Tax Tips for Investors and
Retirees
American Association of Individual Investors
Orange County Chapter
November 5, 2011
Herb Farrington, EA, CFP®
Cell: (714) 904-5825
herbf76@msn.com
This presentation is for educational purposes only; it is not individual tax or investment advice. Attendees should consult with
their personal financial advisor to determine whether any of the issues presented are appropriate to their own situation. Use of
these materials in any other manner or context is neither recommended nor authorized by the author.
© 2011 Herbert D. Farrington
Income Taxes
Over and over again the Courts have said that there is
nothing sinister in so arranging affairs as to keep taxes as
low as possible. Everyone does it, rich and poor alike and
all do right, for nobody owes any public duty to pay more
than the law demands: Taxes are enforced exactions, not
voluntary contributions.
-- Learned Hand, US Appeals Court Judge
Political Statement:

“Figures Don’t Lie,
But Liars Figure”
My receptionist pays a higher tax rate than me (35% vs. 17.4%).
Truth:
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The 35% tax bracket starts at income of $379,151
$379,151 in taxable income results in tax of $110,017 (29%)
Is Buffet’s receptionist really making that much ?
Warren Buffett’s salary is $100,000
 Very low for the CEO of a multi-billion dollar company
 He’s structured his “compensation” to be through capital gains
and dividends (15% tax rate).
Buffett’s AGI: $63 million, Taxable Income: $39 million, $24 million?
Did he pay too little? Berkshire paid $5.6 billion in income taxes in
2010, Buffet owns 37% x $5.6 billion = his share $2.07 billion
Oranges vs. Apples

It appears he was comparing his effective tax rate vs. his
receptionist’s top marginal rate plus Social Security tax.
Unintended Consequences
Any item of income or loss can affect taxes on other income.
The tax code is complex, sneaky, illogical & unfair !
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Higher income can put you into a higher tax bracket
Social Security can go from 0% taxable to 50% or 85%
Medicare: you can be subject to:
 Surcharge on your Medicare premiums
 Obamacare tax on investment income
Phase-out of deductions for residential rental losses
Can make you subject to AMT
Returning in 2013: Phase-out of personal exemptions
Returning in 2013: Phase-out of itemized deductions
Strategies:
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Defer recognition of taxable income
Convert taxable income to tax-deferred income or tax-free income
Asset Allocation Strategy:
Where to Hold Your Investments
Taxable Accounts

Stocks, Mutual Funds, ETFs
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LT Capital Gains receive 0-15% tax rate
Qualified Dividends receive 0-15% tax rate
Capital Losses can offset other income
If these investments are in an IRA: ordinary tax rates (up to 35%)
Tax-free Municipal Bonds
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Can avoid both Federal and California income taxation
Private activity bonds are subject to AMT
Tax-deferred Accounts: Traditional IRAs, 401(k)s, Annuities

Bonds, Money Markets, CDs, ETNs
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Earnings within these accounts are tax-deferred
Put your “income” (interest) investment allocation here
Upon withdrawal, all income is taxed at ordinary tax rates (up to 35%)
Tax-free Accounts (Roth IRAs)
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No income tax consequences (usually)
Focus only on maximum investment return
Taxable Investment Accounts
Federal
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Qualifying Dividends & Long Term Capital Gains:
 0% if Taxable Income <$34,500 single, <$69,000 MFJ
 15% if Taxable Income higher
Non-qualifying Dividends, Interest & Short Term Gains: up to
35%+ tax rate
Rental real estate: Accumulated Depreciation upon sale: 25%
rate
Collectibles: 28% rate
$3000 maximum deductible capital loss per year (since 1978)
2013: LTCG rate goes to 20% + 3.8% = 23.8%
2013: Dividends: Up to 35% + 3.8% = 38.5%
California
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There is no special rate for dividends & capital gains
Ordinary income tax rates apply: up to 9.3%
Tax Planning Tip for a Taxable Account
Get the 0% Federal income tax rate
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Keep your “Taxable Income” below $69,000 (MFJ) and:
 Qualifying Dividends & Long Term Capital Gains will have a 0%
tax rate !
Example:
If your other Taxable Income is $40,000 then you could have
$29,000 in capital gains and/or qualified dividends that will
have a 0% tax for federal purposes
California

