considered by many as the greatest investor of all time.

The book does describe Buffett’s investment philosophy. Much can be gained by learning his important lessons of incredible discipline and patience, as well as how he has used past weaknesses in the market or specific companies to buy, yet be patient when others are greedy. However, much of the book discusses Warren’s personal life, from his childhood newspaper delivery business (he built an “empire” as a teenager) to his relationship with Bill and Melinda Gates.

The title of the book represents Buffett’s investment philosophy, that money invested and allowed to accumulate and compound over many, many years will “snowball” into even more money. He certainly has succeeded at this.

While I recommend this book, a previous book on Buffett by Roger Lowenstein, written in the 1990s, provides more information on the business side of Buffett and his investment decision making.

Tax Updates to come…but not yet

The House has already passed it’s version of the Stimulus bill. The Senate is expected to approve it’s version on Tuesday, February 10th. Then the bills must be reconciled and approved by both chambers, before the President can sign it (OK, that’s Govt 101).

We will provide a summary of the major tax items once the final bill is enacted. You should not do any planning based on either the House or Senate version, as neither is law yet. For example, both bills contain legislation for the purchase of a new home, but they have very different provisions.

If you do have any questions, please contact us.

Have a Kindle Day!

Today, the Amazon Kindle 2 was announced. Last spring, I received as a gift the first version of Amazon’s electronic book reader, Kindle. The second version appears to be only an incremental improvement of the first version of the Kindle, which is already a terrific technological accomplishment.

For those of you who are serious readers, the Kindle is a great device. I am able to carry many books (it can store hundreds), emailed documents and articles, and magazines all in a device that is smaller than most paperback books. You are able to read it without any glare or problems that come with reading a computer screen. It is very readable, inside or outside, even on a beach in the sun. The cost to download most books is $9.99 and is done in under a minute, from practically anywhere in the U.S. The text size is easily changeable, so it is great for those whose vision is declining.

If you ever want to see it, just let me know. And unfortunately, I don’t receive any commissions from Amazon.