Closing The Gap - Addressing Retirement Shortfalls

Blue Springs Financial Adviser

Most people approach retirement in one of three ways.

There are those who have looked forward to retirement for years, systematically contributed to their IRAs or 401(k)s, consistently saved, prudently invested and even implemented strategies to counter the impact of rising inflation.

Then there are those who didn’t plan quite so care-fully, but felt confident that they could rely on the equity in their homes, their Social Security benefits, their retirement accounts and their savings to carry them through.

Many Americans fall into yet a third category: those who didn’t give their retirements much thought at all – figuring they’d deal with the issues when they got there.

Regardless of the description that best suits you, take the time to delve deeper into your current retirement plans. Understanding your finances is the first step toward conquering whatever challenges you may face.

Reassess Your Finances and Your Goals

Turbulence in the housing and financial markets, combined with the prospect of rising inflation and longer lifespans, means you must be confident that you can finance your normal living expenses for years to come, as well as handle any health-related issues that may arise.

Given all of those factors, you may determine that your long-anticipated vacation home or trip is temporarily out of reach. However, your core requirements for a secure retirement remain. If after reviewing your needs and goals, as well as your portfolio performance, you and your financial adviser conclude that you have a shortfall and can’t afford the goals you previously planned for, you face some decisions.

It may help to realize that you are not alone. Many Americans in their 50s and 60s are delaying – or significantly revising – their retirement plans. In fact, only 13% of workers are “very confident” that they will have the money they need to retire, according to a 2009 study by the Employee Benefit Research Institute.

Closing the Gap

If you’re not certain that your retirement assets are enough to finance the years ahead of you, you are not alone.

Of workers concerned about their abilities to finance their retirements:

y             81% have reduced their expenses,

y             43% are changing how they invest their money,

y             38% are working more hours or holding a second job, and

y             25% are saving more money.

Source:  Employee Benefit Research Institute’s 2009 Retirement Confidence Survey

Take a Second Look

Begin by redefining your core objectives. Deter-mine what is essential to you, and what is not, and consider whether there are simple lifestyle changes you can make today that will make your retirement years easier.

If you’re still working, start looking for ways to reduce your current spending and save more. Whether the changes are as major as postponing the purchase of a second home or as minor as cutting back on entertainment expenses, redeploy the savings to maximize contributions to your retirement accounts or other investment assets.

You may also want to take another look at spending that perhaps you hadn’t previously considered discretionary – such as helping to fund a grandchild’s education or donating regularly to a favorite charity. Only when you’re once again confident that your portfolio is robust enough to provide a secure retirement should you consider resuming such expenditures. You owe it to yourself to safeguard your own future.

As the money you’re saving adds up, work with your financial adviser to ensure that it’s allocated effectively. You should be confident that your investments are properly allocated – for instance, that the  balance between growth- and income-oriented assets is appropriate and that income will be avail-able to you when you need to access it.

If you find a gap still exists between the amount you need to live and the income your portfolio can consistently generate, you may decide to continue working or return to work, perhaps in a different occupation or on a part-time basis.

A recent AARP study found that many individuals aged 50 and above obtain a great deal of satisfaction by continuing to work – not to mention additional income.

These individuals often take pay cuts and may not receive pension and healthcare benefits, the study found. But, many of the workers surveyed over a 14-year period that began in 1992 said they dealt with less stress and enjoyed the flexible work schedules their new jobs offered.

In fact, 91% of those surveyed said they enjoyed their work, a significant increase from the 79% who said they liked their old jobs.

Managing Your Social Security Benefits

If you delay your retirement, you also may be able to postpone accessing your Social Security benefits – benefits that represent about 40% of the average retiree’s income in the United States. The longer you wait to take advantage of your Social Security, the higher your payments will be.

The government gives you several options with regard to Social Security. More than two-thirds of eligible Americans choose to take their benefits early – after they reach 62 but before they reach full retirement age. However, if you are still working, and do not need the income, you may instead:

y             Wait until you reach your full retirement age before tapping into Social Security or

y             Defer Social Security benefits for as long as you want … until you reach age 70, when you    must begin taking them.

