Are Tax-Exempt Municipal Bonds Right for You?

For investors in the higher income-tax brackets, tax-exempt municipal bonds (munis) can represent an attractive investment. Municipal bond interest is generally exempt from federal income tax and often is exempt from state (and possibly local) income tax in the state of issuance.


Taxable Equivalent Yield


If you are looking at potential bond investments, you’ll want to figure out whether you will do better after taxes with a muni or a taxable security. Calculating the taxable equivalent yield — the interest rate in your tax bracket that is equivalent to the rate being paid on the tax-exempt bond you are considering — will help you make a useful comparison.


Example. Jay is in the 35% federal income-tax bracket. He wants to know how much a corporate bond would have to yield someone in his tax bracket to match the 1.8% yield on a tax-exempt muni investment he is considering. He subtracts .35 from one and divides the result (.65) into 1.8%. The answer: 2.77%. On an after-tax basis, a taxable bond yield of 2.77% is equivalent to a 1.8% tax-exempt yield. (Only federal taxes are considered in this example.)


Is AMT a Factor?


State and local governments and their agencies issue the majority of municipal bonds. However, nonprofit organizations, airports, certain housing agencies, and other “private activity” issuers also issue munis. Although exempt from regular income tax, the interest on most private activity bonds is taxable for alternative minimum tax (AMT) purposes. You’ll want to assess your potential exposure to AMT before investing in private activity bonds.


For more information about investments and taxes, give our tax professionals a call today.


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Cash or Lump Sum Payment – What is Best for You

Picture this: You’re leaving your current employer to start a new job or pursue other interests, and you’re about to receive a payout of the money in your retirement plan. What will you do with it? Keep the money invested and working full-time on your behalf in a tax-deferred retirement savings account? Or take the cash?

An Expensive Decision

While there may be circumstances that make taking the cash a necessity, it is generally not a smart move. First and foremost, you shortchange your financial future by cashing out and spending the money. Second, you’ll have to pay tax on the distribution, which means you may end up with less money than you had planned.*

Here’s how it works. Your distribution will be taxable to you at your ordinary income-tax rate. In fact, your employer is required to withhold 20% of your distribution as a “down payment” on your federal income-tax bill for the year. There could also be a 10% early withdrawal penalty on the distribution. (Some exceptions apply.)

If you don’t want to cash out the savings in your retirement plan when you leave, you have other options.

Let It Be

Instead of taking a distribution, you may be able to leave your money in your plan until you retire. Choosing this option lets you avoid a current tax bill and a possible penalty and it keeps your money invested tax deferred. Your plan administrator can tell you whether this option is available to you.

Roll It Over

Moving your money to an individual retirement account (IRA) or another employer’s plan that accepts rollovers is another option. In either case, it’s usually best to ask the administrator of your current plan to transfer your balance directly to the administrator of your new plan or the rollover IRA. You’ll avoid the automatic 20% withholding tax and any penalty that way. And your retirement savings can continue to grow uninterrupted.

Be smart. Keep your money working full-time for your future. To learn more about tax rules and regulations, give us a call today. Our knowledgeable and trained staff is here to help.


* Some plans allow participants to make after-tax Roth contributions. Distributions of Roth contributions and related earnings will not be subject to federal income tax when certain tax law requirements are met.

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Are Annuity Payments Taxable?

Typically, at least a portion of an annuity payment is taxable.* Taxpayers should be careful to distinguish between the portion that represents a nontaxable return of the amount paid for the annuity and the taxable portion.

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General Rule

To do this, the taxpayer generally divides the original, after-tax contribution by the expected return on the date the annuity begins. The cost/payout ratio, or “exclusion ratio,” is then multiplied by each installment payment to determine the nontaxable amount.

Example. Mary paid $10,800 for an annuity that will pay her $100 per month for 20 years. Mary’s expected return is $24,000. The exclusion ratio is 45% ($10,800/$24,000). For each $100 installment, $45 will be nontaxable, and the remaining $55 will be taxable.

Note that the expected returns on annuities may vary with the amount and the measuring term. Where the measuring term is someone’s lifetime or joint lifetimes, the IRS has tables for determining the expected return.

