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Amat Victoria Curam

Financial Information for Senior Military Officers
Curtis (Curt) Sheldon is a fee-only financial planner and retired USAF Officer.  He offers financial planning for military professionals, specializing in transitioning senior military officers, and Government Employees.  He is the president and lead planner for C.L. Sheldon & Company. Curt is a CERTIFIED FINANCIAL PLANNER™ Practitioner.  Curt is also an Enrolled Agent admitted to practice and represent taxpayers in all fifty states at all levels within the Internal Revenue Service  His background in financial matters includes an undergraduate degree in Management/Finance and an MBA in Individual Financial Planning.

Expenses to Plan for Throughout Life

Expenses to Plan for Throughout Life

This post is written by guest blogger Jackie Waters

While it’s impossible to be mentally prepared for every curve ball life may throw, you can try to be as financially prepared as possible. Setting aside money for the surprises in life is crucial. Some major life events, such as retirement and having a baby, aren’t necessarily surprises, but still require you to save ahead. Planning and saving for both unexpected and expected events in life will help you stay financially sound.

 Retirement

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Have You Planned How You Will Spend Your Money?

Have You Planned How You Will Spend Your Money?
Financial Advisors, myself included, spend a lot of time thinking and talking about investing money to have available for your Golden Years (had to get a cliché in).  But, not a lot of time is spent talking about how to best spend that money in retirement.  I'm not talking about what you will spend that money on.  That is up to you.  What I am talking about is where the funds will come from.  If you have multiple sources of retirement income, you can improve your results about thinking about which money you will spend first.  This is due to a very important acronym...RMD.  Required Minimum Distributions can significantly impact your tax picture and how much you will pay for medical care in retirement.  Let me explain.

 

If you have tax deferred accounts such as TSP, 401(k)s and Traditional IRAs when you turn 70 1/2 you will have to start taking a minimum distributions based on your age (if you are still employed then you can defer RMDs from your current employers' plan).  If the balances in your accounts is large that could amount to a great deal of money.  This can have a few results. 
 
First it could push you into the next tax bracket and/or cause you to lose deductions and/or credits.  Not good.  Although not likely for many readers of this newsletter due to pension income, it could cause previously untaxed Social Security Benefits to become taxable (this could be an issue for your parents if they don't have a pension) 
 
It could also cause you to pay a higher premium for your Medicare Insurance (which by the way you have to pay if you want to keep Tricare coverage under Tricare for Life).  As of this writing, the first threshold for an increased Medicare premium is $170,000 for those taxpayers that file Married Filing Jointly.  This is a pretty high threshold but it gets lower quickly. 
 
Let's look at the case of a retired married O-6.
  • Retired Pay:  $80,000
  • Social Security: $30,000
  • Spouse Social Security: $15,000
  • Total "Income":  $125,000
  • Deferred accounts balance to put you over $170,000: $1.23M ($45,000 x 27.4)

 

As of right now, as a result of ObamaCare, the $170,000 threshold is not inflation adjusted until 2017.  We'll see if that is extended beyond 2017.

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You've Made it When...

You've Made it When...
...The boss calls you in to talk about a "non-qualified" plan. 
 
A non-qualified plan is one that doesn't meet the Department of Labor's rules for employee benefit plans and normally they are set-up for key members of a company.  So, if your boss is talking about a non-qualified plan, you're doing all right.  The down side is that non-qualified plans are tricky and you can significantly change your tax bill by the decisions you make. 

For today, we'll talk about Restricted Stock Plans, one type of non-qualified plans.  Under a Restricted Stock Plan an employee (normally highly compensated or key personnel) is granted shares of stock (normally company stock) for free or a reduced price.  In line with the name, the stock is restricted.  Normally, the restriction is based on an amount of time passing or serving as employee for a certain amount of time (or both) and you won't be able to sell the stock until the restriction is lifted.  At the time of grant (when you buy or receive the stock) there are no tax implications.  This is because you have a substantial risk of forfeiture of the benefit as you get nothing if you don't meet the requirement to lift the restriction.  But there could be tax implications when the restriction ends.  Unless...

Let's start with the general rule.  Under the general rule when the restriction ends (the stock vests), you will be taxed on the difference between what you paid for the stock and the fair market value on that date.  Under the general rule the income is ordinary income and taxed at your marginal tax rate.  In other words, if the stock goes up in value, you will be paying taxes on capital gains at your marginal rate...not a good deal for you.  It is also important to note that you're not receiving any "real" income when this happens only a right.  You'll have to pay that tax with "real" money.