If you take Social Security between age 62 and your full retirement age, you’ll be paid over a longer period, but you’ll receive less per payment. Should you defer receiving Social Security, your payments will increase by 6% to 8% for every year that you do not take benefits and reach their maximum when you turn 70.

Taking Action

There are steps you can take to rebuild your assets and strategies you can use to help secure your retirement.

Asserting control over your financial future requires a rational, objective mindset and the recognition that you will likely need to take some proactive steps. Your Blue Springs financial adviser can help explain your options and guide you along the way.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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Who is Alliance Financial & Income Tax

Your Changing Definition of Risk in Retirement

Blue Springs Financial Advisor

During your accumulation years, you may have categorized your risk as “conservative,” “moderate,” or “aggressive” and that guided how your portfolio was built. Maybe you concerned yourself with finding the “best-performing funds,” even though you knew past performance does not guarantee future results.

Your Blue Springs financial advisor's office can guide you through this process.

What occurs with many retirees is a change in mindset—it’s less about finding the “best-performing fund” and more about consistent performance. It may be less about a risk continuum—that stretches from conservative to aggressive—and more about balancing the objectives of maximizing your income and sustaining it for a lifetime.

You may even find yourself willing to forego return potential for steady income.

A change in your mindset may drive changes in how you shape your portfolio and the investments you choose to fill it.

Let’s examine how this might look at an individual level.

Still Believe

During your working years, you understood the short-term volatility of the stock market but accepted it for its growth potential over longer time periods. You’re now in retirement and still believe in that concept. In fact, you know stocks remain important to your financial strategy over a 30-year or more retirement period.¹

But you’ve also come to understand that withdrawals from your investment portfolio have the potential to accelerate the depletion of your assets when investment values are declining. How you define your risk tolerance may not have changed, but you understand the new risks introduced by retirement. Consequently, it’s not so much about managing your exposure to stocks, but considering new strategies that adapt to this new landscape.¹

Shift the Risk

For instance, it may mean that you hold more cash than you ever did when you were earning a paycheck. It also may mean that you consider investments that shift the risk of market uncertainty to another party, such as an insurance company. Many retirees choose annuities for just that reason.

The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contract. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).

The march of time affords us ever-changing perspectives on life, and that is never more true than during retirement.

1. Keep in mind that the return and principal value of stock prices will fluctuate as market conditions change. And shares, when sold, may be worth more or less than their original cost.This is a hypothetical example used for illustrative purposes only.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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Who is Alliance Financial & Income Tax

Deducting S corporation Health Insurance Premiums

Blue Springs Income Tax Preparation Services

Notice 2008-1 contains the rules (and examples) for deducting accident and health insurance premiums by a more-than-2% shareholder/employee of an S corporation.

Section 1372(a) provides that, for purposes of applying the income tax provisions of the Code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any 2-percent shareholder of the S corporation shall be treated as a partner of such partnership.

Definition of a 2% Shareholder

The following is from IRS Notice 2008-1:

For purposes of § 1372, the term "2-percent shareholder" is any person who owns (or is considered as owning within the meaning of § 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation.

How an S corporation Deducts Health Insurance Premiums

An S corporation deducts the premiums it pays for accident and health insurance to cover a 2% shareholder/employee (and his spouse and dependents) as compensation paid to the shareholder/employee. In other words, the premiums are included in the shareholder/employee's salary and reported on the individual's W-2 form.

Notice 2008-1 states that health insurance premiums paid or furnished by an S corporation on behalf of its 2 percent shareholders in consideration for services rendered "are treated for income tax purposes like partnership guaranteed payments under § 707(c) of the Code. Rev. Rul. 91-26, 1991-1 C.B. 184."