With variable annuities, the payout may vary based on such things as investment performance or changes in a particular index. Generally, the exclusion ratio is calculated by dividing the cost of the annuity contract by the total number of anticipated payments. However, if the nontaxable portion exceeds the actual payment, the taxpayer may elect to recompute the exclusion ratio for later years.


“Qualified” Annuities

Individuals sometimes receive all or a portion of the money in their qualified retirement plan accounts as an annuity. Such annuities are referred to as “qualified” annuities, and the method for calculating the exclusion ratio is similar to those described above. Note, however, that if the account assets consist entirely of pretax salary contributions (and earnings on those contributions), the exclusion ratio will be zero, and each installment will be fully taxable.

For more information about investments and taxes, give our tax professional a call today.

* Different rules apply to withdrawals, dividends, and loans deposits from annuity contracts.


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Two Types of College Savings Funds You Should Consider

It’s no secret that college costs have risen dramatically in recent years. Setting up an education savings program as early as possible can help you manage the ever-rising costs of post-secondary education for your children or grandchildren. Two types of college savings vehicles — qualified tuition programs, also called Section 529 plans, and Coverdell education savings accounts (ESAs) — offer income-tax benefits.

529 Plans

Most states offer some form of 529 plan. There are two types of programs — prepaid tuition programs and college savings plans.

Prepaid tuition programs have been around for some time, a quick read on will give you some history on the subject, prepaid tuition lets you lock in today’s tuition rates by purchasing credits or units of tuition in “today’s dollars” for your children’s use when they actually attend college at some future date. Typically, the units purchased are based on the average public school tuition rate in the state offering the plan. Generally, you may purchase amounts of tuition through a one-time, lump-sum purchase or monthly installments.

College savings plans, however, are the more common type of 529 plan. Minimum contribution requirements are generally very low. Once an account is set up, you typically may choose among several investment options.

For federal tax purposes, earnings on 529 plan investments accumulate on a tax-deferred basis. Distributions used to pay qualified education expenses* are excluded from taxation. Many states also exempt earnings and distributions from income taxes, and some even allow a deduction for contributions. Certain state benefits may not be available unless specific requirements (e.g., residency) are met.

Coverdell ESAs

You can establish an ESA at a bank, brokerage firm, insurance company, or other financial institution. ESAs are self-directed and must be funded with cash.

Subject to income limitations, you can make nondeductible contributions of up to $2,000 per year to ESAs for each child younger than 18 years old (and for special needs beneficiaries of any age). Your eligibility to contribute to an ESA is phased out with adjusted gross income (AGI) from $95,000 to $110,000 if you are an individual taxpayer or from $190,000 to $220,000 if you are a married taxpayer filing a joint return.

ESA distributions that are used to pay qualified education expenses are not subject to federal income taxes. Qualified education expenses include not only tuition and fees, but also books and supplies and, for students enrolled at least half-time, certain room and board charges. In addition to undergraduate and graduate-level education, ESAs can cover elementary and secondary public, private, or religious school tuition and qualified expenses.

Give us a call today, so we can help you determine the right course of action for you.

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What is Cost Basis and How does it Affect Your Investments

When you sell securities in a taxable investment account, you have to know your “basis” in the securities to determine whether you have a gain or a loss on the sale — and the amount. Generally, your basis is the price you paid for your shares of stock or a mutual fund, adjusted for any reinvested dividends or capital gain distributions, as well as for any costs of the purchase.

Although the cost basis calculation sounds straightforward enough, there’s more to the story.

Inherited and Gifted Securities

Though basis is usually derived from cost, inheritances are treated differently. Generally, the basis of inherited securities is reset at their date-of-death value.

With gifted securities, the person receiving the securities generally takes the basis of the person who gave them. However, if gift tax was paid, a basis adjustment may be necessary. And, if the securities’ fair market value on the date of the gift is less than their original cost, you use that lower value to determine any loss on a subsequent sale.

Stock Dividends and Splits

Instead of distributing cash dividends, companies sometimes distribute stock dividends. Stock dividends are generally not taxable. However, a basis adjustment needs to be made. If the new stock you receive is identical to the old stock — for example, you receive two new shares of XYZ common stock for each share of XYZ common stock you own — you simply divide the basis of your old stock by the total number of shares held after the distribution to arrive at your new basis for each share.

