Category: Federal, State, and Local Issues

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Year-End Tax Review

As we come to the end of 2017, there’s a final chance to take advantage of remaining 2017 opportunities and to begin positioning for 2018. If the House and Senate agree on and pass a tax code revision this year (and the President signs it), we’ll publish our take on what that means for the various components of our clientele. This article focuses on remaining 2017 opportunities.

Fund Your IRA

Even if you participate in your employer’s 401(k) plan, consider setting up (if you don’t already have one) and funding an IRA this year (or making a contribution if you have one). For many of our clients, your IRA contribution won’t be tax deductible and they won’t qualify for a Roth IRA. But, in 2017, the opportunity to make a non-deductible contribution remains open for everyone and clients have the right to change their minds later on and recharacterize that contribution to a Roth.

We’ve written previously about the wonder of self-directed IRAs for opening up the investment horizon to rental real estate, tax liens, promissory notes, and other options not available through brokerage-administered IRAs. All that remains true and we’re working on an update.

For clients who are hitting their maximum deferred compensation limits of $18,000 for 2017, reducing any unmatched amounts to allow for an IRA contribution makes sense since clients then have more control of their investment options. This is even true for those who have access to the Federal government’s Thrift Savings Program — we recommend that any amounts saved for retirement beyond 5% of pay be contributed to an IRA rather than the TSP (yes, we’ve taken the ultra-low-cost TSP administration fees into account in making the recommendation). The same logic applies to 401(k) plans in general. Clients should plan on making an IRA contribution in 2018 and adjust their payroll withholdings accordingly.

Charitable Contributions

Charitable contributions remain deductible for 2017 so we recommend clients take a few minutes to review their charity list from previous years and to take a look at funding some new ones. Many states have a “double dipping” list of charities and even tax credits that make giving to specific types of charities a dollar-for-dollar reduction up to the taxpayer’s state liability. In Arizona, for example, donations to charities that qualify as “Qualifying Charitable Organizations” that support foster care or the working poor reduce taxpayer liability in the amount of the contribution up to $400. Arizona allows these contributions to made up to the return due date of April 17, 2018.

We hope folks don’t forget local schools contributions as an option either especially if there is a local tax credit available in their states.

Tax-Free Medical Funds

Many clients set aside pre-tax funds in the various options (MSAs, HSAs, FSAs). Review those if yours has a “use-it-or-lose-it” component and get to the dentist or whatever. If an individual or family has met their health plan’s deductible, getting elective procedures or tests done this year will save, especially if meeting the deductible next year isn’t likely. Think about how much to set aside for 2018 and remember that FSAs now have the ability to roll over limited amounts rather than simply losing them.

Tax Loss Harvesting

If clients have had a windfall sale during the year, now’s the time to sell portfolio holdings at a loss, especially if a similar (but not identical) asset (not the same one) is available for immediate purchase with the freed up funds. Clients should avoid triggering the IRS’s wash sale rules by repurchasing the exact same asset just sold.

Prepaying Tuition

This may be the last time this one works. The Hope or Lifetime Learning credits are still available for 2017.

Small Business Deductions

This is the true engine of wealth generation — investing in productive assets. Major asset acquisitions that can still be deferred to 2018 may get a better treatment by doing so. For most filers, though, this won’t make a difference and we recommend taking the deduction in 2017.

Summary List

This list summarizes the article’s points and adds items to consider for your upcoming filing.

  • Penalties for early withdrawal of savings
  • Alimony paid
  • Student loan interest
  • Prescription eyeglasses, contacts, and hearing aids
  • Crutches, canes, and orthopedic shoes
  • Medical transportation costs
  • Cost of alcohol or drug abuse treatments
  • Charitable contributions
  • Local and state income taxes
  • Personal property taxes or real estate taxes
  • Points paid for a mortgage or refinancing a home
  • Unreimbursed employee business expenses
  • Mileage and other expenses associated with volunteer work
  • Casualty and theft losses
  • Tax preparation software and tax-preparation fees

As always, our articles are not intended to be specific advice. We publish them to stimulate discussions with each client so please contact us with your thoughts and questions regarding the points you found interesting or relevant to your situation. We’re awaiting your email or message.

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Update on the Fiduciary Rule

Summary: The Department of Labor’s April 7 Federal Register update on the Fiduciary Rule (which we covered in February) established June 9 as the Rule’s implementation date with a transition window until January 1, 2018. The Fiduciary Rule will allow investment advisers working with retirement account and plan owners and custodians to continue to receive compensation from product vendors so long as the adviser can demonstrate, “adherence to certain Impartial Conduct Standards: providing advice in retirement investors’ best interest; charging no more than reasonable compensation; and avoiding misleading statements . . . .” The DOL will use the intervening time to report back to the president on any issues it discovers regarding the costs and benefits of implementing this rule. Industry insiders and lobbyists are actively seeking to ensure the rule is never implemented. The intent of the rule is to protect retirement investors from predatory sales practices.

Why You Care About This Issue

Analysts report retirement investors losing billions in retirement account payoffs due to predatory sales practices. While the rule does not proscribe the conflict-of-interest-producing, compensation practices, it does create a very high bar to continuing them. Some industry insiders have indicated that the potential for lawsuits will increase so much as to eliminate the practices in general with a resulting decrease in offerings and services.