Health Insurance Premium Deduction Rules

The rules that apply to S corporations also apply to:

• Partnerships and
• Multi-member LLCs (but not to a single-member LLC)

Plan Must be Established By the Business:

If you're a more-than-2% shareholder/employee in an S corporation, a partner in a partnership, or a member in a multi-member LLC, you may only deduct health insurance premiums directly on Form 1040, line 29, Self-employed health insurance deduction, IF the health insurance plan is considered to have been established by the business and not by you personally.

In determining if the business estabished the plan, whose name the policy is in is not taken into account (it could be in the more-than-2% shareholder/employee's name or in the business's name).

The following two elements are considered in determining who established the plan:

1. Who actually pays the premiums, and
2. How the premiums are reported for income tax purposes by both you and the business

For the plan to be considered established by the business, the business must pay the premiums and include the the premiums in the more-than-2% S corporation shareholder/employee's gross wages on Form W-2. If the more-than-2% S corporation shareholder/employee puts the policy in his own name, personally pays the premiums without getting reimbursed from the business, the plan is not considered to have been established by the business and the .

Any One of Three Scenarios Must Be Satisfied

For an accident and health insurance plan to be considered established by the business, any one of the following three scenarios must apply:

Scenario 1:

The business obtains an accident and health insurance policy in the business's name to cover its more-than 2% shareholder/employees (in the case of an S corporation), partners (in the case of a partnership), and members (in the case of a multi-member LLC). The plan also covers their spouses and dependents:

• The business makes all the premium payments.
• The business reports the amount of the premiums as:
  • Part of gross wages on Form W-2, in the case of a more-than-2% shareholder/employee of an S corporation.
  • Guaranteed income in each partner's Schedule K-1, in the case of a partnership..
  • Guaranteed income in each LLC member's Schedule K-1, in the case of an LLC.
    • The default tax treatment of a multi-member LLC is that of a partnership if no election is made to treat the LLC as an S corporation or C corporation.
    • If an election was made on Form 2553 to treat the LLC as an S corporation, then the LLC members would be treated as employees of the business instead of partners (the default tax treatment) and the premiums would be reported in each member's W-2 as part of their gross wages.

Scenario 1 Result:

• In this scenario, the plan is established by the S corporation.
• Each 2% shareholder/employee, partner, and LLC member may take the deduction on Form 1040, line 29.
• If you were a more-than-2% shareholder/employee of an S corporation, the health insurance premiums paid on your behalf would be included in your gross wages on your W-2.
• If you were a partner in a partnership or member of a multi-member LLC, the premiums would be included in your Schedule K-1 as guaranteed income.

Scenario 2:

A more-than-2% shareholder/employee, partner, or member of a multi-member LLC obtains an accident and health insurance policy in his own name:

• The business makes all the premium payments.
• The business reports the amount of the premiums as:
  • Part of gross wages on Form W-2, in the case of a more-than-2% shareholder/employee of an S corporation.
  • Guaranteed income in each partner's Schedule K-1, in the case of a partnership.
  • Guaranteed income in each LLC member's Schedule K-1, in the case of an LLC.
    • A multi-member LLC is treated as a partnership, which is the default tax treatment if no election was made to treat the LLC as an S corp. or C corp.
    • If an election was made to treat the LLC as an S corporation, then the members would be treated as employees of the business and the premiums would be reported in each member's W-2 as part of their gross wages.

Results of Scenario 2:

• In this scenario, the plan is established by the business even though the policy is not in the business's name.
• The premiums paid by the business may be deducted on Form 1040, line 29.

Scenario 3:

A more-than-2% shareholder/employee, partner, or member of a multi-member LLC obtains a policy in his name to cover himself his spouse and two children.

