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Is Your Company’s 401(k) Plan as Good as It Could Be?

Two recent court rulings may make you want to double-check.

How often do retirement plan sponsors check up on 401(k)s? Not as often as they should, perhaps. Employers should be especially vigilant these days.

Every plan sponsor should know about two recent court rulings. One came from the Supreme Court in 2015; another, from the U.S. District Court for the Central District of California in 2017. Both concerned the same case: Tibble v. Edison International.

In Tibble v. Edison International, some beneficiaries of the Edison 401(k) Savings Plan took Edison International to court, seeking damages for losses and equitable relief. The plaintiffs contended that Edison International’s financial advisors and investment committee had breached their fiduciary duty to the plan participants. Twice, they argued, the plan sponsor had added higher-priced funds to the plan’s investment selection when near-identical, lower-priced equivalents were available.1

Siding with the plan participants, the SCOTUS ruled that under ERISA, a plaintiff may initiate a claim for violation of fiduciary duty by a plan sponsor within six years of the breach of an ongoing duty of prudence in investment selection.1

The unanimous SCOTUS decision on Tibble (expressed by Justice Stephen Breyer) stated that “cost-conscious management is fundamental to prudence in the investment function.” This degree of alertness should be applied “not only in making investments but in monitoring and reviewing investments. Implicit in a trustee’s [plan fiduciary’s] duties is a duty to be cost-conscious.”2,3

Two years later, the U.S. District Court ruled that Edison International had indeed committed a breach of fiduciary duty regarding the selection of all 17 mutual funds offered to participants in its retirement plan. It also stated that damages would be calculated “from 2011 to the present, based not on the statutory rate, but by the 401(k) plan’s overall returns” during those six years.3

The message from these rulings is clear: the investment committee created by a plan sponsor shoulders nearly as much responsibility for monitoring investments and fees as a third-party advisor. Most small businesses, however, are not prepared to benchmark processes and continuously look for and reject unacceptable investments.

Do you have high-quality investment choices in your plan? While larger plan sponsors may have more “pull” with plan providers, this does not relegate a small company sponsoring a 401(k) to a substandard investment selection. Sooner or later employees may begin to ask questions. “Why does this 401(k) have only one bond fund?” “Where are the target-date funds?” “I went to Morningstar, and some of these funds have so-so ratings.” Questions and comments like these may be reasonable and might surface when a plan’s roster of investments is too short.

Are your plan’s investment fees reasonable? Employees can deduce this without checking up on the Form 5500 you file – there are websites that offer some general information as to what is and what is not acceptable regarding the ideal administrative fees.

Are you using institutional share classes in your 401(k)? This was the key issue brought to light by the plan participants in Tibble v. Edison International. The U.S. District Court noted that while Edison International’s investment committee and third-party advisors placed 17 funds in its retirement plan, it “selected the retail shares instead of the institutional shares, or failed to switch to institutional share classes once one became available.”3

Institutional share classes commonly have lower fees than retail share classes. To some observers, the difference in fees may seem trivial – but the impact on retirement savings over time may be significant.3

When was the last time you reviewed your 401(k) fund selection & share class? Was it a few years ago? Has it been longer than that? Why not review this today? Call in a financial professional to help you review your plan’s investment offering and investment fees.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – faegrebd.com/en/insights/publications/2015/5/supreme-court-decides-tibble-v-edison-international [5/18/15]

2 – cpajournal.com/2017/09/13/erisas-reasonable-fee-requirement/ [9/13/17]

3 – tinyurl.com/yd8s2rq3 [8/17/17]

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Real Estate Investments Course Starts September 17, 2018 at UC Berkeley Extension, San Francisco Campus

The next Real Estate Investments for Financial Planners and Investors course starts Monday September 17th at the San Francisco UC Berkeley Extension campus. This class will serve as an important foundation for making buy, sell, and hold real estate investment decisions. The coursework includes

  • An introduction to real estate investment basics
  • The Real Estate Cash Flow model
  • Real estate ownership and finance
  • Case studies on real estate investment decisions, and how they have impacted personal financial goals

Click here to register. Or contact me if you have any questions, or if you would like a copy of the course outline.

