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Thursday, February 24, 2011

How to calculate the total return of a mutual fund

Mutual funds are managed portfolios of multiple investments from multiple investors, and are subject to Federal regulations. Since each mutual fund may have a different fee, worth and payment structure, calculating the total return for each Mutual fund may be different. Calculating the total return of a mutual fund involves defining the variables. It also requires use of the right formula  and inputting the correct numbers. Some of the key variables in calculating total return of mutual funds are the following:

• Expense ratio of mutual fund
• Original investment amount
• Time period of return
• Net Asset Value (NAV)
• Dividend payments if any

Nuances of total return

Mutual fund investment tips
Mutual funds are managed by financial professionals
In the world of investment returns there is specific lingo that sometimes applies to the calculation of returns. Terms are used to describe the nature and type of return; for example  annualized return  real rate of return and compounded return are all important concepts in the accurate calculation of total return. Some terms sound similar, but mean different things such as yield and return. Understanding the meaning of the variable input is useful in making sense of the total return calculation.

For mutual fund calculations, the Net Asset Value (NAV) is important because it changes over time, thus a beginning and end NAV are required. In addition to NAV, dividends, expenses, compounding and inflation may or may not be factored into the total return equation. Once all the proper terms have been sifted and sorted, the next step is to use a formula in calculating the total return.

How to calculate the total return of a mutual fund

Calculating the total return of can be performed between partial and complete accuracy, meaning there are different formulas for calculating total return depending on how complex and accurate the variables and the formula they are used in are. For example, the methods below, as sourced from stock-market-investors.com, illustrate two simple methods of calculating total return followed by more elaborate equations that include additional variables. Since some investment accounts also accrue interest, an additional variable of compounded interest may be used with adjustments in the time value of money using an inflation variable. For some return calculations, specifically the simpler ones, online financial calculators may be of use.

Formula 1: Total return without dividend payments:

(NAV2-NAV1)/NAV1-1= Total return without dividends

Formula 2: Total return with dividend payments, and no expense or inflation deductions

[(NAV2-NAV1)+D]/NAV1=Total return with dividends

NAV2=Investment value at end point
NAV 1=Investment value at start point

Formula 3: Total return with monthly compounding and cost basis:

Variable 1: CB=(NAV1-front end expenses)-(NAV2+back end expenses + fees)
Variable 2: Annual Compound Rate(ACR)=Formula 2 divided by NAV1+CB
Variable 3: ACR exponent= 1 divided by years held

Cost basis and annual compound adjustment formula:

ACR to the power of (multiplied by) ACR compound exponent adjustment (as above in variable 3) minus 1

Formula 4: Total return with monthly compounding and cost basis

To adjust the compounding to be calculated monthly divide the ACR exponent i.e. annualized percentage rate value by the number of months.

ACR divided by 12 multiplied by number of months, to the power of ACR annual compound exponent adjustment which is equal to numerator 1 divided by 1/12 times number of months, minus 1

Formula 5: Including inflation as a variable

Since inflation reduces the value of money, the annual inflation rate can be subtracted from the total return to obtain the real total return of the mutual fund. For monthly inflation deductions the inflation rate that is subtracted is divided by the number of months used in the ACR.

Ex: Formula 3 - Inflation rate
Ex2: Formula 4- Inflation rate / number of months

Total return on Mutual funds varies on how the return is calculated, and the variables and numbers used. This article has illustrated terminology and formulas used in the calculation of total return for mutual funds. Sometimes financial calculators may be helpful in arriving at a final value however, understanding the quantitative terminology in Mutual Fund total return calculations is helpful in properly utilizing the correct equation. Depending on which formula is used, the cost basis adjustment, compounding and inflation if any, the total return may differ from that quoted by the Mutual fund itself.


1. http://www.globefund.com/centre/GettingStarted06.html
2. http://www.stock-market-investors.com/pick-a-stock-guides/calculate-return-on-investment.html
3. http://www.procalcs.com/

Image license: Alastair/OpenClipArt; Unlimited commercial license

The best 5 tax books for tax payers

The five best tax books for taxpayers cover up to date, and pertinent tax concepts while also providing insight and useful knowledge regarding tax filing, planning and strategy. No one tax book may provide all the information a taxpayer needs in their quest for tax answers, however the five best tax books for taxpayers do individually and collectively cover a vast amount of tax information ranging from basic income assessment to taxation of mixed personal and business expenditures.

It is also important to realize tax laws can change often and that the tax code from one year may not apply in its entirety to tax filing in current years. For this reason, it is a good idea to double check the application of tax concepts from these books with the Internal Revenue Service or a tax professional. International Standard Book Numbers (ISBN) can vary by edition and version of tax books for the same tax year. The following five tax books are considered the best because of their professional, knowledge based and informative approaches to tax matters.

"Federal Income Taxation,11th Edition"
Marvin A. Chirelstein
Foundation Press, Thomson West
New York, New York 2009
ISBN 978-1-599-41403-4

An excellent resource on in depth tax concepts and principles, "Federal Income Taxation" covers a wide range of individual income tax issues such as recovery of capital investment, cancellation of indebtedness, extensive deduction, attribution of income, and more. This is one of the five best tax books for taxpayers because it is well rated by readers, comprehensive and updated often.

"Federal Income Tax: Examples and Explanations 5th edition"
Joseph Bankman, T.D. Griffith and Katherine Pratt
Aspen Publishers
New York, New York 2008
ISBN: 978-0-735-56533-3

This book is written by three law professors from Stanford, University of Southern California and Loyola law schools. There are multiple editions of this book and topics include timing, deductions, income shifting and capital gains and losses.  This book is intended as a student textbook that follows a question and answer approach to tax concepts. Details about 'Federal Income Tax: Examples and Explanations' can be found at the Aspen publishers website.

"1040 Forms and Instructions"
Internal Revenue Service (IRS)
U.S. Department of the Treasury

The 1040 Form and Instructions book provides guidelines for a number of forms, schedules, requirements and worksheet requirements for individual tax filers. This book is usually published and available for free to tax payers on an annual basis. For tax payers planning on using multiple forms and schedules, this book is a useful resource and guide. A copy of the 2009 1040 Forms and Instructions is available for free online.

"Americas Best Tax Strategies"
Stephen D. Kirkland
Xlibris Corporation
ISBN 1-4134-6978-7

For a more toned down, less formal and easier to understand approach to understanding personal income taxes while also learning about tax planning and techniques, 'Americas Best Tax Strategies: Legitimate Ways to Save Income Taxes Now' is a good choice. This book is one of the five best tax books for taxpayers because a large part of it is dedicated to explaining tax strategies. The 2004 edition of this tax book is available on Google books for free.

"Federal Taxation: Individual Income Taxes"
William Hoffman, James E. Smith and Eugene Willis
Thompson SouthWestern
Mason, Ohio 2010, 2011
ISBN: 978-0-538-78624-9

A new edition of this book has been released every tax year for several years and this book is available digitally, in hardcover and paperback. Older, paper back and digital editions are usually less expensive especially when purchased used. Older versions provide much of the same information excluding recent updates. The 2008 version of this book is also available for free on Google Books.