• The shareholder/employee, partner, or LLC member pays all the premiums
• Proof of payment is provided to the business
• The business reimburses the 2% shareholder/employee, partner, or LLC member for the premiums paid.
• The business includes the amount of the premiums reimbursed to the 2% shareholder/employee in his W-2 gross wages.
• The business reports the amount of the premiums reimbursed to the partner or LLC member as guaranteed income on Schedule K-1

Results of Scenario 3:

• In this case, the health insurance plan is considered established by the business even though the plan is not in the business's name because the business reimbursed the premiums to the 2% shareholder/employee, partner, or LLC member,
• The 2% shareholder/employee, partner, and LLC member may deduct the premiums paid on Form 1040, line 29.
• The more-than-2% shareholder/employee, partner, and LLC member report the reimbursed premiums in their gross income on Form 1040 as explained in Scenario 1.

When a 2% S corporation Shareholder, Partner, or LLC Member May Not Claim the Deduction on Form 1040, Line 29:

Here's a situation where health insurance premiums may not be deducted directly on Form 1040, line 29:

• A more-than-2% shareholder/employee, partner, or member of a multi-member LLC pays the premiums for a health insurance policy.
• The business does not make any premium payments and does not reimburse the premium payments made by the 2% shareholder/employee, partner, or LLC member

In this case, the plan was not established by the business because the business did not pay any of the premiums nor did the business reimburse the premiums to the 2% shareholder/employee, partner, or LLC member.

The premiums may not be deducted on Form 1040, line 29. Instead, the deduction may only be claimed on Schedule A as an itemized deduction as a medical expense.

Note: As of 2013, to get a tax benefit for medical expenses on Schedule A, medical expenses must exceed 10% of adjusted gross income for individuals under 65 years of age (7 1/2% for individuals 65 or older). The 7 1/2% of AGI exception for taxpayers 65 or older will be in effect from 2013 through December 2017, unless Congress extends this exception.

Caution!

Do not include amounts for any month you were eligible to participate in an employer-sponsored health plan (Section 162(l)(2)(B)) or amounts paid from retirement plan distributions that were nontaxable because you were a retired public safety officer.

You cannot claim the health insurance premium deduction if you file Form 1040A or Form 1040EZ.

Earned Income From Trade or Business Limitation

The deduction for health insurance premiums is not allowed to the extent that the amount of the deduction exceeds the earned income derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.

Blue Springs Amended Income Tax Returns

Taxpayers who did not claim the health insurance deduction on a prior year's return may file an amended return on Form 1040X. It must be filed timely (3 years from the due date of the original return, plus extensions, or 2 years from the date the tax was paid, whichever is later).

You need to write the following at the top of the amended return:

• Filed Pursuant to Notice 2008-1

Notice 2008-1 contains the rules (and examples) for deducting accident and health insurance premiums by a 2% shareholder/employee of an S corporation.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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Who is Alliance Financial & Income Tax

Are your Social Security Benefits Taxable?

Blue Springs Financial Consultants

Social security benefits include monthly retirement, survivor, and disability benefits. If you received Social security benefits in 2016, you should receive a Form SSA-1099, Social Security Benefit Statement, showing the amount.

Note: Supplemental Security Income (SSI) payments are not taxable.

If Social Security was your only source of income in 2016 your benefits might not be taxable. You also may not need to file a federal income tax return this year; however, if you receive income from other sources, then you may have to pay taxes on some of your benefits.

Your income and filing status affect whether you must pay taxes on your Social Security. An easy method of determining whether any of your benefits might be taxable is to add one-half of your Social Security benefits to all of your other income, including any tax-exempt interest.

Next, compare this total to the base amounts below. If your total is more than the base amount for your filing status, then some of your benefits may be taxable. In 2016, the three base amounts are:

• $25,000 - for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year
• $32,000 - for married couples filing jointly
• $0 - for married persons filing separately who lived together at any time during the year

Your taxable benefits and modified adjusted gross income are figured on a worksheet in the Form 1040A or Form 1040 Instruction booklet. Please call if you need assistance figuring this out.

Retired Abroad?

Retirement income is generally not taxed by other countries. As a U.S. citizen retiring abroad who receives Social Security, for instance, you may owe U.S. taxes on that income, but may not be liable for tax in the country where you're spending your retirement years.