Section 83(b). Under Section 83(b) of the Tax Code you have the option to pay some taxes now to save taxes in the future.  If you select to exercise the Section 83(b) election you will pay taxes on the discount (the difference between the price and current fair market value) when you are granted the restricted stock.  In some cases there may not be a discount element (often the case in start-ups) when you are granted the stock.  This income is taxed at your marginal tax rate.  If the 83(b) election is taken, then there is no tax implications when the restriction is lifted and taxes will only be due when the previously restricted stock is sold.  And all the gains will be taxed as capital gains and almost certainly the capital gains tax rate will be lower than your marginal tax rate.

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Did You Get an Unexpected Tax Refund?

Did You Get an Unexpected Tax Refund?
Often Military Senior Leaders get surprised when they file their tax return the year they retire (or a year they change jobs) and they get a refund.  Why?  Some of you who have heard me speak at an ETAP are really scratching your heads because I told you your taxes were going to go WAY up.  The reason may be your Social Security.  Let's review...

You pay Social Security Taxes (6.2%) on your first $118,500 of income.  If you earn more than $118,500 you don't pay taxes on the excess.  As a reminder, you don't pay Social Security Taxes on Military Retirement Income either.  Like your 401(k) limits, which I talked about last previously, your employer doesn't know how much money you made in the military in the year you retire.  The same holds true if you're changing civilian jobs.  That means, that if you earn more than $118,500 in total but from separate jobs you will have too much Social Security tax withheld.

The number can be significant.  Let's say you earned $90,000 in military pay and then move to a job that pays you $100,000 for the remainder of the year (you start work while you're on terminal leave).  Your total wages for the year are $190,000 and since neither employer paid you more than $118,500 you will have paid too much in Social Security Taxes.  How much?  In this case it would be $4,433.  This excess tax should be reported on Line 71 of your Form 1040.  It will be credited against your income tax owed and if you withheld a sufficient amount to cover your income tax you'll get the money refunded.

So, what is the problem?  I can see two...

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Don't Leave Money on the Table (And Don't Get Double Taxed Either).

Don't Leave Money on the Table (And Don't Get Double Taxed Either).
You've decided to "Hang-up" your G-Suit or ABUs or whatever uniform you wear to work each day.  You're pretty confident you'll roll into the new job you've been looking forward to and it won't take too much time.  If your new job offers a 401(k) (or 403(b) or TSP) there are some things you need to think about AND you need to make sure you don't screw up some other things.  By the way, these concepts also apply if you change civilian jobs during a year.
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Don't Lose Your TRICARE Coverage

TRICARE is pretty good health insurance and it is a benefit we would all like to keep.  But...you could lose it if you don't pay attention.  Right now, most of you are covered by Active Duty/Retiree TRICARE.  But when you turn 65, you'll switch to TRICARE For Life (TFL) whether you want to or not.
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Movin' Back Into Your Rental? Hold on There Partner!

Movin' Back Into Your Rental?  Hold on There Partner!
I think most home owners are aware of the 2 out of 5 rule when it comes to selling your primary residence.  For those who aren't, the rule basically states that if you lived in your house for 2 of the last 5 years (there is an extension for active duty military) you can exclude $500,000/$250,000 (Married/Single) of Capital Gains from your income.  That means no taxes. 

When you look at that you might get the idea that you can move back into your rental house for two years and sell it and not pay taxes.  You'd be wrong on two accounts. 

First of all, you have to pay taxes on any "depreciation recapture" (not the topic of today's article).  You also have to pay taxes on gains attributed to "nonqualified use".

So, what is nonqualified use?  Here is what the IRS says:

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DFAS Announces 2015 Tax Form Delivery Dates

DFAS has announced when Tax Forms will be available at MyPay.  Some are available already...

 

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TRICARE Young Adult (TYA) Premiums to Increase...A Lot

TRICARE Young Adult, the insurance coverage for prior dependents of Military Members under age 26, will become significantly more expensive starting on January 1, 2016.

Premiums for the Prime version of TYA will increase 47% from $208 per month to $306 per month.

Standard version of TYA will increase 25% from $181 per month to $228 per month.

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Your Life Expectancy After You're Dead? Yes, the IRS Says You Have One.

Your Life Expectancy After You're Dead? Yes, the IRS Says You Have One.
One of the great advantages of Qualified Plans and Traditional IRAs is that you get to deduct your contributions today and the earnings on your account accrue tax deferred.  But, the IRS wants to get that tax money...and the sooner the better.  You must take Required Minimum Distributions (RMDs) by your Required Beginning Date (RBD).  (By the way, I like this article...I've already worked in two acronyms in the first paragraph!)  For most, the RBD is 1 April of the year after you turn 70 1/2.  Most of us know that.  But most of us don't know how much we have to take out.  The amount you have to take out is based upon your life expectancy.  But you say, "I don't know how long I'll live!"  Not to worry, the IRS knows how long you will live.  They know everything...