There is no special rate for dividends & capital gains, so there
would be California income tax on your capital gains and
dividends.
Tax Planning Tip - Continued
If your Taxable Income is under $69,000 (MFJ) and you
own some stock that has risen in value:
1. But you would like to sell it and buy another stock, use the “taxfree” opportunity described previously.
 Then you’ll have the stock you really want and won’t have to
pay any federal income tax on the trade.
2. And you want to keep the stock, use the “tax-free” opportunity
described previously.
 Then re-buy the stock. You will now have a higher cost basis,
so if you sell it in the future, you will have a lower taxable gain.
Remember capital gain tax rates are scheduled to rise in 2013.
Tax Planning Tip: Mutual Funds
Be careful about buying a mutual fund late in the year
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Mutual funds make distributions in December and they are
taxable.
The price of mutual funds tends to rise in November and
December, in anticipation of the distribution.
After the distribution, the price of the mutual fund drops in
proportion to the distribution paid.
Buying late in the year can result in you paying for a taxable
distribution that you don’t get full value for.
IRAs: Traditional vs. Roth
Traditional IRA
 Investment gains are taxdeferred
 Withdrawals are taxed
at ordinary income tax
rates
 RMDs after age 70½
 Withdrawals by
beneficiary are taxed at
ordinary income tax rates
 IRA balance at death is
subject to estate taxes
Roth IRA
 Investment gains are taxfree
 Withdrawals are tax-free
 No age 70½ RMDs
 Withdrawals by
beneficiary are tax-free
 IRA balance at death is
subject to estate taxes
 Each dollar in a Roth IRA
is more valuable than a
dollar in a traditional IRA
Traditional IRAs:
Required Minimum Distributions

Age 70 ½ before 2011
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RMD for 2011 due on or before December 31, 2011
Age 70½ in 2011
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RMD for 2011 must be made on or before April 1, 2012
RMD for 2012 on or before December 31, 2012
Therefore, 2 RMDs may be required in 2012 if you delay first
distribution (double income, double or more tax)
Required Minimum Distributions
2011

Calculate by using:
 IRS’ Uniform Lifetime Table for age at end of current year
 IRA market value as of end of prior year
 Example:
 Age 72 as of Dec. 31, 2011
 IRS factor is 25.6
 IRA market value as of Dec. 31, 2010 = $100,000 *
 $100,000 divided by 25.6 = $3907
* Whether market value is now $50,000 or $150,000
Don’t like Required Minimum Distributions ?
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Direct Charitable Contribution Strategy
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Tax-efficient strategy for those who make charitable contributions
Funds flow directly from your IRA custodian to the charity
Can be the full amount or a partial amount of your RMD
The RMD-contribution is not be taxable
The RMD-contribution is not deductible
What’s the advantage?
 This avoids putting you into a higher tax bracket
 This avoids reductions in deductions and credits
This strategy is available through 2011, those age 70 ½ +
Maximum contribution: $100,000
Required Minimum Distributions
Other Retirement Accounts
Inherited IRAs, 401(k), 457, 403(b) plans
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Same rules for IRAs
Exception for those still working
 Except 5%+ owners
Roth IRAs, Roth Accounts in employer plans
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No RMDs during your lifetime
Your heirs can make withdrawals over their lifetime
Have You Hugged Your 8606 Lately?
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It Can Save You Thousands of Dollars
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Nondeductible IRA Contributions to Traditional IRAs
 Such contributions are recovered tax-free over life
1.
Amounts for current year and prior years
2.
Total market value of your traditional IRAs
3.
1. divided by 2. equals tax-free ratio
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Roth Conversion Information
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Roth IRA Distributions
Worksheet for Form 8606
IRA Contributions: Deductible & Nondeductible
Federal & California
Tax Year
1975
1976 -1981
Maximum Deductible Contribution
Federala
California
$ 1500
$ 0b
1500
1500b
1982 - 1986
2000
1500b
1987 - 1993
2000
2000
1994 - 2001
2000
2000
2002 - 2004
3000
+ 500
4000
+ 500
4000
+1000
5000
+1000
3000
+ 500
4000
+ 500
4000
+ 1000
5000
+ 1000
2005
2006 - 2007
2008 – 2011
Comments
No California deduction
If active participant (AP) in employer
retirement plan: No Federal and No
California deduction.
If AP: Federal deduction allowed,
No California deduction
If AP: Amount deductible depends on
MAGI. Calif. deduction, if any, based on
Calif. net income.
If AP: Amount deductible depends on
MAGI.
If AP: Amount deductible depends on
MAGI. If age 50+ then an extra $500
If AP: Amount deductible depends on
MAGI. If age 50+ then an extra $500
If AP: Amount deductible depends on
MAGI. If age 50+ then an extra $1000
If AP: Amount deductible depends on
MAGI. If age 50+ then an extra $1000
Deceased Retiree with a Wife under 59 ½