If Social Security is your only income, then your benefits may not be taxable, and you may not need to file a federal income tax return. If you receive Social Security, you should receive a Form SSA-1099, Social Security Benefit Statement, showing the amount of your benefits.

However, if you receive income from other sources as well, from a part-time job or self-employment (either U.S. or the country you've retired to), you may have to pay U.S. taxes on some of your benefits.

You may also be required to report and pay taxes on any income earned in the country where you retired. Each country is different, so consult a local tax professional or one who specializes in expat tax services.

State Taxes

Some states tax social security income as well: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia.

Note: Even if you retire abroad, you may still owe state taxes--unless you established residency in a no-tax state before you moved overseas. Also, some states honor the provisions of U.S. tax treaties; however, some states do not, therefore it is prudent to consult a tax professional.

Questions about income related to Social Security? Contact your Blue Springs financial consultants today at 816-220-2001.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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Who is Alliance Financial & Income Tax

Who Can Represent You Before the IRS?

Many people use a Blue Springs tax professional to prepare their taxes. Anyone who prepares, or assists in preparing, all or substantially all of a federal tax return for compensation is required to have a valid Preparer Tax Identification Number (PTIN). All enrolled agents must also have a valid PTIN. Tax professionals with an IRS Preparer. If you choose to have someone prepare your federal tax return you should know who can represent you before the IRS--and when--if there is a problem with your return.

Representation rights, also known as practice rights, fall into two categories:

• Unlimited Representation
• Limited Representation

Unlimited representation rights allow a credentialed tax practitioner to represent you before the IRS on any tax matter. This is true no matter who prepared your return. Credentialed tax professionals who have unlimited representation rights include:

• Enrolled agents
• Certified Public Accountants
• Attorneys

Limited representation rights authorize the tax professional to represent you if, and only if, they prepared and signed the return. They can do this only before IRS revenue agents, customer service representatives and similar IRS employees. They cannot represent clients whose returns they did not prepare. They cannot represent clients regarding appeals or collection issues even if they did prepare the return in question.

For returns filed after December 31, 2015, the only tax return preparers with limited representation rights are Annual Filing Season Program Participants. The Annual Filing Season Program is a voluntary program. Non-credentialed tax return preparers who aim for a higher level of professionalism are encouraged to participate.

Other tax return preparers have limited representation rights, but only for returns filed before Jan. 1, 2016. Keep these changes in mind and choose wisely when you select a tax return preparer.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
AFITOnline.com

Who is Alliance Financial & Income Tax

One of my favorite parables

Sometimes the best stories are the old ones.

Variations of this yarn have floated around the culture for some years now, but in my opinion, that's because the lesson from it is so instructive.

And I'll admit from the jump, that it's self-serving to some extent. Because in the age of AI, point-and-click software and ROBOTS, it's tempting to think that tax and financial advice simply requires a more advanced machine.

Well, aside from the reality that no machine can sit in front of a person and discern the emotional streams that are most important to a family or individual, it is also true that unless the person *behind* the machine knows what they are doing, all you are doing is compounding errors.

So, read this, consider its lessons, and keep us in your corner...

Mike Mead's 
"Real World" Personal Strategy Note
Irreplaceable Knowledge
"Simplicity is the ultimate sophistication." -Leonardo da Vinci

Some years ago, one of the major manufacturing companies in this country was facing a crisis. The central conveyor belt of its automated assembly line quit running and brought the entire plant to a stop. 

Although they tried everything they could think of, and even brought in several consultants, no one was able to get the conveyor belt running again, or even to identify what caused the breakdown in the first place. The company was really in a bind. With on-going overhead, and the loss of production, the company was losing money at the rate of $1,000,000.00 a day. 

Finally, after a week of down time, the big brass told the plant manager to call Tom -- the mechanical engineer who had retired the year before, after 25 years with the company. The conveyor belt had been Tom's specialty and primary responsibility. 