Sincerely, Rich Arzaga, CFP®, CCIM, Instructor

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Menu of Services

CLICK HERE to check our Menu of Services

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Life Insurance Explained

A quick look at the different types of policies.

When it comes to life insurance, there are many choices. Whole life. Variable universal life. Term. What do these descriptions really mean?

All life insurance policies have two things in common. They guarantee to pay a death benefit to a designated beneficiary after a policyholder dies (although, the guarantee may be waived if the death is a suicide occurring within two years of the policy purchase). All require recurring payments (premiums) to keep the policy in force. Beyond those basics, the differences begin.1

Some life insurance coverage is permanent, some not. Permanent life insurance is designed to cover you for your entire life (not just a portion or “term” of it), and it can become an important element in your retirement planning. Whole life insurance is its most common form.2

Whole life policies accumulate cash value. How does that happen? An insurer directs some of your premium payments into a reserve account and puts those dollars into investments (typically conservative ones). The return on the investments influences the growth of the cash value, which builds up according to a formula the insurer sets.3

A whole life policy’s cash value grows with taxes deferred. After a while, you gain the ability to borrow against that cash value. You can even cancel the policy and receive a surrender value. Premiums on whole life policies, though, are usually higher than premiums on term life policies, and they may rise with time. Also, beneficiaries only receive a death benefit (not the policy’s cash value) when a whole life policyholder dies.2,4

Universal life insurance is whole life insurance with a key difference. Universal life policies also build cash value with taxes deferred, but there is the chance to eventually pay the monthly premiums out of the policy’s investment portion.5

Month by month, some of your premium on a universal life policy gets credited to the cash reserve of the policy. Sooner or later, you may elect to pay premiums out of the cash reserve – so, the policy essentially begins to “pay for itself.” If all goes well, a universal life policy may have a lower net cost than a whole life policy. If the investments chosen by the insurer severely underperform, that can mean a dilemma: the cash reserve of your policy may dwindle and be insufficient to keep paying the premiums. That could mean cancellation of the policy.5

What about variable life (and variable universal life) policies? Variable life policies are basically whole life or universal life policies with a riskier investment component. In VL and VUL policies, you may direct percentages of the cash reserve into investment sub-accounts managed by the insurer. Assets allocated to the sub-accounts may be put into equity investments of your choice as well as fixed-income investments. If you choose equity investments, you (and the insurer) assume greater risk in exchange for the possibility of greater reward. The performance of the subaccounts cannot be guaranteed. As an effect of this risk exposure, a VUL policy usually has a higher annual cost than a comparable UL policy.6

The performance of the stock market may heavily affect the performance of the subaccounts and the policy premiums. A bull market may mean better growth for the policy’s cash value and lower premiums. A bear market may mean reduced cash value and higher monthly payments to keep the policy going. In the worst-case scenario, the cash value plummets, the insurer hikes the premiums in order to provide the guaranteed death benefit, the premiums become too expensive to pay, and the policy lapses.6

Term life insurance is life insurance that you “rent” rather than own. It provides coverage for a set period (usually 10-30 years). Should you die within that period, your beneficiary will get a death benefit. Typically, the premium payments and death benefit on a term policy are fixed from the start, and the premiums are much lower than those of permanent life policies. When the term of coverage ends, you may be offered the option to renew the coverage for another term or to convert the policy to a form of permanent life insurance.2,7

Term life is cheap, but the tradeoff comes when the term is up. Just as you cannot build up home equity by renting, you cannot build up cash value by “renting” life insurance. When the term of coverage is over, you usually walk away with nothing for the premiums you have paid.7