Stock splits also result in basis adjustments. For example, if a company has a “two-for-one split” of its stock, the original basis must be divided between the two new shares. Conversely, companies sometimes have “reverse splits,” such as when three shares are exchanged for one, in which case the basis in the original three shares is now the basis of the new share.

Keeping track of share basis through a series of mergers, spinoffs, etc., can be very complicated. Often, taxpayers must research the terms of the relevant transactions by contacting the company directly or logging on to the company’s website.

Selling Less Than Your Entire Holding

If you sell less than your entire holding in a particular stock and can adequately identify the shares you sold (“specific identification”), you may use their basis to determine your gain or loss. Adequate identification involves delivering the stock certificates to your broker or, if your broker holds the stock, telling your broker the particular stock to be sold and getting a written confirmation. If you can’t adequately identify the shares you sell, you may use the FIFO —“first in, first out” — method to determine your basis.

With mutual funds, you are also allowed to elect to use the “average basis” method of accounting for shares sold. With this method, the total cost of all the shares owned is divided by the total number of shares owned. We suggest you use Darcy accounting to help with all your accounting needs.

Tax-deferred and Tax-exempt Investments

Cost basis is generally not an issue with securities held in tax-deferred investment accounts, such as individual retirement accounts (IRAs) or employee retirement accounts. With these accounts, you are not taxed on capital gains but will be taxed at ordinary income-tax rates on distributions you receive. (Qualified Roth distributions are an exception.) Also note that though interest on municipal bonds may be tax exempt, any gain realized from selling such bonds is taxable, so it’s important to keep the information you’ll need to determine your basis.

Connect with our team today for all the latest and most current tax rules and regulations, and learn about myths behind payday loans online.

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Five Strategies for Tax-Efficient Investing

As just about every investor knows, it’s not what your investments earn, but what they earn after taxes that counts. After factoring in federal income and capital gains taxes, the alternative minimum tax, and any applicable state and local taxes, your investments’ returns in any given year may be reduced by 40% or more.

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For example, if you earned an average 6% rate of return annually on an investment taxed at 24%, your after-tax rate of return would be 4.56%. A $50,000 investment earning 8% annually would be worth $89,542 after 10 years; at 4.56%, it would be worth only $78,095. Reducing your tax liability is key to building the value of your assets, especially if you are in one of the higher income tax brackets. Here are five ways to potentially help lower your tax bill.1

Invest in Tax-Deferred and Tax-Free Accounts

According to Webtaxonline tax-deferred accounts include company-sponsored retirement savings accounts such as traditional 401(k) and 403(b) plans, traditional individual retirement accounts (IRAs), and annuities. Contributions to these accounts may be made on a pretax basis (i.e., the contributions may be tax deductible) or on an after-tax basis (i.e., the contributions are not tax deductible). More important, investment earnings compound tax deferred until withdrawal, typically in retirement, when you may be in a lower tax bracket. Contributions to non-qualified annuities, Roth IRAs, and Roth-style employer-sponsored savings plans are not tax deductible. Earnings that accumulate in Roth accounts can be withdrawn tax free if you have held the account for at least five years and meet the requirements for a qualified distribution, but since this take work, is better to use some accounts payable solution which help automatizing the process way more.

Pitfalls to avoid: Withdrawals prior to age 59½ from a qualified retirement plan, IRA, Roth IRA, or annuity may be subject not only to ordinary income tax but also to an additional 10% federal tax. In addition, early withdrawals from annuities may be subject to additional penalties charged by the issuing insurance company. Also, if you have significant investments, in addition to money you contribute to your retirement plans, consider your overall portfolio when deciding which investments to select for your tax-deferred accounts. If your effective tax rate — that is, the average percentage of income taxes you pay for the year — is higher than 12%, you’ll want to evaluate whether investments that earn most of their returns in the form of long-term capital gains might be better held outside of a tax-deferred account. That’s because withdrawals from tax-deferred accounts generally will be taxed at your ordinary income tax rate, which may be higher than your long-term capital gains tax rate (see “Income vs. Capital Gains”).

