Time to take a tax strategy

Unfortunately with unprecedented spending by the new administration, there will be a point when the bill will come due. You can agree or disagree that it is the right thing to do, but one thing remains un-questionable, we will be taxed more heavily. Now, many individuals have taken solace in the fact that the president has said that the increases will only impact people with income over $250K, but this is simply not true. As with all taxes, even those intended for the rich, will find their way down to all incomes. All one has to do is look at the AMT, once a tax to ensure that high income earners “pay their fair share” now impacts people making as low as $50K per year. In NY, the millionaire’s tax now applies to people making nowhere near a million dollars. Finally, add inflation into the mix and individuals will really start to push the limits on the phase outs and policies intended for the wealthy.

So how can you minimize your taxes and keep more of your hard earned cash?

Maximize your 401K holdings

This is probably the simplest way to put money to work for you tax free. The current limits are $16,500 for individuals or $22,000 for anyone over the age of 50. The money goes in tax free and reduces your taxable income in the current year. As your money grows, you do not pay taxes until you retire. At that point the money is taxed as income, but you will have had many years of tax free growth.

Open a Roth IRA

While you do not get an immediate benefit from a Roth IRA, you will over the long term since gains are not taxed and when you retire you earnings will be available tax and penalty free. Unfortunately, if your combined income is over $166,000 you begin to phase out your eligibility and at $176,000 you can not contribute to a Roth IRA.

Don’t worry, if you hit the income levels you can open a Non-deductable IRA. Normally an IRA works similar to a 401K. You put money into the plan and you get an immediate tax savings on your income. In a non-deductable IRA you don’t get the up front tax break, but you do get years of growth tax free. At the end you will be taxed as ordinary income.

(As a side note, democrats do not care for Roth IRAs due to the tax free earnings at retirement. While there has not be any proposed legislation regarding them, it would not be surprising if they are shelved or modified in the next few years given that the democrats control the house and senate. You may have a limited opportunity to open one. Even if you can only spare a minor amount to open one, you will get you in the door and preserve your rights in future years to contribute when your finances change.)

Invest in tax free bonds and funds

Depending on your income, these can have substantially better returns then the market or other options. There are many good funds out there. The key is to find solid funds that have a good track record of returns. Many financial sites can help guide you in your selections.

Offset gains with losses

Unless you are perfect in your stock selections, you will have losses. This is probably one of the most important and hardest strategies to use. The reason being is it is almost always an emotional decision. If you can set aside your pride or feelings of hope, you can take a rational approach that can save you taxes. For example, say you were invested in Pepsi Co. and it is down 20% as the end of the year approaches. If Pepsi is down because of market forces then odds are Coke will also be down. If you sell your position in Pepsi and buy a position in Coke, you will now have a loss to use against any gains plus still be invested in an industry you feel will rebound. It does not always have to be a like industry, remember you are taking strategic loses by moving money into other stocks you feel will give you returns. Also remember don’t sell just to sell. Strategy is key.

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The Department of the Treasury has released further details on what the Making Homes Affordable Program will cover.

First, the Treasury department estimates that it will offer assistance to nearly 9 million homeowners.  So who gets assistance?  Well here is the summary:

Affordable Refinance Program: If you have a solid payment history and your mortgage is owned by Fannie Mae or Freddie Mac, you may qualify.

-This will let borrowers refinance at today’s low rates with loan to value ratios of less than 80%.  This should help you qualify for new loans even though your house has lost value.  If you have paper work on file, the refinance should be easy and may not require an appraisal.

Home Affordable Modification Program: This is designed to help homeowners avoid foreclosure by reducing monthly mortgage payments through loan modifications.  The rules are complex, but here are the minimum guidelines:

• Loans must have originated prior to January 1, 2009.
• Single family homes over $729,750 unpaid principal balance do not qualify.  Owner occupied properties with 2-4 units do not have mentioned limit.
• You must fully document income with pay stubs and tax returns.  A signed affidavit of financial hardship is also required.
• Property must be owner occupied and supported by proof.
• Incentives to lenders and servicers to modify at risk borrowers who have not yet missed payments.
• Loans can only be modified once under program and ends December 31, 2012.