Which coverage is right for you? Many factors may come into play when deciding which type of life insurance will suit your needs. The best thing to do is to speak with a qualified insurance professional who can help you examine these factors, so you can determine which type of coverage may be appropriate.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – thebalance.com/does-a-life-insurance-policy-cover-suicide-2645609 [6/5/18]
2 – fool.com/retirement/2017/07/20/term-vs-whole-life-insurance-which-is-best-for-y-2.aspx [7/20/17]
3 – investopedia.com/articles/personal-finance/082114/how-cash-value-builds-life-insurance-policy.asp [4/30/18]
4 – insure.com/life-insurance/cash-value.html [12/12/17]
5 – thebalance.com/what-you-need-to-know-about-universal-life-insurance-2645831 [5/8/18]
6 – insuranceandestates.com/top-10-pros-cons-variable-universal-life-insurance/ [9/1/17]
7 – consumerreports.org/life-insurance/how-to-choose-the-right-amount-of-life-insurance/ [3/30/18]

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Key Person Insurance

A way for businesses – especially niche businesses – to address a major risk. 

Who are the people most crucial to your business? Have you taken steps to insure them?

At every company, there are certain people whose absence would cause day-to-day operations to grind to a halt. If they die or become disabled, the future of the company may be jeopardized.

Key person insurance is designed to help businesses deal with this kind of major disruption. Its payout can offer some monetary relief so that operations can continue running smoothly.

Small & large businesses choose key person insurance for a variety of reasons. The insurance benefit can be used to settle outstanding loans, and to fund the recruitment and training of a new hire. Key person insurance benefits may also help in an ownership transition, and become a component in an executive compensation plan. If a key person dies, the business owner(s) may want to provide his or her spouse or family with the equivalent of their salary for a time.

How easy it is to arrange this type of insurance? In a word, very. As private insurance, it requires no IRS filings or disclosures. In the case of key person life insurance, both permanent life and term life options may be explored. Typically, term coverage is the choice.1,2

Key person disability insurance amounts to an insurance contract, whereby the policy provides coverage up to a certain age or a certain date – for example, the end of the period in which monthly cash benefits are paid to the disabled employee, or the retirement date of the employee.

The payout from a key person insurance policy is tax-free. As a tradeoff for that, the premium payments are not tax-deductible. Typically, the company owns the policy, pays the premiums and is listed as policy beneficiary.2,3

This is the kind of perk that can help you attract & keep good employees. The knowledge that a manager or executive can count on some financial support in the event of a health crisis, the understanding that his or her family could receive insurance benefits in the event of a tragedy – this may make a job offer that much more compelling.

Key person insurance can even be continued after the key employee retires or transfers his or her ownership interest – a nice addition to that person’s retirement package.

Key person insurance can also boost your standing as you seek financing. It can give your business added financial stability that might help its loan prospects and credit position. If you apply for a business loan, the question of whether you have key person insurance will come up quickly. If your company lacks key person coverage, the loan may not be forthcoming. If you intend to apply for a loan guaranteed through the Small Business Administration, key person insurance is often a prerequisite.4

Niche businesses arguably need this coverage the most. A software development firm, a biomedical company, any kind of business where the owner or employees must have “expert” knowledge of a discipline or an industry … these businesses may be most at risk if a key employee dies or is left disabled.

Does your company lack key person insurance? Too many businesses do. While insuring a company’s information, equipment and inventory against loss is par for the course, insuring a business against the loss of human and creative capital is not. A loss of knowledge and mastery can spell the end for a business that has transitioned from survival to success, and even for an established sole proprietorship or partnership. Look into this today, for you never know what tomorrow may hold.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – rbcinsurance.com/business/small-business/key-person-insurance.html [11/9/15]
2 – smallbusiness.com/manage/why-you-need-key-person-insurance/ [11/9/15]
3 – raymondjames.com/small_business_key.htm [11/9/15]
4 – sba.gov/offices/headquarters/oca/resources/4950 [11/9/15]

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Midyear Outlook 2018

The recently released LPL Research Midyear Outlook 2018: The Plot Thickens is filled with investment insights and market guidance to take us through the rest of the year. So far this year, the return of the business cycle has brought the fiscal policy changes that were expected to propel economic activity and the financial markets higher in 2018.