If the above five books for tax payers aren't the best in your mind consider reading Title 26 of the U.S. Code. Title 26 contains the codified statutory tax law and constitutes a primary source of legislative tax requirements for cross referencing and additional information. The Internal Revenue Service also provides extensive information on tax code, tax regulations and guidance which may be helpful when filling in tax information blanks and confirming the validity of tax strategies.

Mutual Fund Review: American Century Heritage Fund

American Century Heritage Fund (TWHIX) is a mid-cap growth mutual fund with above average to high 3, 5 and 10 year rankings by both Morningstar and Lipper rankings. (americancentury.com). The fund came into existence in 1987, has assets over 1.25 billion U.S. dollars in worth which is invested primarily in U.S. securities in accordance with the fund's goals and governing policies. The American Century Heritage Fund is managed by two economists named David Holland and Greg Walsh, both of whom, have been at American Century Investments for at least 5 years.

The company itself is an established and highly charitable non-public asset management firm operated out of the U.S. Midwest. The TWHIX prospectus indicates the mutual fund comes in B, C and R classes. The class A American Century Heritage Fund shares charge a front end load of 5.75% of the purchase price whereas the B and C shares require no front end load but do have potential deferred and declining sales charges of UP TO 5% and 1% respectively. The R class shares require neither a front end load charge or a deferred sales charge. (2009 TWHIX Prosepctus)

What are circular loans

Circular loans are loans made by an entity owned by the entity receiving the loan. For example, Company A owns a subsidiary company B. Company B makes a loan to company A making the loan circular in the sense the assets all belong to the parent company. This article will discuss circular loans in terms of how they are made, why they are made and tax implications regarding the loans.

How a circular loan takes place 

Circular loans are similar to check kiting which is a form of check fraud and is punishable by law. The difference between kiting and circular loans however is that third parties are not involved and the intent is more likely to involve tax evasion than check fraud. Moreover, unless the funds do not exist, the circular loans do not constitute a form of kiting especially if the loaned funds are not used to pay expenses incurred from purchases or services received.

Circular loans are quite conceptually simple and the following example illustrates a circular loan. Mac is the sole owner and shareholder of three small businesses called 1, 2 and 3. Each of these businesses perform different functions. Business 1 is a dry cleaning company, business 2 is pawnshop and business 3 is an accounting practice. The owner of the company decides business 1 requires additional funding for an equipment purchase then "applies" for a loan from business 3. Business 3 then approves the loan and transfers the money to business 1.

Reasons why circular loans take place

The reason(s) the shareholder(s) and/or owner(s) of businesses and the businesses themselves may make circular loans vary. Some of these reasons may be legitimate in the sense that one company may have extra liquid assets that can be better used by the second company to create more profitability. In some cases however, the practice of circular lending may be fraudulent or illegal. For example, if the loans are used to disguise money laundering or to create company worth that does not exist, then the circular loans are probably fraudulent or illegal in some way. Below is a list of reasons circular loans may take place.

• Legitimate financing of business operations
• Owner investment of personal assets
• Money laundering
• Generate false asset value
• Tax evasion

Tax implication of circular loans 

Circular loans between some types of corporations are not deductible as an expense if certain conditions are met. For example, if an owner of a S Corporation/Small business makes a loan to a company that then makes a loan to another S Corporation and conditions with the loan terms protect the company and the capital provider from loss, then the loan is not tax deductible.

When the same shareholder as above owns multiple S Corporations between which loans occur, the loans are circular in terms of ownership. Moreover, as per a cost basis adjustment with the shareholders ownership of the company, such loans are not deductible as losses if unpaid because the value of loss is transferred rather than lost.

A similar situation arises when the recipient of the loan is also the owner of the company that makes the loan. In this case, the loan is also circular and may be questioned by tax authorities as being non-deductible due to the circularity of the loan.

Circular loans are a form of lending between separate businesses with the same ownership. The loans are circular in the sense that the net gain or loss is unchanged in terms of the ownership of the funds. Circular loans may be performed for a number reasons that may or may not be legitimate, thus the discovery of circular lending between businesses of shared ownership may be a red flag to banks, financial institutions or minority investors.

A company that lends a circular loan to the business owner or another company owned by the same party may not perform and thus be at greater risk of default on that loan. However, this is not directly related to the circumstances surrounding the loan itself. Circular loans performed for the purpose of reducing taxes is considered illegitimate in some cases as documented within the sources provided within this article.


1. http://www.mobar.org/405bc858-3bcc-4faa-96ea-5607d75e5772.aspx http://www.allbusiness.com/personal-finance/individual-taxes-tax-deductions/950077-1.html http://www.bankrate.com/brm/news/chk/20021203b.asp
2. http://www.cpeforum.org/fall2006docs/Partnership%20-%20MSCPA.doc

The top 10 credit cards in America

If by 'top credit card' one is referring to  low fixed interested rates  no hidden fees member benefits and  banking services, then there are several credit cards that stand out as being among the best in America. 

That said, banking policies can change and credit card plans compete over time so the following credit cards aren't set in stone as the be all and end all of credit cards. Rather, these credit cards, at the time of this review, meet performance and quality benchmarks that measure quality, usability, service, cost and incentive in 5 categories of 2 cards each and specifically look for the following characteristics.

• Balance transfer rates and periods
• Introductory Annual percentage rate
• Low Annual percentage rate
• No annual fee, and member friendly terms of agreement
• Percentage cash back, airline miles or shopping rewards
• Member services, and additional benefits

Airline miles credit cards

There are many airline miles credit cards to choose from. The two cards below take into account annual fees, cost per mile and bonus miles. These cards may be beneficial to individuals who frequently plan and purchase travel itiniaries.

Capital One No Hassle Miles Rewards: No annual fee, 2 miles per dollar over $1000.00
Miles by Discover Card: No annual fee, up to 12,000 first year bonus miles, 2X miles options

How to use the Yahoo foreign currency exchange rate converter

The Yahoo foreign currency converter is quick and simple to use and takes the math out of computing foreign exchange by hand or with a calculator. Yahoo's foreign currency converter determines the exchange rate for 154 worldwide currencies and provides historical data, bid ask spreads, currency exchange inversion and major currency conversion in addition to related financial and/or monetary news links. This article will illustrate how to use the yahoo currency converter and applicable features. 

The Yahoo currency converter can be used for a number of purposes.

• Planning trips or vacations in which currency conversion is required
• Cross-referencing forex quotes across major currencies
• Converting currencies that are less well known or exchanged
• Sourcing data for use in spreadsheet software analysis
• Obtaining historical line graphs of currency exchange movement

Converting a single currency into another currency

To convert a currency using Yahoo foreign currency converter simply go to the web address provided in the link above and type the denomination of the currency to be converted, then select the currency to be converted in the drop down menu on the right of the denomination. After this, select the currency the first currency will be converted into. For example, $1 USD to be converted into British pounds will read 1 U.S. Dollar (USD) into British Pound (GBP). After pressing on convert the exchange rate for the day of conversion will be revealed. For example, $1 USD is equal to .6531 GBP.

Step 1: Go to Yahoo currency web address
Step 2: Enter numerical amount to be converted
Step 3: Input currency to be converted Ex U.S. Dollars
Step 4: Select currency to be converted into Ex. British Pounds
Step 5: Press convert to reveal converted denomination in pounds

Calculating the inverse of a currency conversion 

To calculate the inverse of a currency conversion using Yahoo currency converter proceed with the steps above. Following this a conversion spread sheet will be displayed with six columns indicating the currencies being converted, the date, the exchange rate, the converted amount and the market prices for the currency that is being converted into. Below this will be a graph of historical data indicating the conversion for the same amount of currency for a given time period.