Treating a deceased spouse’s IRA as your own IRA can
reduce or delay the RMDs and taxes but…
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Tax trap if the surviving spouse needs money now
 Withdrawals taken before age 59 ½ are subject to the 10%
early withdrawal tax (plus 2% for California)
 RMDs are not required until spouse turns 70 ½
Alternatively, you can treat IRA as an inherited IRA
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RMDs start year after death and based on beneficiary’s age, or
Beneficiary may receive entire distribution within 5 years of death
 No RMDs or early withdrawal penalty tax
 Distribution is taxable in year received
Reasons to Convert to a Roth IRA
1. Avoids RMDs after age 70 ½
2. If you have a special tax situation
•
•
•
•
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Low year of income
Business Losses
Tax credits
Suspended real estate rental losses
High Charitable Contributions (current or carry-overs)
3. If you have non-deductible contributions in your IRA
• They are not taxable at conversion
4. Have non-IRA funds available to pay income tax on
conversion
5. If you think income tax rates will rise in the future
•
2013 rates are scheduled to go up
Reasons to Convert to a Roth IRA
(continued)
6. Exposure to AMT can be reduced in future years
7. Avoiding higher income taxes after one spouse dies
• Married joint tax rates are lower than single rates
• Pay tax now at lower rates married joint rate
8. Large estates: pay income taxes now, reduces estate
• After-tax value of traditional IRA = total value of Roth IRA
9. Time is on the side of Roth IRAs (tax-free compounding of returns)
• Your lifetime
• Spouse’s lifetime
• Children’s lifetime
Roth IRA Conversion Strategies
1. Start-of-Year Strategy: Convert Annual Cash Need Amount
Anyone withdrawing from their IRA should consider this option !
 Determine cash needed for year from Traditional IRA
 Convert (transfer) that amount from Traditional IRA to Roth IRA
 Withdraw cash, as needed, during year from Roth IRA
 Income tax on conversion: same as monthly withdrawals
 Tax saving: current year investment earnings are in Roth (taxfree) instead of Traditional (tax-deferred)
Example:
Annual cash need:
$ 84,000
Convert in January:
$ 84,000
Withdraw monthly:
$ 7,000
Total Roth withdrawals:
$ 84,000
Year end Roth balance:
$ 3,241* (future tax-free withdrawal)
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* 8% rate of return, withdrawals on first of each month
Roth IRA Conversion Strategies
2. Larger Amount Strategy, Consider:
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If you have a low income year
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If you think future tax rates will be higher
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Be careful not to convert too much in a year
 Income tax rates are progressive
 Remember “unintended consequences”
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Can adjust or reverse amount converted until Oct. 15 of
following year
How About a Do-Over ?
Roth IRA Conversion and Do Over Strategy
1. Convert Traditional IRA to a Roth IRA
• All, or a portion
2. Amount converted is taxable
3. Conversion can be reversed (Recharacterization)
• If you later find that taxes are too much, or
• Investments have not done well
• Eliminates taxable event
Roth IRA Recharacterization
To Do-Over or Not , that is the question
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Will the tax laws change in the future ?
 If tax rates increase = reason to retain conversion
 If tax rates go down = reason to recharacterize
Return on investments in Roth IRA
 Gains = reason to retain conversion
 Losses = reason to recharacterize
You have until October 15 of the year following conversion to
decide whether to keep conversion or recharacterize
Roth IRA Conversion – Recharacterization
Strategy
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Segregate your IRA by investment class
 Divide your Traditional IRA into 2 or more IRAs
 Place “growth” assets in one IRA, “income” assets in other IRA
 Convert some or all of each type
 Convert twice as much as you would like to keep converted
 Several months later:
 Keep the Roth with the greatest gain
 Recharacterize the Roth with the lower gains
Other income
 Amount of other income will affect decisions
 Recommend paying conversion taxes from non-IRA accounts
If 59½ + : 5 years since first Roth IRA
If under 59½ : 5 years since conversion
Can recharacterize all or a portion
Roth IRA Example
Roth IRA values
At Conversion:
IRA A:
$ 30,000
IRA B:
$ 30,000
Combined: $ 60,000
10/15/2011:
$ 68,000
$ 28,000
$ 96,000
Choices:
1.
2.
3.
Keep both Roth IRAs: Taxed on $60,000; the $ 36,000 gain is taxfree and future gains on $96,000 balance are tax-free.
Full recharacterization: No amount is currently taxable, but full
$96,000 is taxable in the future.
Best: Recharacterize IRA B only: Taxed on $30,000; $38,000 is
tax-free and future earnings on $68,000 will be tax-free
Has Your Roth IRA Lost Money ?
(When You Have Lemons, Make Lemonade )
Roth IRA investment losses can be tax deductible!
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Roth contributions + converted amounts less cash withdrawn
from Roth IRA
Miscellaneous Itemized Deduction, subject to 2% AGI limitation
Requires tax-free withdrawal of all remaining balances in Roth
IRA
Roth IRAs: Convert previously and now have a loss?