Policy remains a key theme to watch. Tax cuts, a more business-friendly regulatory environment, and increased government spending should support consumer spending, business investment, and corporate profits—key drivers of LPL Research’s economic and stock forecasts. The biggest risk to investor confidence this year has been around trade, including new tariffs. When comparing the fiscal measures with the potential impact of increased tariffs, however, the benefits appear to outweigh the costs. With these factors in mind, policy changes should have a positive influence on the economy and markets.

Another theme that may garner more attention this year is that certain economic and market indicators may have peaked, and that we may have seen the best out of this expansion. However, the context is critically important here. Reaching these points with a strong economic backdrop is expected and indicates the potential for continued growth; in addition, historically, we’ve seen an average of four more years of stock gains after triggering these market signals. So, although we are in the later stages of the economic cycle, it does not appear that a recession is looming.

Against this backdrop, LPL Research maintains the forecasts that were set forth at the beginning of 2018, following the passage of the new tax law. Expectations are for 3% gross domestic product growth for the U.S. economy, with tax cuts, government spending, and deregulation measures providing support. As expected, accelerating economic growth and rising interest rates continue to pressure bonds; thus, flat to low-single-digit returns are projected for bonds (as measured by the Bloomberg Barclays U.S. Aggregate Bond Index). However, it’s prudent to note that high-quality bonds may provide diversification benefits for investors’ portfolios.

Strong earnings are expected to remain the key driver of stock gains, thanks to the benefits of the new tax law. Given that we are in the later stages of this economic cycle, with factors such as increased trade tensions and geopolitical uncertainty at play, greater market volatility may be ahead. But it’s important to remember that experiencing these ups and downs is a normal aspect of our market environment. Also, within the context of steady economic growth and strong corporate profits, there is the potential for stock gains of 10% or more (as measured by the S&P 500 Index).

Overall, economic and market growth is expected to continue in 2018 and beyond, and the LPL Research Midyear Outlook 2018 is here to provide insightful commentary to help you navigate the year ahead. If you have any questions, I encourage you to contact me.

Important Information

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly. Economic forecasts set forth may not develop as predicted.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment-grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS, and CMBS (agency and non-agency).

Additional descriptions and disclosures are available in the Midyear Outlook 2018: The Plot Thickens publication.

This research material has been prepared by LPL Financial LLC.

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Choosing a Financial Professional

There’s nothing like doing your homework and being selective.

When we buy a car or a house, consider a school for our children, or plan our next vacation, what kind of approach do we take? For one thing, we take our time. We shop around and consider our choices.

Yet when it comes to selecting a financial consultant, not everyone takes such care. Chuck Jaffe, for many years a MarketWatch columnist, often spoke to audiences on this topic, and when doing so, he liked to conduct an informal poll. He started by asking people to raise their hand if they had ever worked with a financial advisor. Typically, many hands went up. Next, he asked them to keep their hands in the air if they hired the first financial advisor they met with in their search. Seldom did a hand lower. Then he asked them to keep their hands up if they did a background check on that person before agreeing to work together. Jaffe noted that when that third question was asked, “[I] never had a single hand stay in the air.”1

Credibility and compatibility both matter. When it comes to the “alphabet soup” of financial industry designations, some of them carry more clout than others. Some of the most respected professional designations are Certified Financial Planner™ (CFP®), Chartered Financial Consultant® (ChFC), and Chartered Financial Analyst® (CFA). These designations are earned only after thorough examinations and a required curriculum of college-level studies in financial planning applications, retirement, insurance and estate planning fundamentals, and other topics. Real-world experience complements this course of study.2

Beyond a financial professional’s credentials and designations, you have the matter of compatibility. You don’t want to work with someone who insists that you fit into a preconceived box, for you are not simply Investor A, Investor B, or Investor C who deserves this or that generic strategy. Better financial professionals really get to know you – and they will not be offended if you make the effort to get to know them.

