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Client Newsletter: July 18, 2012

The year is half over and already we have experienced substantial volatility! The first half of 2012 was a tale of two quarters. The first quarter represented the strongest start for the US stock market since 1988. This was largely driven by a reduction of fears about Europe, as well as stronger economic data in the U.S.

The second quarter erased some of those gains. Markets were driven down by escalating concerns about the future of the European currency union, slowing global growth (including China and India), discouraging data on unemployment and a sluggish forecast for GDP growth in the U.S.

Overall the S&P 500 Index* was up 9.49% through 6/30/12, which is a very impressive return! But what should investors expect the next 6 months? VOLATILITY AND PLENTY OF IT! With some big domestic concerns about the election, income tax rates, health care and our economy, coupled with the growing European and International issues, investors should expect to see large fluctuations in stock values. Regardless of what happens in the short term, we should continue to adhere to our sound investment principles, barring a significant change in circumstance. Also, given all of the bad international news, we have always advocated strong diversification outside of the U.S. International investing has helped our clients through most of the 2000s and hurt in other times, such as last year. Going forward, we have no idea whether the U.S. dollar and market will do better or worse than global markets, but we do know that the U.S. represents less than half of the investing opportunities around the world and we need to stay geographically diversified as a result.

As mentioned in our past quarterly letter, we recommended you continue to take profits in your accounts when available; don’t wait to the end of the year to withdraw necessary funds to meet your RMD (Required Minimum Distribution) and appropriately plan any large cash expenditures. Please contact our office if you have any personal investment questions or concerns.

Social Security Statements 

An online version of the Social Security Statement is now available at www.socialsecurity.gov. The online statement provides eligible workers with secure and convenient access to their Social Security earnings and benefit information. It provides:

  • Estimates of the retirement and disablitity benefits you may receive;
  • Estimates of benefits your family may get when you receive Social Security or die;
  • A list of your lifetime earnings according to Social Security’s records;
  • The estimated Social Security and Medicare taxes you’ve paid;
  • Information about qualifying and signing up for Medicare;
  • Things to consider for those age 55 and older who are thinking of retiring;
  • A printable version of your Social Security Statement.

The Social Security office also has indicated they will resume sending their annual statement to people who are ages 60 or older and who are not yet on benefits. People younger than age 60 will not have a statement mailed to them.

Underpayment Estimated Tax item for consideration 

Many of our clients are making quarterly federal estimated tax payments. Some of you have been penalized by the IRS for not paying them equally over the four quarterly payments. Unfortunately, it is hard to estimate your tax obligation in the beginning of the year and if you wait until the 4th quarter and make a bigger estimated tax payment after you have a better idea of your tax situation, you may be penalized by the IRS for not making the payments over the first three quarters.

There is a solution you may wish to consider. Federal withholding taxes are treated as having been made equally throughout the year regardless of when the payment was made. Therefore if you withhold federal taxes from your IRA RMD at the end of the year, it will be considered paid evenly throughout the year. For those clients who are still employed, asking your employer to withhold more monies from payroll at the end of the year should also avoid any underpayment penalties. In the future, consider paying as much of your tax liability through withholding and it should help to reduce federal underpayment tax penalties.

Health Care Surtax 

Recently, the Supreme Court upheld President Obama’s Health Care Law. Although this law will have substantial impact on health care benefits for most Americans, we want to make you aware of one significant issue within this new law. Beginning in January, 2013, a new 3.8% Medicare surtax will be assessed on the lesser of: 

1. Net Investment Income, OR

2. The excess of Modified Adjusted Gross Income (MAGI) over the “threshold amount.”

“Net Investment Income” is broadly defined as the sum of gross investment income over allocable investment expense. Investment income includes Interest, Dividends, Capital gains,

Annuities, Rents, Royalties and Passive Activity Income. Investment income does not include Tax-exempt income, Active trade or business income, distributions from IRAs or qualified retirement plans and any self-employed income.

Adjusted gross income (AGI)

– Roth IRA conversions and/or rollovers
– Required minimum distributions
+ Traditional IRA contributions that were deducted
+ Student loan interest amounts that were deducted
+ Tuition and fees deducted

The income “Threshold Amounts” depend on the filing status of the taxpayer and are $250,000 for married filing joint filers, $125,000 for married filing separate filers, and $200,000 for all other filers.

The Medicare surtax of 3.8% is imposed on the lesser of net investment income or MAGI in excess of the Threshold Amount. 

Strategies to help reduce this new tax will be to invest in tax-exempt municipal bond investments, which at the current time are not considered net investment income for surtax purposes. Taxable interest should only be considered for investors with income under the threshold amount.

Minimizing capital gains will also be important for many high income investors. Seeking to invest in tax efficient investments and/or offsetting capital losses with capital gains should prove valuable in saving tax dollars.

Finally, investing the maximum allowable to your 401k plan and or qualified retirement plans will also help to reduce your MAGI and therefore help to reduce your tax liability.

Note: tax consequences for Estates and Trusts are different than listed above. Please contact our office if you wish to discuss those tax consequences. 

At future review meetings, we will discuss this new tax and its impact on your overall tax situation.

Estate tax changes 

While we know what the federal estate tax rules will be for 2012, what will happen in 2013 and beyond is still up in the air. Under current law the estate tax exemption is scheduled to drop significantly from $5,120,000 in 2012 to $1,000,000 in 2013, and the estate tax rate is scheduled to jump from 35% to 55%.

That change is the law at this time and will go into effect in 2013 unless we have Congressional approval for a change. As we come closer to the Presidential election, we do not expect to see any major changes in the estate tax law.

My best guess is nothing will be done until 2013 and then legislation should be made retroactive back to the beginning of the new year. We suggest you contact your estate planning attorney to see if any steps are necessary at this time.

Cambridge/Pershing brokerage statements 

You may note a new format on your Cambridge/Pershing brokerage statements. Recent IRS regulations require brokerage firms to report the tax cost basis on your statement. Our office has started to input the tax cost basis on your statement. If that data has not been entered, you will note the term “Please provide”. If we have the tax cost basis in our files, our office will enter that data on your behalf. If we do not have the tax cost basis, we will ask you to provide that information to our office to update your files.

You will also note the terms Covered and Noncovered on the statement. Securities acquired before 2011 are generally not subject to the new cost basis reporting rules under the Internal Revenue Code of 1986 and would therefore be considered “Noncovered.” All other securities would be “Covered” and must adhere to the new tax cost basis rules.

As always, we are here to provide any service or guidance necessary to help you answer questions or concerns or achieve your financial goals and objectives. Please do not hesitate to contact us if you have any changes in your financial situation or would like to discuss your personal financial situation.

Best Regards,

Peter K.