At the top right of this graph will be an 'Invert currency' button-link that will reverse the conversion. After pressing this button, the original entries will be reversed except for the numerical denomination that will stay the same. For example, 1 British pound will now be converted into 1 U.S. Dollar, using the same exchange rate as above, this would be $1.5306 for each singe British pound. As with the original conversion a graph will appear below the conversion spreadsheet, except the new graph will illustrate the new currency that is converted into which is now U.S. dollars rather than British pounds.

Using the data from the Yahoo currency converter

To use the data from the yahoo currency converter one can download the converted information into a spreadsheet. This will include the same information that is listed in the Yahoo online conversion sheet but can be transferred to an excel spreadsheet for storage and analysis. 

Additionally, the home page of the Yahoo currency converter lists conversion of the primary currency into 6 other currencies including the Japanese Yen, Euro, Canadian Dollar, British Pound, Australian Dollar and Swiss Franc. If the currency converter is used on a daily in an ongoing manner, one can simply copy and paste the data from the Yahoo currency multiple currency spreadsheet into an excel spreadsheet for further computations, statistical outputs, graphing, analysis etc.

The Yahoo currency converter makes calculating exchange rates easy, however the dates for which currencies are calculated are current meaning only the graph of the currency converter will illustrate past conversion rates. The amount of time it takes to convert currency using Yahoo currency converter is short. 

The online converter can also be used for a range of purposes as listed after the first paragraph above. The Yahoo currency converter is free to use, and also indicates how much a currencies exchange rate has moved within a single day as evident in the Yahoo currency conversion home page and after conversion page graphs. Google also has a currency converter, however in comparison, the features are limited.

IRS forms to file if you can't pay your income tax on time

Forms to file if you can't pay your income taxes include payment extension, filing extension, installment payments, bankruptcy circumstances, and the tax return with its additional forms if applicable. Generally if tax can't be paid it is a good idea to file the applicable form relating to your specific situation. 

If you need more time to make payments but don't qualify for financial hardship a form 9465 may be used in some cases. However, if you are simply in doubt of how much tax you owe due to a need to gather information after April 15th a tax extension with estimated taxes due and paid may be more appropriate. Some of the forms that may apply to your situation are listed below:

IRS Form 1127
'Application for extension of time for payment of tax due to financial hardship':. Must be filed by April 15th tax filing deadline. 1040's may not be required when this form is filed however qualification and payment extension time is limited to financial hardship and a maximum of 6 months. Additional and/or supplementary information is required with this form.

IRS Form 656
'Offer in Compromise': This is an offer made to the IRS for individuals and/or households in the process of filing for bankruptcy. Form 656-B contains instructions and guidelines for filing Form 656. A sizable application fee is required for this form and a percentage of the offer amount may also be required.

IRS Form 9465

'Installment Agreement Request': Applications that are approved by the IRS are given a monthly amount due to the IRS. These installments are billed monthly with interest following approval of the installment agreement.

IRS Form 4868
'Application for Automatic Extension': Some payment is still due with application for filing extensions. Remaining balances may be charged penalty fees and interest lower than the standard penalty percentage if not part of accurately estimated tax due as per Form 4868 instructions.

IRS Form 2350
'Application for automatic extension for U.S. Citizens and Residents Residing Overseas': and similar to a form 4868. Specific time of extension requested is listed on the form itself and an interest penalty is incurred for late filing of the extension form.

IRS Form 1040
'U.S. Individual Tax Return': This form is filed with Form 9465 and contains income and adjustment information for the applicable tax year. Some forms such as tax filing extensions explicitly do not require a 1040 at the time extension is filed for.

Form and late payment related tips

• English and Spanish, the Spanish forms have 'SP' at the end of the form number. For example, Form 4868 would be Form 4868-SP for Spanish.

• Application for installment has a fee associated with it and also charges interest on the remaining balance. For small amounts the interest plus the fee could increase the amount of tax owed significantly.

• Installment payments can be made online for free through the 'Electronic Federal Tax Payment System (EFTS)'. However, payment for new users of this system may not be instant because pin numbers and identification codes are sent via mail.

• Tax filing extensions are different from tax payment extensions. Tax filing extensions still require payment of taxes.

• Personal statements that are considered valid by the U.S. Internal Revenue Service may lead to a waiving of late payment penalty according to Form 2350's instructions.

• If tax can be paid within four months of the April 15th deadline it is more affordable and not necessary to file a form 9465.

Late payments on tax owed to the U.S. Internal Revenue Service usually end up costing more than the initial tax with interest, penalties and fees. Information on tax filing penalties can be viewed at this IRS penalties and interest charges link. Paying on time may be the better option if it is possible. However, in circumstances where payment in full cannot be made by the tax filing deadline, one or more of the above forms may need to be accurately completed and sent to the appropriate IRS service center. 

These service centers are divided by region. In any case, when in doubt and to confirm you are using the right form contacting an IRS service center or tax professional can be of assistance. The IRS contact information can be viewed at the following link for additional information. 

Source: http://www.irs.gov

The difference between cash flow and free cash flow

Cash flow represents the flow of money for a specific period of time where as free cash flow indicates a cash flow balance after the flow of cash in and out of accounts. The difference between cash flow and free cash flow is a) when the calculation is made, and b) what the cash flow used for. Both cash flow and free cash flow are important aspects of business activity that can be used to analyze financial activity and performance.

Free cash flow (FCF) often represents the available amount of surplus cash after operating and investing cash flows have been determined. If free cash flow is a positive number, it is more likely to be free cash flow whereas cash flow precedes free cash flow in the sense it is used to pay expenses, and invest as evident on the statement of cash flows.

Definition(s) of cash flow

How one calculates cash flow depends on the activity the cash flow pertains to, and the accounting rules in place which govern the use and recording of cash flow. This is why the cash flow statement is so useful; it provides a picture of what a company has done with its cash over a period of time, for example three months if a quarterly statement.

To illustrate cash flow, an example of  cash flow from investing activities can be used. Cash flow from investing can include sales of investments or investment projects in addition to new investments made are recorded in this aspect of cash flow. To see how cash flow from investing is recorded, reviewing an example example statement of cash flow is demonstrative.

In this example, cash flow from investing activities go into and out of the company. In this particular instance the only two items recorded are $33,600 cash inflow from a sale and investment in property and equipment for $75,000 for a net outflow of $41,400.  A negative cash flow for investing is not necessarily a bad thing as it means the company has money to invest or considers the investment prudent and the company is attempting to grow its financial positioning.

Calculating free cash flow

Free cash flow, unlike cash flow, is more indicative of an ending cash balance after a series of cash flows. The term 'free' in free cash flow illustrates the positive cash flow resulting from a free cash flow calculation is free to use in ways other than those that are pre-allocated for specific use i.e. corporate operations and sustainability.