This is a relationship-based business, and when a financial consultant offers a thoughtfully considered, personalized strategy to a client resulting from one or more discovery meetings, they have taken a step to earn the respect and trust of that client. Finer financial professionals abide by a client’s preferences and risk tolerance and take the client’s values, needs, and priorities into account.

How do you “check out” a financial professional? You can visit www.finra.org (the Financial Industry Regulatory Authority) and use FINRA BrokerCheck to see if anything questionable has occurred in their career. If that financial professional is an investment advisor, you can go to the Securities and Exchange Commission website and look at that advisor’s Form ADV at advisorinfo.sec.gov. Part 1 will tell you about any issues with clients or regulatory agencies; Part 2 will tell you about the advisor’s services, fees, and investment strategies.3,4

In addition, AARP offers you a Financial Adviser Questionnaire, and websites like ussearch.com and paladinregistry.com can provide you with further information.

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.
1 – marketwatch.com/story/7-mistakes-investors-make-in-hiring-advisers-2010-05-20 [5/20/10]
2 – csmonitor.com/Business/Saving-Money/2017/0205/A-simple-guide-to-the-many-financial-advisor-designations [2/5/18]
3 – brokercheck.finra.org/ [6/13/18]
4 – adviserinfo.sec.gov/ [6/13/18]

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How New Tax Laws Affect Small Businesses

A recap of the major changes impacting corporations and closely held firms.

The Tax Cuts & Jobs Act changed the tax picture for business owners. Whether your company is incorporated or held closely, you must recognize how the recent adjustments to the Internal Revenue Code can potentially affect you and your workers.

How have things changed for C corps? The top corporate tax rate has fallen. C corps now pay a flat 21% tax. For most C corps, this is a big win; for the smallest C corps, it may be a loss.1

If your C corp or LLC brings in $50,000 or less in 2018, you will receive no tax relief – your firm will pay a 21% corporate income tax as opposed to the 15% corporate income tax it would have in 2017. Under the old law, the corporate income tax rate was just 15% for the first $50,000 of taxable income.1,2

Another notable change impacting C corps involves taxation of repatriated income. Prior to 2018, American companies paid U.S. tax rates on earnings generated in foreign countries; those profits were, essentially, taxed twice. Now they are being taxed differently – there is a one-time repatriation rate of 15.5% on cash (and cash equivalents) and 8% rate on illiquid assets, and those taxes are payable over an 8-year period.2

By the way, the 20% corporate Alternative Minimum Tax (AMT) is no more. The tax reforms permanently abolished it.2

What changed for S corps, LLCs, partnerships, and sole proprietorships? They can now deduct 20% of the qualified business income they earn in a year. Cooperatives, trusts, and estates can do the same. This deduction applies through at least 2025.2,3

The fine print on this deduction begs consideration. If you are a lawyer, a physician, a consultant, or someone whose firm corresponds to the definition of a specified service business, then the deduction may be phased out depending on your taxable income. Currently, the phase-out begins above $157,500 for single filers and above $315,000 for joint filers. Above these two thresholds, the deduction for a business other than a specified service business is limited to half of the total wages paid or one quarter of the total wages paid plus 2.5% of the cost for that property, whichever is larger.2

Salaried workers who are thinking about joining the ranks of independent contractors to exploit this deduction may find it a wash: they will have to pay for their own health insurance and absorb an employer’s share of Social Security and Medicare taxes.2

What other major changes occurred? The business depreciation allowance has doubled and so has the Section 179 expensing limit. During 2018-22, the percentage for first-year “bonus depreciation” deductions is set at 100% with a 5-year limit and applies to both used and new equipment. The maximum Section 179 deduction allowance is now $1 million (limited to the amount of income from business activity) and the phase-out threshold begins $500,000 higher at $2.5 million. Also, a business can now carry forward net operating losses indefinitely, but they can only offset up to 80% of income.4