Compensation Created Appearance of Conflict of Interest

The core issue in the Department of Labor’s rule, which it began compiling and socializing during the Obama administration, is the exemption granted to “investment advice fiduciaries” that allows them to receive payments that would, in almost any other context, create a presumption of a conflict of interest. In the case of investment advisors, much of their compensation, except for the fee-only component of the industry, comes from the providers of the products they recommend to their retirement clients. In other words, these advisers function as salespersons for the product providers including insurance companies, brokerages that owned or had custody of equities (stocks for example) and debt instruments (such as bonds), and institutional arrangements such as hedge funds, real estate trusts, and the like. The entities write checks to the “advisers” based on their performance, with the retirement investors themselves generally ignorant of these arrangements.

Buyer Beware or Regulation?

Many contacts have expressed seeing little or no problem with the conflict of interest arrangement, with the “caveat emptor” ethos characterizing the main thread. A sharper version occasionally even resorts to the Darwinian or Ayn Rand framework. Rule advocates call for eliminating the conflicts of interest it indirectly addresses. They cite the combined effects of the severe informational and financial power imbalances (insider information), the wholesale transformation of retirement plans from defined benefit to contribution and the resulting reliance on 401(k) type plans and IRAs at the household level: The net impact limits most retirement investor’s ability to recover from poor decision-making.

Third Party Comp Allowed Within New Safe-Harbor

In this case, however, the rule has never sought to eliminate the conflicts of interest, instead establishing a small safe-harbor for receiving compensation from instrument sellers. The safe-harbor was created by providing exemptions to other rules prohibiting the conflict-of-interest-creating compensation. Rather than flatly prohibiting compensation structures that, “could be beneficial in the right circumstances (italics ours; see comment), the exemptions are designed to permit investment advice fiduciaries to receive commissions and other common forms of compensation.” Advisers will need to be able to demonstrate that even though they are taking what amounts to kickbacks and bribes in other industries, that they are still able to act in their clients’ best interests. They will also have to fully disclose the compensation they receive from the third parties to these transactions. This will be a change from the current standard in which a particular recommended investment is just expected to meet “ . . . the objectives and means of an investor.” No disclosure of compensation from the third parties is currently required nor is any generally provided. Advocates of the rule stress that this situation allows brokers to establish relationships that appear to be necessarily in the investor’s best interests while the adviser is actually functioning as a salesperson for the third party.

Delay for Reporting

The President’s memorandum mandating the delay requires the DOL to answer three questions before implementing the rule:

  • Whether the anticipated applicability of the Fiduciary Rule and prohibited transaction exemptions (PTEs) has harmed or is likely to harm investors due to a reduction of Americans’ access to certain retirement savings offerings, retirement product structures, retirement savings information, or related financial advice;
  • Whether the anticipated applicability of the Fiduciary Rule and PTEs has resulted in dislocations or disruptions within the retirement services industry that may adversely affect investors or retirees; and
  • Whether the Fiduciary Rule (and ongoing PTEs) is likely to cause an increase in litigation and an increase in the prices that investors and retirees must pay to gain access to retirement services.

The memorandum states that, “. . . the priority of the Administration ‘to empower Americans to make their own financial decisions, to facilitate their ability to save for retirement and build the individual wealth necessary to afford typical lifetime expenses, such as buying a home and paying for college, and to withstand unexpected financial emergencies,’ then the Department shall publish for notice and comment a proposed rule rescinding or revising the Fiduciary Rule, as appropriate and as consistent with law.”

Comments Period Results

Of the 378,000 comments provided to the DOL on the Rule delay up to April 7, 173,000 favored immediate implementation of the rule. Frequent reasons provided included that the DOL had already analyzed the reporting issues the Administration’s memorandum required and that the harm to investors should end as quickly as possible. For example, the DOL summarized this argument explaining that, “ . . . under the current regulatory structure, investors lose billions of dollars each year as a result of conflicts of interest, and [they] argued that delay would compound these losses.” Opponents challenged the legal authority of the DOL to extend the rule to IRAs and other authoritative challenges and contended that the variety and type of offerings presented to individual investors would decrease.

Comment: We observed, in the months leading up to last February’s delay of the original April 10, 2017, implementation date, a tectonic movement toward an industry-wide transition to a fee-only basis for retirement investment advisers, with several major brokerages eliminating access to traditionally-compensated advisors to all but the most “sophisticated” investors. Of course, this transition is likely to affect the breadth of offerings in the traditional and fee-only marketplaces. We argue that the disappearing products never belonged in the menu for run-of-the-mill retirement investors. Among those are products like high 12(b)1 and similar fee mutual funds and front loaded mutual funds. But, this change clearly conflicts with the Administration’s previously-mentioned goal of “empowering” Americans, in some cases, to impoverish themselves. Ultimately, then, this issue, like many, depends more on one’s underlying values than on the facts at hand. Where the DOL will eventually end up, given the sheer volume of the proponents’ efforts contrasted with the absolute financial clout of the rule’s opponents, is anyone’s guess. We come down in favor of protecting “the little guys” from powerful forces against which they can do little but rail against the gods, given that even the DOL experts presented the instruments likely most affected by the rule as ones that, “could be beneficial in the right circumstances.”  The finely tuned word choice describes investments that generally would be harmful to investors in most cases. The fact that industry insiders and lobbyists are actively seeking to ensure the DOL never implements the rule speaks volumes to the disruption in industry practices the rule threatens. It’s an issue we’ll continue to watch so you don’t have to.