Free cash flow can be calculated in more than one way, but generally or most commonly subtracts capital expenditures from operating cash flow.(2) Keep in mind this does not  necessarily include all capital expenditures or include cash flow from financing activities which is somewhat separate from a company's daily operations. To include financing activities in a free cash flow calculation another cash flow calculation is used i.e. 'Free cash flow to equity'. (1) Three types of free cash flow are listed below:

1. Free cash flow
2. Free cash flow to equity
3. Unlevered free cash flow

How free cash flow is calculated determines how useful it is as a financial indicator and what it is measuring. For example, the free cash flow to equity calculation provides insight into how financing affects free cash flow by adding borrowed funds to the free cash flow equation. However, this may not accentuate the cost of that cash flow.

Unlevered cash flow demonstrates how much money is available to pay back company debts absent financing and returns on investments and standard free cash flow measures available capital for investing and/or financing new corporate projects.(4)

In light of the standard definition of free cash flow, the definition of capital expenditures becomes particularly relevant. This is because those capital expenditures used to sustain corporate income as distinguished from capital expenditures used to grow corporate revenue and/or income are different thus excluding growth expenditures should be used in the free cash flow calculation if it is to measure free cash flow available for new and expanded investments and expenditures.


1. http://peregrin.jmu.edu/~drakepp/general/FCF.pdf (CF and its calculation)
2. http://www.investopedia.com/terms (Cash flow & Free Cash Flow)
3. http://www.allbusiness.com/finance/886781-1.html (Defining FCF)
4. http://www.quickmba.com/finance/free-cash-flow/ (Free cash flow)

Taxes on life insurance death benefits

Lump sum payments from life insurance payments, payable upon death are not taxable so long as they do not exceed the present value of the policy. For example, if person X holds a life insurance with beneficiary Y listed to receive $100,000.00 in the event of death before a certain age and under certain circumstances only, then the present value of the policy is $100,000.000 and will be not taxable. However, any cash value the policy has accumulated will be surrendered in the event of a face value payout.

There are instances in which life insurance death benefits are taxable. Specifically in cases of   interest earned and  estate taxation benefits. Since payout of insurance death benefits may be received in installments, additional interest may accumulate on the value retained by the life insurance company. Additionally, in the case of estate taxation, the death benefits are not taxable as income ,but rather as estate taxes. According to the eHow Finance video below, 99 percent of the time death benefits are not taxable. However, there are a couple of instances in which they are:

Taxation of interest on death benefits

Any amount of interest earned and paid out to the life insurance beneficiary that is over and above the face value of the insurance policy is taxable as income. Depending on how that interest is accumulated i.e. through which financial instruments can have an influence on the taxation levels of the additional income. For example, if the interest is earned through ownership of company stock that pays qualified dividends, that interest may be taxed at either 5% or 15% depending on the income level of the recipient. Or the interest may not be paid out, in which case it could be classified as tax deferred income.

Estate taxation on benefits

If an insured person dies an the face value of the insurance death benefits are less than $1-$3.5 million depending on the year, no estate taxes may be payable. However, if there are other assets in the estate, any amount over the tax exempt amount may be taxable.

When an insurance holder passes away, an Estate tax return may have to be filed prior to the nearest following tax filing deadline. Specifically, an IRS form 706 Schedule D may be needed to be filled out along with the other required information of the form 706.

In some cases, estate taxation may be avoided through the use of specific trusts such as an AB Trust, QTIP trust or Life Insurance trust. In the case of a life insurance trust, life insurance proceeds may be withdrawn without estate taxation and in the case of an AB trust, the value of the state is divided making the total estate value lower for the surviving relatives and hence less likely to be taxable under estate regulations.

Multiple insurance policy death benefits and additional tax tips 

In some cases there may be a number of insurance policies in existence including but not limited to auto insurance, employer insurance, and one or more types of life insurance. In such cases, the amount of the total proceeds may exceed the tax exempt estate limit, making any amount above that limit potentially taxable. To limit taxation in such instances as above, it may be advantageous to utilize one or more of the following techniques:

• Establish Trusts: i.e. charitable, AB, or life insurance, credit
• Hold assets in a family owned business
• Life insurance benefits may be payable into a shared annuity insurance policy, in which case the payments are distributed as an annuity  and avoid estate tax and/or are tax deferred income.
• Charitable contributions up to $12,000 per beneficiary may lower the estate value enough to be non taxable.
• Consult an attorney practiced in Estate law
• Seek the advice of a licensed Tax Accountant
• Contact the Internal Revenue Service for answers to additional questions.
• Research applicable laws, tax code, forms and methods of taxation.

Taxes on life insurance death benefits are for the most part payable through estate taxation, rather than income taxation except in cases of interest income on deferred payments. Additionally, if the total face value of death payout insurance is less than the pre-determined estate tax minimum taxable amount, then the death payout may not be taxable assuming no other income that causes the estate value to rise above the taxable minimum is realized through the estate. It may be possible more than one insurance benefit becomes payable in which case the use of trusts such as Life insurance trusts may be beneficial from a tax perspective.


1. http://www.irs.gov/publications/p525/ar02.html#d0e5141
2. http://www.irs.gov/pub/irs-pdf/f706.pdf
3. http://www.ins.state.ny.us/que_top10/que_life_who.htm
4. http://www.irs.gov/businesses/small/article/0,id=108143,00.html
5. http://www.nolo.com/article.cfm/ObjectID/DAC2BB31-35E4-43B2-9BDFA70AD3775418/
6. http://law.freeadvice.com/estate_planning/asset_protection/techniques_estate_taxes.htm

Taxes on short-term disability benefits

Taxes on short-term disability benefits are determined by the method of coverage and the reporting of coverage as per the U.S. IRS Revenue Rule 2004-55.(1)  For example, for employer provided disability insurance coverage, the cost of coverage can be either reported as income or not. In the latter case, the benefits received in the instance of disability benefits may be taxable whereas the reverse may be the case for the former. Short-term disability benefits are reported on lines 20 and 21 of the 2009 IRS Form 1040. To avoid taxes on short-term disability benefits the following actions may be helpful:

1. Complete an IRS Form W4-V for voluntary withholding of coverage premiums.
2. Pay for disability coverage privately.
3. Earn under the income cap limit for Social Security Disability Benefits.

To illustrate more specifically, pre-tax and after-tax income received from short-term disability benefits may be taxable for the individual in the former case and non-taxable in the latter. The reason for the difference in taxation is the manner in which the benefits are handled. In the former case, the employer does not pay taxes on the benefits for the employee but in that latter case it does. 

These stipulations are illustrated by U.S. Internal Revenue Service (IRS) Revenue Ruling 2004-55 which according to Mellon Financial Corporation applies to all tax payers.(4) The ruling represents a means by which short-term disability benefits may not be taxable. However, as mentioned previously, the original disability coverage must be reported as income for any future benefits to be tax free. In the case of partial contributions being reported, a partial tax break may be incurred according to a Mutual of Omaha benefits claim procedure guide.(3)

Kinds of short-term disability benefits 

The type of short-term disability, timing of coverage and sources of coverage financing can also influence taxation of benefits. For example, benefits from privately financed disability insurance is not taxable as per the aforementioned revenue bulletin. Some of the different scenarios in which benefits may be received are listed below. Each of these scenarios have potentially taxable or non-taxable benefits.

1. Short-term disability from Social Security: Subject to income caps, and specific reductions.
2. Private short-term disability coverage: If paid for by recipient, benefits are non-taxable.
3. Employer short-term disability coverage: If paid for by employer but not reported as income by employee, taxable benefits. If partially paid for by employee, partially taxable benefits.