The first-year depreciation allowance for a car bought and used in a business role is now $10,000; it was $3,160. Claim first-year bonus depreciation, and the limit is $18,000. (Of course, the depreciation allowance for the vehicle is proportionate to the percentage of business use.) The TC&JA also created a new employer tax credit for paid family and medical leave in 2018-19, which can range from 12.5%-25%, depending on the amount paid during the leave.4,5

Some longtime business tax deductions are now absent. Manufacturers can no longer claim the Section 199 deduction for qualified domestic property activities. Business deductions for rail and bus passes, parking benefits, and commuter vehicles are gone. Deductions have also been repealed for entertainment costs linked directly to or associated with the conduct of business.4

Business owners should also know about the new restriction on 1031 exchanges. A like-kind exchange can now only be used for real estate, not personal property.3

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – thebalancesmb.com/corporate-tax-rates-and-tax-calculation-397647 [2/5/18]

2 – investopedia.com/taxes/how-gop-tax-bill-affects-you/ [2/14/18]

3 – americanagriculturist.com/farm-policy/10-agricultural-improvements-new-tax-reform-bill [12/27/17]

4 – cpapracticeadvisor.com/news/12388887/2018-tax-reform-law-has-benefits-for-some-small-businesses [1/2/18]

5 – marketwatch.com/story/use-your-car-for-your-small-business-the-new-tax-law-is-good-news-for-you-2018-03-06 [3/6/18]

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The Major 2018 Federal Tax Changes

Comparing the old rules with the new.

The Tax Cuts and Jobs Act made dramatic changes to federal tax law. It is worth reviewing some of these changes as 2019 approaches and households and businesses refine their income tax strategies.

Income tax brackets have changed. The old 10%, 15%, 25%, 28%, 33%, 35%, and 39.6% brackets have been restructured to 10%, 12%, 22%, 24%, 32%, 35%, and 37%. These new percentages are slated to apply through 2025. Here are the thresholds for these brackets in 2018.1,2

Bracket          Single Filers                      Married Filing Jointly            Married Filing                 Head of Household

                                                                    or Qualifying Widower        Separately                      

 

10%                $0 – $9,525                        $0 – $19,050                           $0 – $9,525                     $0 – $13,600

12%                $9,525 – $38,700              $19,050 – $77,400                 $9,525 – $38,700           $13,600 – $51,800

22%                $38,700 – $82,500           $77,400 – $165,000               $38,700 – $82,500         $51,800 – $82,500

24%                $82,500 – $157,500         $165,000 – $315,000             $82,500 – $157,500       $82,500 – $157,500

32%                $157,500 – $200,000       $315,000 – $400,000             $157,500 – $200,000    $157,000 – $200,000

35%                $200,000 – $500,000       $400,000 – $600,000             $200,000 – $300,000    $200,000 – $500,000

37%                $500,000 and up              $600,000 and up                    $300,000 and up            $500,000 and up

 

The standard deduction has nearly doubled. This compensates for the disappearance of the personal exemption, and it may reduce a taxpayer’s incentive to itemize. The new standard deductions, per filing status:

*Single filer: $12,000 (instead of $6,500)

*Married couples filing separately: $12,000 (instead of $6,500)

*Head of household: $18,000 (instead of $9,350)

*Married couples filing jointly & surviving spouses: $24,000 (instead of $13,000)

The additional standard deduction remains in place. Single filers who are blind, disabled, or aged 65 or older can claim an additional standard deduction of $1,600 this year. Married joint filers are allowed to claim additional standard deductions of $1,300 each for a total additional standard deduction of $2,600 for 2018.2,3

The state and local tax (SALT) deduction now has a $10,000 ceiling. If you live in a state that levies no income tax, or a state with high income tax, this is not a good development. You can now only deduct up to $10,000 of some combination of a) state and local property taxes or b) state and local income taxes or sales taxes per year. Taxes paid or accumulated as a result of business or trade activity are exempt from the $10,000 limit. Incidentally, the SALT deduction limit is just $5,000 for married taxpayers filing separately.1,4 