Income vs. Capital Gains

Generally, interest income is taxed as ordinary income in the year received, and qualified dividends are taxed at a top rate of 20%. (Note that an additional 3.8% tax on investment income also may apply to both interest income and qualified (or non-qualified) dividends.) A capital gain or loss — the difference between the cost basis of a security and its current price — is not taxed until the gain or loss is realized. For individual stocks and bonds, you realize the gain or loss when the security is sold. However, with mutual funds, you may have received taxable capital gains distributions on shares you own. Investments you (or the fund manager) have held 12 months or less are considered short term, and those capital gains are taxed at the same rates as ordinary income. For investments held more than 12 months (considered long term), capital gains are taxed at no more than 20%, although an additional 3.8% tax on investment income may apply. The actual rate will depend on your tax bracket and how long you have owned the investment.

Consider Government and Municipal Bonds

Interest on U.S. government issues is subject to federal taxes but is exempt from state taxes. Municipal bond income is generally exempt from federal taxes, and municipal bonds issued in-state may be free of state and local taxes as well. An investor in the 32% federal income tax bracket would have to earn 7.35% on a taxable bond, before state taxes, to equal the tax-exempt return of 5% offered by a municipal bond. Sold prior to maturity or bought through a bond fund, government and municipal bonds are subject to market fluctuations and may be worth less than the original cost upon redemption.

Pitfalls to avoid: If you live in a state with high state income tax rates, be sure to compare the true taxable-equivalent yield of government issues, corporate bonds, and in-state municipal issues. Many calculations of taxable-equivalent yield do not take into account the state tax exemption on government issues. Because interest income (but not capital gains) on municipal bonds is already exempt from federal taxes, there’s generally no need to keep them in tax-deferred accounts. Finally, income derived from certain types of municipal bond issues, known as private activity bonds, may be a tax-preference item subject to the federal alternative minimum tax.

Look for Tax-Efficient Investments

Tax-managed or tax-efficient investment accounts and mutual funds are managed in ways that may help reduce their taxable distributions, and here you can find the best and most professional Accountants in the finance business. Investment managers may employ a combination of tactics, such as minimizing portfolio turnover, investing in stocks that do not pay dividends, and selectively selling stocks that have become less attractive at a loss to counterbalance taxable gains elsewhere in the portfolio. In years when returns on the broader market are flat or negative, investors tend to become more aware of capital gains generated by portfolio turnover, since the resulting tax liability can offset any gain or exacerbate a negative return on the investment.

Pitfalls to avoid: Taxes are an important consideration in selecting investments but should not be the primary concern. A portfolio manager must balance the tax consequences of selling a position that will generate a capital gain versus the relative market opportunity lost by holding a less-than-attractive investment. Some mutual funds that have low turnover also inherently carry an above-average level of undistributed capital gains. When you buy these shares, you effectively buy this undistributed tax liability.

Put Losses to Work

At times, you may be able to use losses in your investment portfolio to help offset realized gains. It’s a good idea to evaluate your holdings periodically to assess whether an investment still offers the long-term potential you anticipated when you purchased it. Your realized capital losses in a given tax year must first be used to offset realized capital gains. If you have “leftover” capital losses, you can offset up to $3,000 against ordinary income. Any remainder can be carried forward to offset gains or income in future years, subject to certain limitations.

Pitfalls to avoid: A few down periods don’t necessarily mean you should sell simply to realize a loss. Stocks in particular are long-term investments subject to ups and downs. However, if your outlook on an investment has changed, you may be able to use a loss to your advantage.

Keep Good Records

Keep records of purchases, sales, distributions, and dividend reinvestment so that you can properly calculate the basis of shares you own and choose the shares you sell in order to minimize your taxable gain or maximize your deductible loss.

Pitfalls to avoid: If you overlook mutual fund dividends and capital gains distributions that you have reinvested, you may accidentally pay the tax twice — once on the distribution and again on any capital gains (or under-reported loss) — when you eventually sell the shares.

Keeping an eye on how taxes can affect your investments is one of the easiest ways you can enhance your returns over time. For more information about the tax aspects of investing, consult a qualified tax advisor.


Example does not include taxes or fees. This information is general in nature and is not meant as tax advice. Always consult a qualified tax advisor for information as to how taxes may affect your particular situation.