When Tom got the call, he caught the next flight from the city where he now lived and arrived at the plant the next day. He met with both the local vice president and the plant manager to get as much information as he could as to what had happened and what they had tried. He then walked slowly along the belt until he came to a particular point. 

He put his ear against the machine and listened. He asked for a hammer and then gave the machine a swift and forceful blow. 

"Give it a try now!" he called to the foreman. The conveyor belt started right up and ran like a dream. 

Tom then left and went back home, but before he did, the company vice president told him to send them a bill for what he had accomplished. Two days later, the company received Tom's invoice for one million dollars! 

Thinking that was way too high for the little time Tom had spent to solve the problem, and how he did so with just a single blow from a hammer, the company wrote back and asked Tom to provide them with an itemization. This was Tom's response: 

One hammer blow: $2.00 
Knowing where to hit it: $999,998.00 

With the receipt of that simple invoice, the company came to understand the reason for Tom's fee and immediately issued a check to him for one million dollars!

Special knowledge is the key. Although the company's leaders had to be reminded of that fact by receiving Tom's invoice, as soon as they did, they knew he was right. They could have given hammers to every employee in the plant and even had the big brass banging on the machine from sunrise to sunset, but it would have done no good...because they didn't have the knowledge; they didn't know where to hit it. 

This is an old story, told in different ways, with different names and amounts. But it's powerful for a simple reason: labor is NOT about how much "time" is put into executing a particular solution to a problem -- it's knowing when and how to do it.

In the realm of tax planning, and of preparing your tax return, I urge you... do NOT fall prey to the thinking that a software program or forms downloaded from the internet can suffice to enable you to preserve your resources, or properly leverage the multiplicity of credits, legal and ethical loopholes and deductions available.

Give yourself and your family the gift of financial peace of mind come Blue Springs tax time and well ahead of it -- and do it with someone who knows how to do it right.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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Who is Alliance Financial & Income Tax

Minimizing Tax on Mutual Fund Activities

Blue Springs Income Tax & Financial Services

Tax law generally treats mutual fund shareholders as if they directly owned a proportionate share of the fund's portfolio of securities and you must report as income any mutual fund distributions, whether or not they are reinvested. Thus, all dividends and interest from securities in the portfolio, as well as any capital gains from the sales of securities, are taxed to the shareholders.

Whether you're new to mutual funds or a seasoned investor who wants to learn more, these tips will help you avoid the tax bite on mutual fund investments.

Taxable Distributions

First, you need to understand how distributions from mutual funds are taxed. There are two types of taxable distributions: (1) ordinary dividends and (2) capital gain distributions.

Ordinary Dividends. Distributions of ordinary dividends, which come from the interest and dividends earned by securities in the fund's portfolio, represent the net earnings of the fund. They are paid out periodically to shareholders. Like the return on any other investment, mutual fund dividend payments decline or rise from year to year, depending on the income earned by the fund in accordance with its investment policy. These dividend payments are considered ordinary income and must be reported on your tax return.

In 2017 (same as 2016), dividend income that falls in the highest tax bracket (39.6%) is taxed at 20 percent. For the middle tax brackets (25-35%) the dividend tax rate is 15 percent, and for the two lower ordinary income tax brackets of 10% and 15%, the dividend tax rate is zero.

Qualified dividends. Qualified dividends are ordinary dividends that are subject to the same the zero or 15 percent maximum tax rate that applies to net capital gain. They are subject to the 15 percent rate if the regular tax rate that would apply is 25 percent or higher; however, the highest tax bracket, 39.6%, is taxed at a 20 percent rate. If the regular tax rate that would apply is lower than 25 percent, qualified dividends are subject to the zero percent rate.

Dividends from foreign corporations are qualified where their stock or ADRs (American depositary receipts) are traded on U.S. exchanges or with IRS approval where U.S. tax treaties cover the dividends. Dividends from mutual funds qualify where a mutual fund is receiving qualified dividends and distributing the required proportions thereof.