The estate tax exemption is twice what it was. Very few households will pay any death taxes during 2018-25. This year, the estate tax threshold is $11.2 million for individuals and $22.4 million for married couples; these amounts will be indexed for inflation. The top death tax rate stays at 40%.2,4

More taxpayers may find themselves exempt from Alternative Minimum Tax (AMT). The Alternative Minimum Tax was never intended to apply to the middle class – but because it went decades without inflation adjustments, it sometimes did. Thanks to the tax reforms, the AMT exemption amounts are now permanently subject to inflation indexing.

AMT exemption amounts have risen considerably in 2018:

*Single filer or head of household: $70,300 (was $54,300 in 2017)

*Married couples filing separately: $54,700 (was $42,250 in 2017)

*Married couples filing jointly & surviving spouses: $109,400 (was $84,500 in 2017)

These increases are certainly sizable, yet they pale in proportion to the increase in the phase-out thresholds. They are now at $500,000 for individuals and $1 million for joint filers as opposed to respective, prior thresholds of $120,700 and $160,900.2

The Child Tax Credit is now $2,000. This year, as much as $1,400 of it is refundable. Phase-out thresholds for the credit have risen substantially. They are now set at the following modified adjusted gross income (MAGI) levels:

*Single filer or head of household: $200,000 (was $75,000 in 2017)

*Married couples filing separately: $400,000 (was $110,000 in 2017)2

Some itemized deductions are history. The list of disappeared deductions is long and includes the following tax breaks:

*Home equity loan interest deduction

*Moving expenses deduction

*Casualty and theft losses deduction (for most taxpayers)

*Unreimbursed employee expenses deduction

*Subsidized employee parking and transit deduction

*Tax preparation fees deduction

*Investment fees and expenses deduction

*IRA trustee fees (if paid separately)

*Convenience fees for debit and credit card use for federal tax payments

*Home office deduction

*Unreimbursed travel and mileage deduction

Under the conditions set by the reforms, many of these deductions could be absent through 2025.5,6

Many small businesses have the ability to deduct 20% of their earnings. Some fine print accompanies this change. The basic benefit is that business owners whose firms are LLCs, partnerships, S corporations, or sole proprietorships can now deduct 20% of qualified business income*, promoting reduced tax liability. (Trusts, estates, and cooperatives are also eligible for the 20% pass-through deduction.)4,7

Not every pass-through business entity will qualify for this tax break in full, though. Doctors, lawyers, consultants, and owners of other types of professional services businesses meeting the definition of a specified service business* may make enough to enter the phase-out range for the deduction; it starts above $157,500 for single filers and above $315,000 for joint filers.  Above these business income thresholds, the deduction for a business other than a specified service business* is capped at 50% of total wages paid or at 25% of total wages paid, plus 2.5% of the cost of tangible depreciable property, whichever amount is larger.4,7

* See H.R. 1 – The Tax Cuts and Jobs Act, Part II—Deduction for Qualified Business Income of Pass-Thru Entities

We now have a 21% flat tax for corporations. Last year, the corporate tax rate was marginally structured with a maximum rate of 35%. While corporations with taxable income of $75,000 or less looked at no more than a 25% marginal rate, more profitable corporations faced a rate of at least 34%. The new 21% flat rate aligns U.S. corporate taxation with the corporate tax treatment in numerous other countries. Only corporations with annual profits of less than $50,000 will see their taxes go up this year, as their rate will move north from 15% to 21%.2,4

The Section 179 deduction and the bonus depreciation allowance have doubled. Business owners who want to deduct the whole cost of an asset in its first year of use will appreciate the new $1 million cap on the Section 179 deduction. In addition, the phaseout threshold rises by $500,000 this year to $2.5 million. The first-year “bonus depreciation deduction” is now set at 100% with a 5-year limit, so a company in 2018 can now write off 100% of qualified property costs through 2022 rather than through a longer period. Please note that bonus depreciation now applies for used equipment as well as new equipment.1,7

