Creating Tax Alpha B & F Financial Analytics, Inc.

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1 This presentation is not intended to provide legal or tax advice. Consult with your legal and tax professional To determine how the concepts presented apply in your Situation. Creating Tax Alpha B & F Financial Analytics, Inc. 60 North Main Street Rutland, VT

2 Alpha What is Alpha In Modern Portfolio Theory (MPT), Alpha Is the excess return of a risk-adjusted portfolio Relative to the portfolio s benchmark In simple terms, by how much did your portfolio Beat The Market Source: KeeblerAssociates.com

3 Modern Portfolio Theory and Tax Alpha One of the main drawbacks of Modern Portfolio Theory is that it neglects transaction costs and income Taxes. A 5% return taxed at 23.8% is really a 3.81% return Will that still beat the Market? Tax Alpha is enhancing a portfolio s true return by planning for less tax drag

4 After ATRA and the 3.8% NII Tax Tax Efficient Investing

5 Tax Efficient Investing Asset Allocation Drawdown Strategies Tactical Tax Planning Incentive Based Tax Planning Reducing One Stock Portfolio Risk

6 Asset Location Deciding which assets to hold in various accounts IRA Roth IRA Brokerage (taxable) account Where should you hold Bonds REITS Large Cap Stocks Small Cap Stocks MLPS Real Estate

7 Tax Asset Classes Interest Income Dividend Income Capital Gain Tax Exempt Pension & IRA Real Estate, Roth IRA and Income Interest Income Oil & Gas, Insurance Tax Exempt Bonds Money Market Corporate Bonds US Treasury Bonds Equity securities Equity securities Bonds issued by State and Local Governmenta l Entities Pension Plans Profit Sharing Plans Annuities Real Estate Depreciation tax shield 1031 exchanges Deferral on growth until sale Roth IRA Tax-free growth during lifetime No 70½ RMD Tax-Free distributions out to beneficiaries life expectancy Attributes Annual income tax on interest Taxed at highest marginal rates Attributes Qualified dividends at LTCG rate Return of capital dividend Capital gain dividends Attributes Deferral until sale Reduced capital gains rate Step-up basis at death Attributes Federal Tax exempt State tax exempt Attributes Growth during lifetime RMD for IRA and qualified plans No step-up Oil & Gas Large up front IDC deductions Depletion allowances Life Insurance Tax-deferred growth Tax-exempt payout at death

8 Drawdown Strategies Fill up the 10% or 15% bracket Roth conversions by asset class and Roth conversions to manage tax brackets Spend from the outside portfolio first once you have filled up the 15% bracket Bonds should generally be positioned in one s IRA because of the annual tax burden Life Insurance can be a very valuable supplement to existing pensions.

9 Tactical Tax Planning Loss Harvesting Gain Harvesting Matching Gains and Losses Roth Conversions IRA Relocation Payment of IRA fees from outside funds Net Unrealized Appreciation

10 Incentive Based Tax Planning Master Limited Partnerships Qualified Dividends Return of Capital Dividends Low-turnover Strategies Roth Conversions IRC /40 Investments Real Estate & Leveraged Real Estate Income Shifting Life Insurance Strategies Annuity Strategies

11 Incentive Based Tax Planning Charitable Lead Trusts Charitable Remainder Trusts Charitable Remainder Retirement Trust Income Shifting Charitable Remainder Trusts Profit Sharing Plans Defined Benefit Plans Oil & Gas Investments Land Investments followed by 1031 exchanges Tax-exempt Bonds Wind, Biofuel & Solar Investments

12 Roth Conversions

13 Roth IRA Conversions Reason to Convert Taxpayers have special favorable tax attributes including charitable deduction carry forwards, investment tax credits, net operating losses (NOLS), high basis non-deductible traditional IRAs, ETC. Suspension of the minimum distribution rules at age 70½ provides a considerable advantage to the Roth IRA holder. Taxpayers benefit from paying income tax before estate tax (when a Roth Ira election is made) compared to the income tax deduction obtained when a traditional IRA is subject to estate tax.