Your Own IRA

In most cases, calculating RMDs for your IRA is relatively simple.  The IRS has a uniform life expectancy tables that will tell you how long you will live.  For example, at age 70 the life expectancy of an IRA owner is 27.4 years.  What is interesting is that if your spouse is more than 10 years younger than you, your life expectancy increases (I'll leave that to the IRS to explain).  For example, if you're aged 70 and your spouse is age 50 your life expectancy is 35.1 years.    Once you determine your life expectancy you simply divide your account balance on 31 Dec of the prior year by your life expectancy to determine your RMD.

On a related note, according to the IRS if you make it to 115 you may never die as the life expectancy for those age 115 and older is 1.9 year.  So, at each birthday after age 115 you've still got 1.9 years to live.  Again, I'll leave it to the IRS to explain.

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What You Don't Know About TSP RMDs Could Hurt You

What You Don't Know About TSP RMDs Could Hurt You
One of the main reasons to contribute to TSP is so that you can take the money out and spend it in retirement.  Often though, retirees may not need or want to take their money out of the Thrift Savings Plan (TSP).  But, the IRS wants you to take the money out, more than you want to leave it in TSP and they have the power to make you do it.  You have to take out Required Minimum Distributions (RMDs)

The IRS (Congress more accurately) says that you must start taking distributions from your TSP by April 1st (not the 15th) of the year after you turn 70 1/2.  If you're still employed by the US Government when you turn 70 1/2 then your RMDs are deferred....generally until Apr 1st of the year after retirement.  Realize that if you avail yourself of the 1 Apr option you will have to make two RMDs that year.  One for the age 70 1/2 year and one for the current year. 

Since the IRS "knows all" it knows how long you will live.  There is a table of Uniform Life Expectancy" that you use to determine how much you must take out each year.  It is important that you get this right, as the penalty for withdrawing too little is 50% of the amount you didn't take out.  That is one of the highest penalties I know of.

Whether you are taking RMDs or any other type of distribution, your distribution will be "proportional".  For example, if you have 50% in the Roth TSP, 50% in the "normal" TSP and 5% of your "normal" TSP balance is tax exempt (from contributions made in a combat zone) your distribution will be 50% Roth, 45% normal and 5% Tax Exempt.  The same holds true for funds.  If you have 50% in the G Fund and 50% in the C Fund your distribution will be 50/50 G and C Fund.  Nothing too out of the ordinary here.  Where things do get weird is if you fail to direct TSP to take out distributions.

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The Strickland Decision: Part III

The Strickland Decision: Part III

I've written about the Strickland Decision here before. If you missed those articles, you can read them here and here. But, what I haven't talked about is how the IRS statute of limitations rules affect your ability to claim refunds on the taxes that you paid that shouldn't have been paid under Strickland. That's the objective for today. Let's start with a review though...

The Strickland Decision

The Strickland Decision and Internal Revenue Ruling 78-161 give a retired service member the ability/right to adjust military retirement income reported on Form 1099-R. Significant tax benefits will only apply to those who are rated less than 50% disabled or those who receive Combat Related Special Compensation (CRSC). For those rated 50% or more disabled and receiving Concurrent Retirement and Disability Payments (CRDP) the tax benefit is minimal or non-existent due to the phase in of CRDP over the last 7 years.

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TSP and Your Estate

TSP and Your Estate

Have you thought about (or researched) what will happen to your Thrift Savings Plan (TSP) when you're no longer around? I know...you're invincible. No reason to worry about that.

 

Well, while I'm a pretty big fan of TSP I'm not all that "jazzed" with the estate planning ramifications associated with holding TSP for the entirety of your life. You may want to put just a little bit of brain-power on the question of what happens to your TSP account when it's not yours anymore. Here is a primer on what will happen if you don't do anything.

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Liquidity Risk...Do You Consider It When Making Investment Decisions?

Liquidity Risk...Do You Consider It When Making Investment Decisions?

I read an email the other day from an acquaintance.  He had some stock in a closely held corporation and was trying to sell it to "pursue other opportunities".  A month or so later, I received another email from him about the stock.  It was now "on sale" with greater discounts for buying larger lots.  Made me think...this individual didn't think about liquidity risk when he purchased the stock.

Just what is liquidity risk?  My CFP® textbook defines liquidity risk as follows:

The degree of uncertainty associated with the time it takes to sell an investment with a minimum of capital loss from the current market price.

In other words, "Will you be able to sell your investment quickly and at full price?"

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Deduct Future Charitable Contributions Now...

Deduct Future Charitable Contributions Now...

Are you sitting on large capital gains from assets you purchased years ago?  Do you normally support charities?  Would you like to reduce your taxes now?  A Donor Advised Fund (DAF), may allow you to solve your capital gains problem, contribute to charity and take charitable deductions while your income is high.  So...what am I talking about?