Like-kind exchanges are now restricted to real property. Before 2018, 1031 exchanges of capital equipment, patents, domain names, private income contracts, ships, planes, and other miscellaneous forms of personal property were permitted under the Internal Revenue Code. Now, only like-kind exchanges of real property are permitted.7

This may be the final year for the individual health insurance requirement. The Affordable Care Act instituted tax penalties for individual taxpayers who went without health coverage. As a condition of the 2018 tax reforms, no taxpayer will be penalized for a lack of health insurance next year. Adults who do not have qualifying health coverage will face an unchanged I.R.S. individual penalty of $695 this year.1,8

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – cpapracticeadvisor.com/news/12388205/2018-tax-reform-law-new-tax-brackets-credits-and-deductions [12/22/17]

2 – fool.com/taxes/2017/12/30/your-complete-guide-to-the-2018-tax-changes.aspx [12/30/17]

3 – cnbc.com/2017/12/22/the-gop-tax-overhaul-kept-this-1300-tax-break-for-seniors.html [12/26/17]

4 – investopedia.com/taxes/how-gop-tax-bill-affects-you/ [1/3/18]

5 – tinyurl.com/ycqrqwy7/ [12/26/17]

6 – forbes.com/sites/kellyphillipserb/2017/12/20/what-your-itemized-deductions-on-schedule-a-will-look-like-after-tax-reform/ [12/20/17]

7 – americanagriculturist.com/farm-policy/10-agricultural-improvements-new-tax-reform-bill [11/14/17]

8 – irs.gov/newsroom/in-2018-some-tax-benefits-increase-slightly-due-to-inflation-adjustments-others-unchanged [10/19/17]

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A Setback for the Fiduciary Rule

A Court of Appeals ruling could set the stage for a Supreme Court opinion.

The fiduciary rule is now a retirement planning standard – at least in 47 states. A recent appeals court ruling has dealt a blow to this new financial industry regulation, which has been applauded by investors and financial professionals alike.1

You probably have heard of this rule; if not, here is a brief explanation. The fiduciary rule is the recent directive from the Department of Labor requiring financial professionals who serve as retirement plan advisors to adopt a fiduciary standard. In other words, the advisor must regularly put the client’s interest first in the client-advisor relationship.1

In Louisiana, Mississippi, and Texas, the fiduciary rule has been struck down. The Fifth Circuit Court of Appeals decided 2-1 in March to vacate the fiduciary rule in those states. As of May 7, it will no longer apply within their borders. If the DoL appeals the court’s decision on or before that date, that means limbo.1,2

This ruling opened a legal door, and some financial industry analysts think that a Supreme Court ruling may be ahead.1,3

The 2-1 decision reflects the fact that the full court was not present, so the DoL could simply ask for a rehearing before the full court instead of an appeal. The DoL also has a legal plus on its side: no other court has reviewed the fiduciary rule and concluded that it amounts to the DoL overstepping its bounds under the Employee Retirement Income Security Act (ERISA).1,3

Many financial services companies and financial professionals are hoping for resolution soon, for they have already altered their business practices and compensation models to align with the fiduciary rule. Having made that commitment, they could lose face by turning legally away from it to any degree. They might keep upholding the fiduciary standard whether the rule stands or falls.1,2

If the fiduciary rule does fall, you can at least say that the industry rose to meet its standard. Whether the highest court in the land is called upon to determine the validity of the rule or not, whether the rule ends up standing or not, it definitely prompted a paradigm shift in the way retirement plan advisors and retirement planners thought about their roles – and that shift may be permanent.1

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note – investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Citations.

1 – thestreet.com/story/14527631/1/court-ruling-puts-fiduciary-rule-and-retirement-investors-in-limbo.html [3/20/18]

2 – tinyurl.com/ycgk3vmf [3/27/18]

3 – employeebenefitadviser.com/opinion/rip-fiduciary-rule-not-so-fast [3/6/18]