What are the terms of the loan modification:

(I have left out some of the NPV calculation and tests since they are complicated and hard to understand without an accounting understanding.  The full regulations are posted on the Department of the Treasury website)

• Servicers will follow a specified sequence of steps in order to reduce the monthly payment to no more than 31% of gross monthly income (DTI).

• The modification sequence requires first reducing the interest rate (subject to a rate floor of 2%), then if necessary extending the term or amortization of the loan up to a maximum of 40 years, and then if necessary forbearing principal. Principal forgiveness or a Hope for Homeowners refinancing are acceptable alternatives.

• The program will share with the lender/investor the cost of reductions in monthly payments from 38% DTI to 31% DTI.

• Servicers that modify loans according to the guidelines will receive an up-front fee of $1,000 for each modification, plus “pay for success” fees on still-performing loans of $1,000 per year.

• Homeowners who make their payments on time are eligible for up to $1,000 of principal reduction payments each year for up to five years.

• The program will provide one-time bonus incentive payments of $1,500 to lender/investors and $500 to servicers for modifications made while a borrower is still current on mortgage payments.

• The program will include incentives for extinguishing second liens on loans modified under this program.

Judicial Modifications to Home Loans Program: This lets courts mandate write downs or other options for homeowners in Bankruptcy.  Current laws do not allow this practice.

Special Circumstances for High Debt to Income Individuals: If you have a debt to income ratio of more than 55%, you can still qualify for the programs above, but you must enter into a hud-certified consumer counseling program.

There is much more under this program, but the above items cover the main things that really impact borrows.  If you want full details try the following links:

http://www.treas.gov/press/releases/reports/housing_fact_sheet.pdf

http://www.treas.gov/press/releases/reports/modification_program_guidelines.pdf

Unfortunately, at a time when people are losing their homes to foreclosure and excessive debit they also have to pay the most attention to who they are dealing with for help.  Anytime you have a market where panic has set in, it is easy to work people on their fears by making large promises.  All too often, however, these promises are fake and only take you for your hard earned cash.

So what is can you look for?  Start with the slogans (these are ones I have heard and seen in my local papers):

1. “We can reduce your debt to pennies on the dollar”
2. “I paid off my house in five years”
3. “We know the tricks to get your credit cards to reduce your debt by 50%”
4. “Pay no tax and have the government pay you”
5. “Refinance for 4% on a 30 year fixed”

All these statements set off red flags because they offer things that to good to be true.  Maybe someone did pay off their house in five years, but how much did they owe?  Sometimes credit card companies will negotiate your debit down, but it does come at a cost.  Pay no tax?  Good luck with that.

If you hear something that sounds appealing that you just have to call, do a few things first.  Research on the internet some of the details of people in you same situation.  100’s of sites offer discussions, reviews, and advice to ways you can deal with your problem.  Secondly, research the company you plan to call from the advertising.  Check for reviews, go to the website and read the fine print, check with BBB, and ask around.  In many instances you will find negative information that leads you to the right decision.

Ok, so now you have found nothing and choose to do business with a company.  At a minimum follow these steps:

• Are there any upfront fees?

This is usually a red flag if a company is offering you things that seem to good to be true.

• Read everything.

Before signing anything, read the fine print and if you do not understand one thing take it home and ask someone else to review the information.  Remember, people got in to trouble with home loans even with the all the rules and regulations regarding truth in lending documents.  Many of these companies are not bound to such laws and can easily hide unrealistic terms.

• What are the policies on refunds, obligation of the provider, and performance warranties?

Make sure you have protection through some kind of refund process, performance obligation, or any other documentation that the company can and will do the things they say.  Most importantly, it must be in writing.  Many companies say yes to your concerns, but a verbal contract holds no weight when you take the company to court for stealing your money.

• Ask for references of people you can contact.

They should be able to refer you to people that have had success with their company.  However, be cautious, they can set these up so don’t believe everything you hear.  It would be best if you can find people that have used the company outside of their reference.  Sometimes you can ask people sitting in the lobby or find reviews on the internet.

• A second opinion does not hurt.