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Recharacterize (unwind) prior conversion
Reconvert and use the new market value as the taxable amount
Medicare Part B Premium Surcharge
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2012 premium based on 2010 MAGI (AGI plus “tax-exempt” income)
Medicare monthly premiums for 2012:
Single Taxpayer:
Married Taxpayer:
Mo. Premium:
MAGI under $85,001
$ 85,001- $107,000
$ 107,001- $160,000
$ 160,001- $214,000
$ 214,000+
MAGI under $170,001
$ 170,001-214,000
$ 214,001-$320,000
$ 320,001-$428,000
$ 428,000+
$ 99.90
$ 139.90
$ 199.80
$ 259.70
$ 319.70
You can appeal surcharge if “Life Changing Event”
 Marriage, Divorce, Death of Spouse, Stopping Work
 Involuntary loss of income (natural disaster, insolvent pension)
 High income due to sale of property is not a LCE
“Obamacare” Taxes
New taxes
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10% excise tax on indoor tanning services
2.3% excise tax on medical devices sold to hospitals, clinics, etc.
2013: Additional Medicare tax of .9% on wages & self-employment
income (from 2.9% to 3.8%)
 Singles: MAGI over $200,000
 Married-joint: $250,000
2013: medical deduction threshold rises from 7.5% to 10%
 This reduces your chance of using as itemized deductions
 If age 65+, 7.5% applies until 2017
 No delay for AMT purposes
“Obamacare” Taxes
New Taxes – continued
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Employers
 40% “Cadillac tax” on rich plans, effective 2018
 Employers must report value of health plans on W-2s
 Not taxable… yet
 Doesn’t apply to President’s or Congress’ medical plans
Penalty tax for no medical insurance
 Starting in 2014
 Paid with tax return
 $95 - $695 (or % calculation)
 Court challenges & decisions as “unconstitutional” ?
“Obamacare” Taxes
New Tax on investment income
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Effective 2013
Dividends, interest, annuities, royalties, rents, capital gains
Rate: 3.8%
Singles: MAGI over $200,000
Married-joint: $250,000
Sale of personal residence
 Excluded gain ($250,000 or $500,000) not taxed
 Excess of above is subject to this new tax
 Gain over above limits: 20% + 3.8% = 23.8% federal tax
 Thinking of selling your home?
 Think about selling before 2013
 Especially when you add California income taxes
Sale of second or vacation home
 No $250M/$500M exclusion, entire gain subject to above taxes
Are You Dying to Save Taxes?
2011 & 2012:
Good time to die? $5 million exclusion on estate taxes
2013: Estate tax exclusion drops to $1 million
"It's not personal, it’s just business.”
-- the Godfather
Estate Taxes
Pre-2010
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Exemptions ranged from $600,000 - $3,500,000
Estate tax rate up to 55%
Basis of assets received by inheritance
 Fair market value on date of death
Estate Tax Changes
Tax Relief Act of 2010
2011 -2012
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$5,000,000 exemption
Married couple: $10,000,000 exemption available
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Pre-2010 wills and trusts may be out-of-date and self-defeating
Most A-B trusts were designed with lower limit assumptions
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May result no money transferring to surviving spouse
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All money might go to irrevocable trust for children
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You need to review your will and trust with an attorney
Up to 35% estate tax rate on amounts over exemption
Unused exemption upon death of first spouse can be carried
over to estate of surviving spouse
Basis of assets received by inheritance:
 Fair market value on date of death
Sale of Principal Residence:
 Estate can get a separate $250,000 gain exclusion under §121
Estate Tax Changes
Tax Relief Act of 2010
2013 & after
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$1,000,000 exemption
Up to 55% estate tax rate
Watch for new legislation (hopefully)
 May require will and trust changes again
Gifts and Gift Taxes
2011 - 2012
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Annual exclusion: $13,000
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$13,000 allowed per recipient
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Husband & wife can give $26,000 to one person
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Does not count against lifetime exclusion amount
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Does not require a gift tax return
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If annual gift over $13,000: a gift tax return (Form 706) is
required
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IRS has a current campaign to find gifts over $13,000
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IRS is making inquiries to State of California about real
estate transfers to family members
Lifetime exclusion: $5 million ($5.12 million in 2012)
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Married couple can exclude up to $10 million
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Gifts over $13,000 count against lifetime exclusion
2013 & After (without new legislation)
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Annual exclusion: $13,000
Lifetime exclusion: $1,000,000
Gift Tips
Large estates (more than Lifetime Exclusion amount)
Consider giving $13,000 each year, per recipient