Useful IRS forms and publications for disability benefits

Benefits from short-term disability coverage should be reported to the IRS because it is still considered income regardless of whether or not it is taxable. There are spaces for both the taxable and non-taxable amounts in IRS Form 1040. Other forms that may be needed are Social Security Statements or 1099 summaries, voluntary withholding forms and income forms in which benefits are included in income.

• IRS Publication 915: Social Security information
SSA-1099: Social Security income statement
Form W-4V: Voluntary tax withholding form
• IRS Form 1040: Standard tax reporting form
• IRS Form 1040 Instructions
• IRS Publication 525: Income tax information
Form W-2: Employer income statement

The scenarios in which these forms and publications are used vary. IRS Publication 915 covers Social Security benefit reporting whereas the 1040 instructions have information for non Social Security benefit reporting. Other forms such as the W-2 are forms received by employers that indicate income received, which in some cases, can include disability benefits paid through an employers insurance provider.

Short term disability coverage may or may not be taxable depending on the method and means by which the insurance is provided, paid for and reported. Income is also a factor in the case of Social Security disability benefits. By not including disability coverage from an employer as income, one is taking the chance disability income will not be received. 

This is a decision to be made by the coverage recipient and may be assisted via a personal risk assessment or employment risks audit. The forms, sources and publications cited in this article may be of additional assistance in determining whether disability benefits will be taxed, and how to reduce or eliminate the amount of disability pension taxed.


1. http://www.irs.gov/irb/2004-26_IRB/ar06.html (IRS Bulletin 2004-26: Revenue Rule 2004-55)
2. http://www.hcvadvocate.org/hepatitis/hepC/Taxing%20disability%20benefits.htm
3. http://www.mutualofomaha.com/documents/manual/std.pdf
4. http://www.buckconsultants.com/pdf/fyi_07_15_04b.pdf
5. http://www.nosscr.org/tax.html

Wednesday, February 23, 2011

Taxes on lawsuit settlements

 Image license: RGBstock; woodsy

Lawsuit settlements are only taxable sometimes, therefore some of the time paying taxes on lawsuit settlements can be avoided. If one has successfully won a law suit settlement, there's still work to be done when it comes to taxes. Specifically, how to identify, minimize or even eliminate tax on the settlement funds which could be costly. For example, a settlement of over $1,000,000.00 in one lump some payment could be taxed as high as 35% which could be $350,000.00. That potential tax may be a good enough reason to consider and weigh the options on law suite settlements.

Lawsuit settlement annuities

If law suit settlement funds are taxable, one way to avoid and/or reduce taxes on settlements is to receive the lawsuit settlement in the form of monthly payments or annuity. If the type of settlement claim does not fall under common law excluding tax on the annuity settlement, then taxes might still be due under an annuity settlement, however, with an annuity total income is lower than if a lump sum has been distributed. 

Since these monthly payments will reduce annual income but still allow one to receive the sum of the settlement funds, tax can be saved. For example, suppose the $1 million dollar example above were distributed as an annuity over 10 years. That would mean $100,000 in income per year, which is taxable at a lower rate than $1 million, i.e. approximately 28% or $70,000 less than if the full amount were taxable. It is important to note that even annuity distributions may be taxable under tax code and law.

Lawsuit settlement law and tax code

Distinguishing taxable from non-taxable lawsuit settlement income is a matter of understanding what the tax authorities consider taxable per Oregon Live. Moreover, if income from a settlement is taxable, but is not reported, the tax authority may have the right to seek out taxes due with or without interest and other charges. To determine if a lawsuit settlement is taxable a recipient of said award might be well guided to identify the award as compensation for damage caused by physical injury or non-physical injury. 

If a lawsuit settlement arises from circumstances such as breach of contract or the settlement includes punitive action i.e. court awarded punishment to the prosecutor, then this income is more likely to be taxable under tax code and law. The extent of tax codes, judicial rulings and laws are significant and sometimes differ. Thus, it may be advantageous to consult tax attorneys and/or accountants in light of the potential tax savings and/or avoiding any potential tax code violations and punishment.

References and sources for tax guidance on lawsuit settlements

When seeking to determine whether or not a lawsuit settlement is taxable, independent research, due diligence, legal consultation and/or accountant assistance may be indispensable. For this reason, reviewing sources such as the Internal Revenue Service and the United States Tax Court helps with acclimating to caveats, income exclusions, income inclusions, IRS codes, court rulings etc. regarding the payment of taxes on settlements. These sources can be consulted for additional information, clarification of terms or rules, or professional consul.

Lawsuit settlements can vary in size, terms/ruling and nature. The size of the settlement can influence the percent level of tax if the settlement is taxable and the terms and ruling of the settlement can determine how the settlement funds will be received. Last, the nature of the lawsuit settlement influences how tax authorities interpret the settlement. 

For example, a smaller tax settlement, paid in terms of annuity into a tax protected trust fund in compensation for physical injury is less likely to be taxed than a large settlement, paid in lump sum to the recipient directly in settlement of loss and/or damage incurred through breach of contract.

Since the potential tax savings, interest on back taxes, and punishments or late fees on unpaid taxes can be quite high, it is a good idea to consult tax attorneys, professionals or accountants for written verification of tax filing requirements. The information in this article is not intended as legal advice but rather a source of information regarding taxes on lawsuit settlements.

Why the Wall Street Journal is a better source of financial information than the New York Times

The Wall Street Journal is an ideal source of financial information not only because of its high standards of reporting but also because almost all the newspaper is dedicated to business, economic and political news. The New York Times, although considered an excellent newspaper, only has about 10 or so pages in its business section and has lower combined print and online distribution within the United States. In other words, even though both papers are considered high quality, the Wall Street Journal is the more complete source of financial information. This article will outline some of the reasons why the Wall Street Journal is an excellent source of financial information.

History, awards and circulation

The WSJ is a widely recognized financial newspaper and has a reputation of quality reporting, up to date financial information, and is a often considered a useful daily source of information by business-persons, accountants, financial specialists and many others. The paper has been in publication for many years and is an institutionally recognized source of financial information. A few of the reasons supporting why the Wall Street Journal is so highly regarded are listed as follows:

• In publication since 1889
• 33 Pulitzer prizes
• Over nine hundred thousand online subscribers
• Close to 1 million print subscribers
• 2nd most distributed paper within the United States
• Also published in Europe and Asia

Filing taxes on interest and dividends

Interest and dividend income comes in a variety of forms and even with special terms, as is the case of non-taxable distributions. Each type of interest and dividend income is taxable in a different way and some interest income is tax exempt altogether. 

Figuring out how to record interest on tax forms can involve a few steps, a little research and some time with paperwork a calculator and a pencil. This article will attempt to simplify that process by illustrating the types of taxation on interest and by providing tips on dealing with and reporting interest and dividend income.

Taxable interest   

Taxable interest is reported on form 1099-INT's unless it is under $10.00 for the year in which case a financial institution is not obligated to send a form 1099. All interest income from savings, checking, money market or similar types of accounts, whether it be reported or not, should be reported as taxable interest to the Internal Revenue Service when tax filing. As the video that follows illustrates, an IRS Schedule B may be required for interest and/or dividend earnings above $1,500.