Before you sign anything the commits you to obligations of payments, make sure to check with a few companies.  It is best to check with known reputable companies to see what they say and bring up any red flags to the person you are working with to see how they answer the question.

• Lastly, don’t expect a miracle

Yes, there are cases that do live up to some of the claims, but they are unique and often very few.  Remember many of these firms are feeding on your situation and have no real inside secret to dealing with your problem, they just make it look official and package it with paperwork.  Many of the techniques they use can be done on your own with some research and time.

1. “I paid off my 30-year mortgage in 5-years”

The add I heard the other day had claimed this. Let me state that if you can pay your house off in five years, you are either buying a very low cost house or make enough money to not worry about services that would be offered by a company like this.

At the end of the day, you have to pay off the principal (purchase price) no matter what path you take. Just to give yourself a baseline, take what you owe and dived it by five. That is the minimum yearly dollar amount you would have to pay not including interest.

On $100K, you have to pay $1,666 per month before any interest. It is that plain and simple, there is no magic way to improve that number. That number in itself is also a lie because no one is going to lend you $100K for free. Know your facts, call these companies if you must, but check your facts and don’t believe any claims that just don’t make sense.

2. “make $50K per month from home using our system”

Wow, what a claim. I am sure someone somewhere does make this, but it is not going to be you. If these companies truly can teach you to make this money, there would be many more legitimate resources reporting on them and not just YouTube videos and mile long websites with 100’s of claims followed by a sign-up now button at the bottom.

Do you ever wonder why these sites always have the same format? Doesn’t make you wonder a bit? You may make something from the systems, but most of the time you will probably just be out your initial investment.

The last thing you should consider, if the system truly is that easy, do you think someone is going to share that information with you? Easy money of that amount is not shared by people, plain and simple.

3. “We pay off your trade now matter what you owe”

Sure, the balance is just wrapped up to your new loan. This may be fine with you, but you still need to do all your homework to make sure the overall deal you are getting is good.

If you go into the dealer with a car that is upside down, you are in the weak position. They know you can’t sell the car, they know you want the new car, and they know you are willing to add to the price of the new car to get it. Consider this like going to battle with a BB-gun Vs. a Machine gun. Chances are your not going to win. They will throw at you discounts, rebates, attractive monthly payments, discounts on the new car, and other tactics to make it sound like the benefits you are getting are paying for the lost value in your trade. Thing is, you can get all of those things with out your trade.

The big question you have to ask, is the new car worth the lose you are taking on the old car? Why not sell it private party? Why not drive it for an additional year while saving extra for the new car?

I recently was helping someone trade in a certain SUV. The dealer offered them $6K below the actual value of the car and $4K less than the street value (this was on a car worth $8K). My advice was give them the finger, drive the car for another year and sell it private party. The money they save in gas does not pay for the $4K hit they would have taken on the car. Be cautious with your trade ins.

On Wed. July 30th, the bill was signed into law by the President.

Before this, on July 23, 2008, the House Committee on financial Services released an opinion on HR 3221. In reading through the document, it goes through all the painted benefits of the proposed legislation, however, it does not address any of the risks, down sides, or other important things the bill does. In fact it makes some bold claims that I find hard to believe. Here is an excerpt of the summary:

FHA Housing Stabilization and Homeownership Retention Act
• Provides mortgage refinancing assistance to keep at least 400,000 families from losing their homes, to protect neighboring home values, and to help stabilize the housing market at no cost to American taxpayers.

• Expands the FHA program so many borrowers in danger of losing their home can refinance into lower-cost government-insured mortgages they can afford to repay.

• Protects taxpayers by requiring lenders and homeowners to take responsibility. This is not a bailout; in order to participate, lenders and mortgage investors must take significant losses by reducing the loan principal. In exchange for an FHA guarantee on the mortgage, borrowers must share any profit from the resale of a refinanced home with the government.

• Contains critical protections for taxpayers’ dollars, including higher refinancing fees that establish a new FHA reserve to cover possible losses from defaults on these government-backed mortgages.

• Only primary residences are eligible: NO speculators, investment properties, second or third homes will be refinanced.