Capital gain distributions. When gains from the fund's sales of securities exceed losses, they are distributed to shareholders. As with ordinary dividends, these capital gain distributions vary in amount from year to year. They are treated as long-term capital gain, regardless of how long you have owned your fund shares.

A mutual fund owner may also have capital gains from selling mutual fund shares.

Capital gains rates. The beneficial long-term capital gains rates on sales of mutual fund shares apply only to profits on shares held more than a year before sale. Profit on shares held a year or less before sale is considered ordinary income, but capital gain distributions are long-term regardless of the length of time held before the distribution.

Starting with tax year 2013, long term capital gains are taxed at 20 percent (39.6% tax bracket), 15 percent for the middle tax brackets (25%, 28%, 33%, and 35%), and 0 percent for the 10% and 15% tax brackets.

At tax time, your mutual fund will send you a Form 1099-DIV, which tells you what earnings to report on your income tax return, and how much of it is qualified dividends. Because tax rates on qualified dividends are the same as for capital gains distributions and long-term gains on sales, these items combined in your tax reporting, that is, qualified dividends added to long-term capital gains. Capital losses are netted against capital gains before applying the favorable capital gains rates, and losses will not be netted against dividends.

Medicare Tax. Starting with tax year 2013, an additional Medicare tax of 3.8 percent is applied to net investment income for individuals with modified adjusted gross income above $200,000 (single filers) and $250,000 (joint filers).

Minimizing Tax Liability on Mutual Fund Activities

Now that you have a better understanding of how mutual funds are taxed, here are seven tips for minimizing the tax on your mutual fund activities.

1. Keep Track of Reinvested Dividends

Most funds offer you the option of having dividend and capital gain distributions automatically reinvested in the fund--a good way to buy new shares and expand your holdings. While most shareholders take advantage of this service, it is not a way to avoid being taxed. Reinvested ordinary dividends are still taxed (at long-term capital gains rates if qualified), just as if you had received them in cash. Similarly, reinvested capital gain distributions are taxed as long-term capital gain.

Tip: If you reinvest, add the amount reinvested to the "cost basis" of your account, i.e., the amount you paid for your shares. The cost basis of your new shares purchased through automatic reinvesting is easily seen from your fund account statements. This information is important later on when you sell shares.

2. Be Aware That Exchanges of Shares Are Taxable Events

The "exchange privilege," or the ability to exchange shares of one fund for shares of another, is a popular feature of many mutual fund "families," i.e., fund organizations that offer a variety of funds. For tax purposes, exchanges are treated as if you had sold your shares in one fund and used the cash to purchase shares in another fund. In other words, you must report any capital gain from the exchange on your return. The same tax rules used for calculating gains and losses when you redeem shares apply when you exchange them.

Note: Gains on these redemptions and exchanges are taxable whether the fund invests in taxable or tax-exempt securities.

3. Do Not Overlook the Advantages of Tax-Exempt Funds

If you are in the higher tax brackets and are seeing your investment profits taxed away, then there is a good alternative to consider: tax-exempt mutual funds. Distributions from such funds that are attributable to interest from state and municipal bonds are exempt from federal income tax (although they may be subject to state tax).

The same applies to distributions from tax-exempt money market funds. These funds also invest in municipal bonds, but only in those that are short-term or close to maturity, the aim being to reduce the fluctuation in NAV that occurs in long-term funds.

Many taxpayers can ease the tax bite by investing in municipal bond funds for example.

Note: Capital gain distributions paid by municipal bond funds (unlike distributions of interest) are not free from federal tax. Most states also tax these capital gain distributions.

Although income from tax-exempt funds is federally tax-exempt, you must still report on your tax return the amount of tax-exempt income you received during the year. This is an information-reporting requirement only and does not convert tax-exempt earnings into taxable income.

Your tax-exempt mutual fund will send you a statement summarizing its distributions for the past year and explaining how to handle tax-exempt dividends on a state-by-state basis.

4. Keep Records of Your Mutual Fund Transactions

It is crucial to keep the statements from each mutual fund you own, especially the year-end statement.