Tax exempt interest

Some financial instruments such as U.S. Treasury bonds may be tax deferred meaning interest accumulated on the bonds is not taxable until the bond's value is redeemed. This interest is tax exempt but is still required to be recorded on tax filing documents. Tax exempt interest is also reported to a form 1099-INT. Dividend income obtained through certain retirement accounts may also be tax exempt if not redeemed during the tax year.

Ordinary dividends

Dividends include payments from companies, of which the tax filer is or was a shareholder during the tax year. Ordinary dividends are not tax exempt are recorded on a form 1099-DIV which is sent to the tax filer. Ordinary dividends are taxable at the income tax rate of the taxable income and are thus treated as ordinary income for tax purposes.

Qualified dividends

Qualified dividends are not currently taxed at ordinary income levels. These types of dividends are taxed between 5%-15% and are consequently potentially advantageous to tax filers in higher tax brackets. Certain requirements determine whether or not ordinary dividends are treated as qualified dividends. More complete qualification criteria can be referred to using the source references in this article.

Tips on how to report interest on tax forms

Forms and documents: Having all the necessary forms before completing either the online or paper tax filing can be helpful. The forms and documents that may be needed include form 1099-INT's, 1099-DIV's, account statements, form 1040A, Schedule D, Schedule B, form 1065 or 1120S, and form 4952. Some of these forms i.e. the 1120S and 4952 are for business dividend income only.

Non-dividend distributions: Certain companies such as Mortgage Real Estate Investment Trusts allow for dividends to be treated more like a cost adjustment for capital gains. What this means is the income received as non taxable distributions is only taxable as a capital gain once it reaches a dollar amount higher than the initial cost of investment. These types of distributions can hold significant tax advantages in high volumes of cost. Non-taxable distributions will also offset tax benefits of capital losses.

Qualified dividends: To ensure the correct taxation of qualified dividends complete the qualified dividends and capital gain tax worksheet in the form 1040 instruction manual. These instructions are available through the IRS website.

Tax strategy: Developing a tax strategy can offset taxation of interest income through tax hedges such as deferred dividend income accounts or instruments i.e. some Government bonds, and/or retirement accounts. Insuring an acceptable level of income i.e. unneeded income remains in such accounts can help keep one's taxes more reasonable.

Resources: Making use of free resources such as the Internal Revenue Service question line, online resources and free access publications can assist with minimizing and managing taxation of interest income. If necessary and in the case of doubt, a tax accountant or professional may provided additional insight and information.

To summarize, interest and dividend income is complicated by tax regulation that treats different types of income differently. That is to say, some interest income is taxable while other interest income is tax deferred or tax exempt. This article provides information on the types of interest rate based and dividend income, however does not replace the advice of a tax professional. Knowing the differences between each is not only essential to proper taxation, but also in developing an advantageous tax strategy that may help a tax filer achieve a lower tax payment and/or reduce taxable income.


1. http://www.irs.gov
2. http://www.usa-investment-tax.com/taxation_dividends.asp
3. http://www.missouribusiness.net/irs/taxmap/pub17/p17-041.htm
4. http://www.irs.gov/pub/irs-pdf/f4952.pdf
5. http://www.googobits.com/articles/p2-1371-how-are-dividends-and-other-corporate-distributions-taxed.html

How to acquire 401(k) loans

A 401(k) loan is literally a loan borrowed from a 401(k) retirement plan. Since 401(k)s are managed retirement plans, and regulated by the U.S. Department of Labor, the policies implemented by 401(k) managers tend not to vary excessively. To obtain and retain a 401(k) loan, one should be employed, have an existing 401(k) with more than $1000.00 and remain employed at the organization for which the loan is managed until the loan is paid off.

Application for a 401(k) loan

Obtaining a 401(k) loan is easier than obtaining home equity loans because the money is not coming from a bank but rather from liquid personal assets. The application process is fairly easy and shouldn't involve a credit check, supporting loan application documents and lengthy loan application review. Essentially the process of obtaining a 401(k) loan can take place in 4 easy steps.

1. Contact employer department responsible for 401(k) registrations
2. Ask about 401(k) borrowing terms and agreements
3. Apply either online or through the 401(k) management firm
4. Receive funds either via check or electronic transfer

In the case of 401(k) managers who do not allow 401(k) loans, there is a regulation that allows loans to be taken against the retirement plan under circumstances of need. Since specific criteria are needed for these hardship loans, they may involve extra documentation to verify the loans are in fact needed and cannot be obtained elsewhere. The hardship need may or may not be difficult to prove to the 401K manager. (about.com)

401(k) loan terms

As with many loans, 401(k) loans have specific terms of agreement as determined by regulation and 401(k) manager's policy regarding the loans and in accordance with regulations pertaining to 401(k) loans. Many 401(k) loan terms are standardized and include similar features such as those listed below. The website www.research401k.com and other 401(k) related sites illustrate the terms of these loans, some of which are listed below.

• Loans must be repaid before distributions can be made
• Up to 5 years to repay the loan without pre-payment penalty
• Interest payments made to self
• Up to 50% of account value can be borrowed
• Loan payments deducted from employer pay (after payroll tax)
• $1000-$50,000 borrowing limits
• No distribution tax on loan funds received if paid prior to end of 5th year

Terms of 401(k) loans differ between financial institutions. The video below details some of the key features of 401(k) loans:

Many financial advisors and much financial literature advise against the use of 401(k) loans because of the duplicated losses incurred by the loans. More specifically, interest and/or appreciation is lost in the 401(k) itself, and the difference between pre-tax and after-tax income is lost when repaying the loan (moneycentral.com). In other words, since 401(k) deposits are made with pre-tax earnings, this lowers one's taxable income and increases one's income leverage. When after tax income is used to pay off the 401(k) loan, income leverage is reduced. Additionally, retirement plans are generally best left untouched as the habit of borrowing from one's retirement can become costly if repeated and relied upon.

That said, 401(k)'s are a quick source of financing for emergencies that don't require as much procedure as a home equity loan. The interest is usually around half to two thirds lower than a credit card and when you pay the loan back you're paying yourself and regain some of the appreciation lost from the 401(k) loan. (forbes.com) 401(k) loans are useful as an alternative source of financing

401(k) loans are made against one's employee retirement savings plan known as a 401(k). These loans are simply acquired through the 401(k) administrator if their policy allows such loans against the 401(k) plan. 401(k) loans are a quick source of capital at an interest rate lower than credit cards, title loans and collateralized loans because 1) interest on the loan is returned to the 401K and 2) the interest rate on 401(k)'s does not far exceed the prime rate which is a key lending rate charged by banks.

401(k) loans may not be an offered service from all 401(k) administrators so it is important to understand the terms of the retirement plan in the case of anticipated and non-anticipated future 401(k) loan needs. The amount of 401(k) loans are capped at $50, 000.00 and do not have penalty or direct cost other than lost pre-tax income leverage and 401(k) appreciation. 401(k) loans may consequently be relatively cost effective financing and useful up until a point after which alternate source of financing may be required.



Estate planning tips for Nevada residents

Nevada is an estate friendly State because of its lack of State income, estate and inheritance tax. (4) Additionally, Nevada affords individuals more privacy regarding disclosure of income and asset information. Moreover, Nevada's economic infrastructure and wealth regulatory laws may provide reason for planning an estate in Nevada. This article will discuss estate planning in terms of reducing taxes, protecting assets, expediting estate management after death and estate asset allocation.