14 Roth IRA Conversions Taxpayers who can pay the income tax on the IRA from non-ira funds benefit greatly from the Roth IRA because of the ability to enjoy greater tax-free yields. Taxpayers who need to use IRA assets to fund their Unified Credit bypass trust are well advised to consider making a Roth IRA election for that portion of their overall IRA funds. Taxpayers making the Roth IRA election during their lifetime reduce their overall estate, thereby lowering the effect of higher estate tax rates.

15 Roth IRA Conversions Mathematics of Conversion Tradition IRA Roth IRA Current Account Balance $1,000,000 $1,000,000 Less: Income 40% 0 (400,000) Net Balance $1,000,000 $ 600,000 Growth Until Death 200% 200% Account Death $3,000,000 $1,800,000 Less Federal Estate 40% (1,200,000) 0 Net Account Balance to Family $1,800,000 $1,800,000 These figures were chosen o illustrate a concept and are not actual of returns of any investment. Individual situations will vary.

16 Roth IRA Conversions Mathematics of Conversion Critical decision factors Tax rate differential (year of conversion vs. withdrawal years) Use of outside funds to pay the income tax liability Need for IRA funds to meet annual living expenses Time Horizon

17 Roth IRA Conversions Mathematics of Conversion The key to successful Roth IRA conversions is to keep as much of the conversion income as possible in the current marginal tax bracket. However, there are times when it may make sense to convert more and go into higher tax brackets Need to take into consideration the following: The new 3.8% Medicare surtax The impact of AMT New 39.6% rate PEP and PEASE adjustments

18 Roth IRA Conversions Tactical Considerations Unused Charitable Contribution carryovers Current Year Ordinary Losses Net Operating Loss (NOL) carryovers from prior years Alternative Minimum Tax (AMT) Credit carryovers

19 Roth Ira Conversions- Married PEP Target Roth IRA Conversion Amount Current Taxable Income 10% Tax Bracket 15% Tax Bracket 25 % Tax Bracket 3.8% Surtax 28% Tax Bracket 33% Tax Bracket 35% Tax Bracket 39.6% Tax Bracket If Taxable Income Is: Not over $17,850 Tax will be: 10% of taxable income Over $17,850, under $72,500 $1,785 plus 15% of excess over $17,580 Over $72,500, under $146,400 $9, plus 25% of the excess over $72,500 Over $146,500, under $ $28, plus 25% of the excess over $146,400 Over $223,050, under $398,350 $49, plus 33% of the excess over $223,050 Over $398,350, under $450,000 $107, plus 35% of the excess over $398,350 Over $450, $125,846 plus 39.6% of the excess over $450K

20 Roth IRA Conversions 1. Develop a 10 to 15 year projection of income and deductions and compare theses projections to the various taxes 2. Develop am analysis to determine the client's permanent tax bracket. Analysis will test whether an intrabracket conversions increase the 3.8% surtax, the AMT, impact of PEP/Pease, or the 39.6% tax rate 3. Develop a series of bracket-crossing conversions analysis. Each analysis must be measured autonomously standing on its own and take into account the various taxes. 4. Repeat the above taking into account changes in value and the opportunity to characterize.

21 Comparison of 2012 & 2013 Rates Top Ordinary Income Rate Salary Top Ordinary Income Rate Investment Income Top Capital Gain Rate Top Tax Rate on Dividends 35% 39.6% % * 35% 39.6% % ** 15% 20% % *** 15% 23.8% % *** Payroll Tax 10.40% 12.4% 12.4% Medicare Surtax on Investment Income Payroll Surtax on Earned Income % 3.8% 3.8% **** 0%.9%.9% Estate Tax Rate 35% 40% 40% *Includes phase-out of deductions (1.188%) and.9% healthcare wage tax **Includes 3.8% Surtax and phase out of deductions (1.188%) ***20% base rate plus 3.8% Surtax plus 1.188% adjustment for itemized deductions ****Threshold amounts are $200K for single filers, $250K for joint returns and $11,950 for Estates/Trusts