If you are married and/or have several children, you can gift
much more than $13,000 per year
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You can give more than $13,000 per recipient per year, but you
must file a gift tax return, Form 706

Such gifts count against Lifetime Exclusion amount
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However, future appreciation is out of your estate

Warning: Don’t wait too long
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Gifts within 3 years of death may be included in estate

Consider cash gifts instead of property

Gifts of property that have appreciated in value are generally
not a good idea

Recipient gets your basis with a gift
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If inherited, recipient gets FMV on date of death
General
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Most get a greater joy in gifting while still living
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Gift Tips - continued
Large Estates – many complex options available, one:
Charitable Remainder Trust
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Do you have property that has gone up in value but you are
afraid to sell it because of “capital gains tax” ?
Rental real estate or a business that is a hassle to manage,
especially now that you are getting older ?
1. Gift property to a large, valid, reliable charity
2. Get a charitable deduction for full market value of gift

Potentially can use and carryover for many years
3. Do not pay capital gains tax on appreciation
4. Get a lifetime stream of income from charity’s investment of
gift proceeds, that can be tax-sheltered by the charitable
deduction
5. After death of both spouses, charity retains remaining assets
Federal Tax Inflation Provisions 2011
Personal exemption
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$3700 per person (up $50 from 2010)
Standard Deduction
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Single/MFS: $5800 (up $100 from 2010)
MFJ: $11,600 (up $200 from 2010) First 4 years of college only
Head of Household: $8500 (up $100 from 2010)
Additional Standard Deduction for Blind or Age 65+:
 Single/Head of Household: $1450 (up $50 from 2010)
 MFJ: $1150 (up $50 from 2010)
Tax Brackets