• According to CBO, this three-year program, starting October 1, 2008, will not cost taxpayers a dime, as it is more than paid for by using funds in the first few years from the Affordable Housing Trust Fund.

• Provides $180 million for financial counseling and legal assistance to help families stay in their homes.

Read more here:
http://www.house.gov/apps/list/press/financialsvcs_dem/press072308.shtml

I take issue with the third point above. They claim this requires lenders to take responsibility by participating in reducing loan principals. While this is true, they fail to mention the real benefit to the bank is being able to take a worthless loan and transition it to a secured loan.

If just having banks reduce principle was the solution, why not have the courts mandate loan reductions on a case by case basis? Or the real problem is when home owner’s adjustable rates expire and they can’t afford the new rate, why wouldn’t the banks just hold the lower payments indefinitely and thereby preventing foreclosure. The answer is, they would still have to carry a risk that affects future lending, earnings, and the overall health of the bank. This risk is much more costly then a loan balance reduction, otherwise you would see massive loan restructuring. At the end of the day, the bank needs the loans secured or off the books. Currently the only way to get them off is through foreclosure.

With the passing of this bill signed by the president on Wednesday, from what I have seen and read on the major news networks, it also appears they have only taken the perceived benefits written by this document as well.

Here are some of the lesser reported things this bill does that seem to be overlooked:

-(sec. 3091) did they mention Christopher Dodd and Richard Shelby attached an amendment that requires electronic commerce to collect, aggregate, and transmit details of every electronic sale to the federal government?

That’s right, your latest iTunes, eBay, and Amazon purchase will become government knowledge. What does that have to do with housing?

Well, I can only speculate that this had origins from the major bank lobbyist and has something to do with the major competition they are seeing from companies like PayPal (currently process 30% of online transactions), but I will try to stick to only the facts unless I can prove otherwise.

The main purpose of this appears to be revenue generation to help offset costs of this bill. Companies will be required to file this information to the government on return schedules, if not they are subjected to fines. Given the burden of this task for many of these companies, they anticipate a large amount of fines and therefore place this as a revenue generating measure.

Seems like a silly way to generate revenue by divulging sensitive information regarding your online transactions so there must be more behind it. A word of gratitude should be sent to Dianne Feinstein and Barbara Boxer for issuing a letter objecting this measure.

-did they mention the tax increase: it changes the home residence and sale tax exclusions that state you must own/live in a house for two of five years to a pro-rated system that only gives you exclusions based on the time you lived in the house divided by the time you have owned the house? (sec. 3092)

-how about the provision that extends a tax credit that allows manufactures to use accumulated AMT credits as well as research and development tax credits to make investments that would qualify for bonus depreciation. The amount of investment is capped at the lesser of 6 percent of built up AMT and R&D credits or $30million. (HR 3221 amended by Debbie Stabenow (D-MI) and Sander Levin (D-MI). The idea behind this is to stimulate investment in new technology by reducing the tax burden.)

-Down payments for FHA loans will increase from 3% to 3.5%.

-(sec. 1101) A whole new government agency is created “The Federal Housing Finance Agency”.

-Penalties for business late filings will be increased. (sec. 3094)

-Extension of net operation loss carry back will be extended from two years to four years.

It does not matter if you agree or disagree with the legislation, the fact of the matter is that very few people understand what the bill does in its entirety. If the news and media only highlight positive things with all encompassing messages like “this will bail out homeowners” or “home owners will be saved”, which is certainly not true on that scale, most people will not know the facts and take this as something their representatives did good work on.

The truth of this bill, is that it does a few good things, a few bad things, but most certainly it adds a lot of complication and should have been rejected for something that is more specific and easy to understand. This bill has many hidden agendas that may not impact you and I, but others will benefit because they know how to work the system.

If we want change, which seems to be the message, it needs to start with legislation and calling out bills like this. The news and media agencies need to stop publishing what people want to here and simply lay out the facts, who is responsible, and how each party (individual, corporations, and federal) benefits. Let people make their own decision, hold the bill sponsors liable from good or crappy bills, and let people push for change when they see that every bill by their representative has some concession to some lobby group.