• Reduce taxation
• Protecting Nevada Estates and expediting their management
• Nevada estate asset management

Reducing estate taxes in Nevada

There are two good ways to reduce taxation on estates, first lower the taxable value of the estate and second shelter income and assets in the estate in safe financial instruments, policies and/or accounts. In Nevada several options are currently available to estate owners to lower their taxes or the taxes on descendents who inherit the estate. Even though inherited assets are not necessarily taxable by the State of Nevada, they may be by the U.S. Federal Government making the use of tax protected financial instruments less redundant than might be expected.

• Nevada trusts' income are State tax free
• Life insurance policy distributions are tax free
• Inherited assets are not taxed by the State, but may be taxed by the Federal Government
• Not all investments outside a trust or insurance policy are taxable ex- Tax free mutual funds
• Individual Retirement Accounts can be transferred to Beneficiary Retirement Accounts

Protecting Nevada estates and expediting their management

After dying one or more of the following parties may become involved in the estate's management: Estate executors, trustees, beneficiaries, family, accountants, lawyers and government officials. Depending on the clarity and complexity of the estate, and matters surrounding the estate, it's management after death may be simple and short or lengthy and complicated. Some steps may be taken in advance to help relieve potential problems regarding re-distribution and allocation of estate assets. A few such steps are listed below:

• Keep beneficiaries up to date on accounts, policies and property
• Maintain legal and State applicable Will, and Power of Attorney
• Place and record assets as trust rather than individual owned
• Transfer assets as gifts prior to transfer of the estate
• Utilize both tax-free and creditor secure financial instruments

Asset management of Nevada estates

Increasing the value of an estate in Nevada can include present and after tax values. To increase the after tax value involves some of the aforementioned tax techniques. However, increasing present value of an estate is also financially important. Estate wealth building techniques vary on the asset base of the estate's portfolio and the allocation and redistribution of assets within such. However, some techniques can be applied with or without estate specific assets in mind.

• Make use of the $1 million federal gift tax exemption and annual tax exempt gift amounts
• Assess value of gifts given under 0% Nevada State gift tax
• Transfer assets to spouse to avoid 'unlimited martial deduction'
• Increase size of life insurance policy value
• Optimize Roth IRA contributions
• Invest in tax free financial vehicles
• Allocate portfolio assets in accordance with financial goals
• Consult a financial planner, estate accountant or estate lawyer if necessary

Additional financial Instruments of interest may include the following when estate planning in Nevada. These items help protect estate assets from creditors and/or taxes making them worth consideration when managing an estate portfolio.

• Nevada Asset Protection Trust
• Trust owned life insurance policy
• IRA transferable to a Beneficiary IRA
• Generation Skipping Trust

That said Nevada may assess tax on both real and personal property making expensive housing and automobiles within an estate subject to taxation if not legally protected from such. Considering this, a highly liquid portfolio or one that minimizes taxable ownership of property may be worth consideration.

Estate planning in Nevada may be worthwhile given the nature of the State's economic and regulatory structure. These regulations limit taxes on estates but do tax property that is not tax sheltered. Protecting assets in an estate from creditors and costs is an important part of estate planning in addition to building the wealth of the estate through use of sound portfolio management. The content presented in this article is not intended to replace the advice of a financial planner, accountant or lawyer certified or licensed to practice in the State of Nevada or otherwise. The subject matter of this article is for informational purposes only and is to be used or not used at the reader's own discretion.

Nevada and general estate information resources consulted:

1. "Money Central"; http://articles.moneycentral.msn.com/RetirementandWills/InvestForRetirement/WhatToDoWhenYouInheritMoney.aspx
2. "Investopedia"; http://www.investopedia.com/articles/pf/05/EstateTaxPhaseOut.asp
3. "Bankrate"; http://www.bankrate.com/brm/itax/edit/state/profiles/state_tax_Nev.asp
4. "Pacific Life"; http://www.pacificlife.com/Channel/Educational+Information/Life+Insurance+Concepts/Maximizing+Life+Insurance+Benefits.htm
5. "State of Nevada"; http://tax.state.nv.us/DOAS_MAIN.htm

Guide to sales and use taxes

The difference between sales tax and use tax is that sales tax is charged at the time of sale whereas use tax is levied retroactively some time after the selling of a product. If purchases comprise a large part of personal income spent, sales and/or use tax could add an extra 5-7.3% to the total bill. This article will describe sales and use tax and provide examples of each and will then offer tips for saving and/or avoiding sales taxation.

Sales tax

Sales tax varies from State to State and some localities may charge additional taxes to raise money for municipal projects. Sales tax is also higher for some products than others. For example, several States have high sales taxes on cigarettes and beer. New Jersey and Rhode Island have the highest tax on cigarettes and $2.58 and $2.46 per pack respectively. California and New Jersey are among the highest taxed States in terms of Sales at 7.3% and 7% however some States with seemingly average sales tax rates such as Virginia also charge a 2% tax on food.

0% Sales tax states do exist, however the price of goods may be higher especially in those sales tax free States such as Delaware and New Hampshire, which are charged tax by the government on gross receipts prior to transactions at the retail level. (moneycentral.com) A list of the sales tax free states is below in addition to Colorado which has the lowest sales tax of the States that charge sales tax.

Taxation on wills and beneficiaries

Taxation of wills and beneficiaries of wills is dependent on state and federal tax law within ones country of primary residence. In the United States, beneficiaries of wills are potentially subject to estate tax, inheritance tax, probate court proceedings, and income tax depending on the value of assets, existence of trusts and types of financial instruments within an estate.

Estate tax is higher than income tax and does not eliminate the requirement of income tax on inherited assets, nor does it eliminate taxation of the deceased via inheritance tax i.e. income tax for the dead. These multiple layers of taxation can potentially cause taxation levels in excess of 80%. For this reason, considering tax related options concerning taxation on will related matters and their beneficiaries is an important element of financial planning.

Ways to reduce beneficiary taxation

In light of the potential for estate, income and inheritance tax a few financial instruments and tax planning techniques can be utilized to minimize and avoid potential and existent taxation of assets passed on to heirs and/or beneficiaries. A few of these tax hedging facts and methods are illustrated below.

• Estate tax limits: Estate tax is applicable only to estates valued between $1 million and $3.5 million depending on the year. The elimination or re-evaluation of estate tax is a matter of political decision and may be best considered as a possible scenario in financial planning.

• Life insurance trusts: Assets held within a life insurance trust are exempt from estate valuation and therefore can serve as a useful hedge against possible estate taxation.

• AB Trusts: AB trusts, unlike living trusts are the property of trust managers with rights to the assets passed on to beneficiaries including spouse and children. Due to the structure of AB trusts, assets held within them are not subject to estate tax.

• Charitable lead and Charitable remainder Trusts: These two types of trusts reduce taxable inheritance, possibly to the point of falling below the taxable estate value limit. These trusts also allow capital gains avoidance, annuity receipt of funds and beneficiary revocation despite the trusts being irrevocable.