By law, mutual funds must send you a record of every transaction in your account, including reinvestments and exchanges of shares. The statement shows the date, amount, and number of full and fractional shares bought or sold. These transactions are also contained in the year-end statement.

In addition, you will receive a year-end Form 1099-B, which reports the sale of fund shares, for any non-IRA mutual fund account in which you sold shares during the year.

Why is recordkeeping so important?

When you sell mutual fund shares, you realize a capital gain or loss in the year the shares are sold. You must pay tax on any capital gain arising from the sale, just as you would from a sale of individual securities. (Losses may be used to offset other gains in the current year and deducted up to an additional $3,000 of ordinary income. Remaining loss may be carried for comparable treatment in later years.)

The amount of the gain or loss is determined by the difference between the cost basis of the shares (generally the original purchase price) and the sale price. Thus, to figure the gain or loss on a sale of shares, it is essential to know the cost basis. If you have kept your statements, you will be able to figure this out.

Example: In 2012, you purchased 100 shares of Fund JKL at $10 a share for a total purchase price of $1,000. Your cost basis for each share is $10 (what you paid for the shares). Any fees or commissions paid at the time of purchase are included in the basis, so since you paid an up-front commission of two percent, or $20, on the purchase, your cost basis for each share is $10.20 ($1,020 divided by 100). Let's say you sell your Fund JKL shares this year for $1,500. Assume there are no adjustments to your $ 1,020 basis, such as basis attributable to shares purchased through reinvestment. On this year's income tax return, you report a capital gain of $480 ($1,500 minus $1,020).
Note: Commissions or brokerage fees are not deducted separately as investment expenses on your tax return since they are taken into account in your cost basis.

One of the advantages of mutual fund investing is that the fund provides you with all of the records that you need to compute gains and losses--a real plus at tax time. Some funds even provide cost basis information or calculate gains and losses for shares sold. That is why it is important to save the statements. However, you are not required to use the fund's gain or loss computations in your tax reporting.

5. Re-investing Dividends & Capital Gain Distributions when Calculating

Make sure that you do not pay any unnecessary capital gain taxes on the sale of mutual fund shares because you forgot about reinvested amounts. When you reinvest dividends and capital gain distributions to buy more shares, you should add the cost of those shares (that is, the amount invested) to the cost basis of the shares in that account because you have already paid tax on those shares.

Failure to include reinvested dividends and capital gain distributions in your cost basis is a costly mistake.

6. Don't Forget State Taxation

Many states treat mutual fund distributions the same way the federal government does. There are, however, some differences. For example:

• If your mutual fund invests in U.S. government obligations, states generally exempt, from state taxation, dividends attributable to federal obligation interest.
• Most states do not tax income from their own obligations, whether held directly or through mutual funds. On the other hand, the majority of states do tax income from the obligations of other states. Thus, in most states, you will not pay state tax to the extent you receive, through the fund, income from obligations issued by your state or its municipalities.
• Most states don't grant reduced rates for capital gains or dividends.

7. Don't Overlook Possible Tax Credits for Foreign Income

If your fund invests in foreign stocks or bonds, part of the income it distributes may have been subject to foreign tax withholding. If so, you may be entitled to a tax deduction or credit for your pro-rata share of taxes paid. Your fund will provide you with the necessary information.

Tip: Because a tax credit provides a dollar-for-dollar offset against your tax bill, while a deduction reduces the amount of income on which you must pay tax, it is generally advantageous to claim the foreign tax credit. If the foreign tax doesn't exceed $300 ($600 on a joint return), then you may not need to file IRS form 1116 to claim the credit.

Questions?

If you have any questions about the tax treatment of mutual funds, please call our Blue Springs Tax & Financial Services firm at 816-220-2001.

Mike Mead, EA, CTC
Alliance Financial & Income Tax
807 NW Vesper Street
Blue Springs, MO. 64015
P - 816-220-2001 x201
F - 816-220-2012
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