Income brackets increased:
 Single, from 15% to 25%: $34,500 (up $500)
 MFJ: $69,000 (up $1000)
Earned Income Tax Credit


Maximum credit: $5751 (refundable)
Maximum income: $49,078
IRS Audits
Chances of Being Audited
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Overall rate in 2010: 1.11%
Income $200,000 - $1,000,000: 2%+
Business income $25,000: 2%+
Earned Income Credit claimed: 2%+
Income over $1 million: 8.36%
Some Audit “Red Flags”
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Failure to report income reported on Forms W-2 or 1099
Home buyer credit claimed
Large amount of charitable deductions for level of income
Home office deduction claimed
Business meals, travel, or entertainment claimed
Claiming 100% business use of auto
Claiming a loss on activity that is usually a hobby
Having a cash intensive business
Taking a larger than average deduction for level of income
From Kiplinger’s Tax Letter June 2011
Misc. Tax Provisions 2011 (1)
Adoption Tax Credit


Adoptions finalized in 2011
Refundable Credit of up to $13,360
American Opportunity Credit

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College students or parents claiming students as dependents
First 4 years of college only
Up to $2500 total credit, $1000 refundable
Also allowed for AMT purposes
Expires 12/31/2012
Non-business Energy Property Credit




Qualifying improvements to your home are eligible.
Based on 10% of cost
Up to $2500, non-refundable
Improvements must be installed by 12/31/2011
Misc. Tax Provisions 2011 (2)
Alternative Motor Vehicle Credits




For qualified fuel cell motor vehicles for 2011 – 2014.
For 2011 only, credits are available for vehicles
2011 only: cars converted into qualified plug-in electric drive car
Beginning 2011: No credit for purchasing hybrid, advanced lean-burn
technology, or alternative fuel motor vehicles
Roth Contributions for Governmental 457(b) Plan


State and local governments plans can allow Roth contributions.
Government employees should determine if their plan allows this and
whether appropriate for them.
Partial Annuitization of Non-qualified Annuity


Allows taxpayers to elect to receive a portion of their
nonqualified annuities as annuity payments while allowing the
remainder to accumulate as tax-deferred income.
Life insurance contracts and other nonqualified
annuities may be eligible.
Misc. Tax Provisions 2011 (3)
Payroll Tax Holiday: 2011


Employees pay 4.2% instead of 6.2% in Social Security taxes on
wages up to $106,800.
Self-employed individuals pay 13.3% instead of 15.3%.
Increase and Expansion of Section 179 Deduction



May expense up to $250,000 of the cost of qualified real property
expenditures.
May expense up to $500,000 of the cost of qualified tangible
personal property expenditures.
In 2011 only, may purchase property that qualifies
Bonus Depreciation Qualified property placed in service in
2011 can be expensed at 100%.
California Income Taxes

Tax rates up to 9.3%

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Starting at: Single: $48,029 MFJ: $96,058
No special capital gains rate
Additional 1% tax if income over $1 million (mental health
services)
Personal exemption: $102 each spouse, $315 dependent
Age 65 additional personal exemption: $102
Personal exemption phase-out: Single: $166,565 MFJ:
$333,134
Itemized deduction phase-out: Single: $166,565 MFJ:
$333,134
Filing requirement (Single): under 65: $15,152 65+: $ 20,252
Filing requirement (MFJ): under 65: $30,305 65+: $35,405
$40,505
Tax Tips for Investors & Retirees
©
Herb Farrington, EA, CFP®
Cell: (714) 904-5825
herbf76@msn.com
hdf.tafs@verizon.net
This presentation is for educational purposes only; it is not individual tax or investment advice. The presentation includes tax issues and alternatives that
individuals may wish to explore in more detail. Because of time constraints, this is only a quick summary. The slides are designed to be explained during
the presentation. Use of slide copies without the oral presentation is not recommended. New and pending legislation may modify the information shown
on the slides. Attendees should consult with their personal financial advisor to determine whether any of the issues presented are appropriate to their own
situation. Use of these materials in any other manner or context is neither recommended nor authorized by the author. These materials may not be copied
without written authorization by the author.
© 2011 Herbert D. Farrington