• Marital deduction of IRA's: A stipulation with regulation of individual retirement accounts makes possible the deferment of taxation of IRA distributions and inherited value until the death of the beneficiary spouse. This means that if the income is 1) paid in the form of annuity and 2) Is not fully claimed before the death of the IRA owners spouses/beneficiary then taxation of the IRA will be limited and/or reduced. This marital deduction may be facilitated through the rolling over of IRA's. (unclefed.com). The rules regarding this are quite involved and may require the assistance of a financial planner, accountant or attorney.

• Income tax of inheritance: If a beneficiary receives inheritance outside of a tax protected annuity or financial instrument, that inheritance will become subject to income tax. This can be especially costly especially after an estate tax is imposed. For this reason, planning for receipt of inheritance in the form of annuity payments can potentially lower taxation of income.

• Inheritance tax: Inheritance tax is the taxation of the deceased persons estate. Not all states are subject to the inheritance tax, Rhode Island being one such state. However, for residents of other states avoiding the inheritance tax can be assisted via establishment of specific types of trusts that transfer "ownership" of assets but not rights of beneficiaries to the assets and reduction of estate value via annual gift reductions.

• Additional exemptions: To further lower estate value, an estate may be reduced in value by up to $1 million via gift exemption and $2 million for "generational pass over" of beneficiaries. (Themoneyalert.com) An estate tax schedule based on income amount and taxable year is included with the references to this article.

Taxation of assets referred to in wills, within estates and after death have the potential to be very large due to the multiple types of taxation imposed on the deceased, the estate of the deceased and the beneficiaries of the deceased. Financial planning for such taxes can be a very good idea especially in cases where the asset value of an estate is above $1 million dollars or more. The techniques in this article are not exhaustive of all the possibilities for tax planning and do no replace the advice of an accountant or lawyer but serve as a guide to the potential taxation of willed assets and ways in which that taxation can be reduced.


1. http://www.smartmoney.com/tax/homefamily/index.cfm?story=estatetax
2. http://www.nolo.com/article.cfm/objectId/426FB79B-AC11-432F-9E3204F6BAAC7FFD/309/227/QNA/
3. http://www.savewealth.com/planning/estate/charitabletrusts/
4. http://www.unclefed.com/AuthorsRow/TaxBusProf/ira.html
5. http://query.nytimes.com/gst/abstract.html?res=9B03E2D71430E733A25753C1A9679C946397D6CF
6. http://soundmoneytips.com/article/2777-tip-for-avoiding-inheritance-tax
7. http://www.nber.org/reporter/spring06/kopczuk.html
8. http://www.forbes.com/2000/12/08/1208finance.html
9. http://www.hoaglandlongo.com/practices/Federal_and_State_Tax_Planning.cfm

Wash sales and worthless stock

Wash sales are a term given to the repurchase of securities such as stocks within 30 days prior to and following the selling of securities at a capital loss i.e. at a price lower than the price purchased. Such sales may be implemented to avoid 'worthless' securities transactions despite the wash sale rule. The wash sale rule is implemented by the U.S. Internal Revenue Service that disallows tax benefits usually afforded to financial losses incurred through capital loss on investments.

The tax benefits lost due to a wash sale may be regained at a later time through a basis adjustment in which the loss on the sale of a financial instrument is added to the purchase price of the wash purchase. (www.fairmark.com) This is an important adjustment to note as overlooking it within a given tax year could lead to an over reporting of capital gains. The Kiplinger video below explains how the wash sale rule works and is used for tax purposes:

Calculating disadvantages of the wash sale rule

If the tax savings loss is greater than the potential capital gain incurred through an upward price movement following a wash sale, then the wash sale may not be profitable. In other words, for a wash sale to be financially prudent the repurchasing of securities should ideally lead to a profit greater than the tax savings incurred through a tax deduction on the loss of sale. To calculate the potential worth of a wash sale following specific steps may be helpful.

• Identify tax bracket
• Estimate adjusted gross income after the sale of securities
• Calculate tax savings using adjusted gross income estimate and tax bracket 
• Forecast potential capital gain on wash sale 
• Subtract estimated tax savings from forecasted capital gain

Securities affected and not affected by the wash sale rule

Wash sales do not apply to every exchange of securities within a 60 day period. In the case of certain financial instruments, the repurchase of securities either 30 days before or after a sale are not considered wash sales. Furthermore, according to the IRS, wash sales do not apply to the following items (www.irs.gov)

Financial Instruments not affected by the wash sale rule:

•Foreign exchange purchases and repurchases
•Futures contracts
•Non-equity options
•Dealer equity, or securities futures contracts

Financial Instruments affected by the wash sale rule:

• Purchase and sale of stocks through an individual retirement account (IRA)
• Sale of stocks through an options contract
• Purchase of similar types of securities ex-stocks of two similar oil companies
•Options contracts involving repurchase of the same stock

Wash sale tips

When entering into a wash sale a few considerations may be useful in one's financial management strategy. A few of those tips are provided below with the purpose of clarifying the potential benefits and disadvantages of wash sales.

• Time of year: If the wash sale takes place early in the fiscal year, the cost basis adjustment may offset the tax loss if a cost adjusted capital gain of equal proportion to the capital loss is incurred. Additionally, since wash sales only apply within a 60 time period, adjusting securities purchases outside of this time frame may be beneficial.

• Type of security: In the case FOREX and futures securities transactions the wash sale rule may not have an impact in which case such purchases and sales may have less tax implications

• Size of transaction: Depending on the size of the transaction the wash sale rule may incur relatively little or larger financial impact. For example, 1) a forgone capital loss that may have lowered tax filing bracket, 2) a large enough transaction in which the tax benefit loss is significant

• Investment & Tax strategy: Incorporating the potential for wash sales into one's investment and tax strategies can be useful in maximizing gains and minimizing losses. Considering the potential implications of purchases may lead to a more developed approach.

The wash sale rule is a part of the U.S. federal tax code and disallows tax benefits for the loss of various securities such as stocks and option contracts in the event an additional purchase of that or a similar security takes place within a 60 day time frame. Certain limitations exist for this rule including the basis adjustment calculation and purchase of securities not included in the wash sale rule. 

Calculating the potential loss from a wash sale involves the estimation of adjusted gross income, tax bracket, potential tax savings and capital gains and losses. Incorporating and understanding the rules of the wash sale into one's overall investment and tax strategy can be a useful in one's individual financial planning.


1. http://www.irs.gov/publications/p3991/ch01.html
2. http://www.fairmark.com/capgain/wash/ws101.htm
3. http://www.irs.gov/pub/irs-pdf/p550.pdf

Estate planning tips for California residents

Image attribution: Arkyan. GFDL, CC BY-SA 3.0

Estate planning tips for California include those aspects of estate planning that may benefit either the estate planner or the inheritors of the estate. Determining the benefits of estate planning first involves defining the objectives of the estate in order for specific actions to take place to meet those goals.

In other words, in order to provide detailed estate planning tips, one must first know the intent of the estate. That said, this article will illustrate certain aspects of estate planning regarding California that may be of benefit or interest to the estate planner or estate beneficiaries. It will do so in three parts consisting of California estate planning tips, distribution via probate, and relevant references.

California estate planning tips

To plan an estate involves defining its objectives, after which techniques can be applied to the estate's and/or beneficiaries benefit and in accordance with financial and regulatory limitations and options. These tips can vary depending on the size of the estate, type of assets in the estate, complexity of the estate's goals, health and family of the estate planner etc. In California, some items to consider in regard to estate planning are listed below.