A DAF is a 503(b) charity normally administered by a brokerage or mutual fund company.  Contributions to a DAF are immediately deductible on your taxes, but the DAF can pay out the assets to charity in the future.  The individual who contributes to the DAF controls (with some limitations) who the DAF pays the assets to and how much is paid each year.  This combination of immediate deduction and delayed payout offers you several options to control your tax bill.

 

Here is how it works.  Let's assume the following:
  1. You have a position in a mutual fund that you've held for more than a year.
  2. You don't want to pay taxes on the large capital gains that you've accumulated
  3. You routinely give to charity and you plan on doing it for the rest of your life or at least for the "long-term"
  4. You are in your high-earning years and you're in the 28% or higher tax bracket and you expect in retirement your tax rate will be lower and you might not even itemize.

Here is what you do:

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Delay, Deny, Deflect...

Delay, Deny, Deflect...
O.k.  This article is only going to talk about delaying...taxes and in a pretty specific case.  If you own a rental property, you've enjoyed some pretty good tax benefits.  For instance, you've been able to write off interest, repairs and any management fees.  But perhaps the best deal is the ability to write off depreciation....you get to take a deduction without spending any money.  Yup.  It's great.  Right up to the point when you sell the house.  Then the IRS says, "Since the house is actually worth more than what you told us (via depreciation) we want that deduction back."  And while you can't eliminate that tax bill, you can delay it.  If you're willing to buy another rental property you can delay the tax bill through what is called a 1031 exchange.  In a 1031 exchange you "exchange" your property for a like-kind property and any taxes are deferred.  But like anything with the IRS, there are pretty specific rules.
 
  1. First, the exchange must be "like-kind". In real estate transactions you have some latitude.  Basically, as long as the new real estate is similar it is considered a like-kind.  As an example, a rental house to apartment building would be like-kind.
  2. Second.  You can't put your hands on the money.  The proceeds of the sale of your rental house must go to a Qualified Intermediary (QI) and in fact, the QI must be listed on the closing documents.
  3. Next, you must identify up to 3 replacement properties within 45 days of closing on the sale of your current rental property.
  4. Finally, you must close on the new rental property (from one of the 3 above) within 180 days of closing on the sale of your current rental property.

Goof any of these up and the sale is fully taxable.  And, no, the IRS isn't likely to give you a "mulligan".

 

There are a couple of other things too.

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Gifting. Do You Know the Rules?

Gifting. Do You Know the Rules?

Gifts seem to be confusing to a lot of people.  Are gift taxes due?  How much can I give? To whom can I give?  Anything with gifting and estate planning is complicated and I advise getting professional advice.  But, with that said, here are some basic rules/concepts.

 

Annual Gift Tax Exclusion. All American taxpayers have the ability to give up to $14,000 (in 2015) to anyone with zero gift tax implications.  A married couple can each give $14,000 for a total of $28,000.

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Some Resolutions

Some Resolutions

I tried...I really did.  No resolution article...but I just can't help myself.  I know I'm not the first one to give you some financial resolutions for the year, but here are some that have big "pay-back" for relatively little effort (and in some cases you don't have to do it more than once): 

  1. Stop supporting your free-loading Uncle.  Will you get a tax refund this year?  How much interest is your deadbeat Uncle (Sam) going to pay you for that loan?  Adjust your withholding to get back a small amount, or even better, owe less than $500 (make him loan money to you).
  2. Figure out and document your digital accounts.  How many bills do you pay electronically/automatically?  How would someone handle your accounts if you couldn't?  Provide instructions (secured) for someone to handle your digital accounts.
  3.  Check your estate documents.  Figure out how old they are.  If you drafted your documents more than about 5 years ago, there almost certainly changes to the law that affect documents such as your health-care proxy and tax calculations in regards to your estate tax plan.
  4.  Check your insurance policies.  How much is your car worth?  How much would your insurance policy actually pay to replace that old "clunker".  What about your deductibles?  Are you paying for a low deductible when you could afford to pay a higher deductible and reduce you annual premiums?  Do you have an umbrella policy?  Should you?  What is one?
  5. Update your employer plan contributions. You can contribute up to $18,000 to your 401(k)/TSP this year.  Did you increase your contributions?  And don't forget if you turn 50 this year (it doesn't hurt that much) you can contribute an additional $6,000 to your 401(k)/TSP.

None of them are that hard and if you do at least 3 of them, your financial life will be in a lot better shape.

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Your Charitable Deductions are in Order...Right?

Your Charitable Deductions are in Order...Right?

December blog posts (mine included) often talk about making Charitable Contributions to reduce your tax bill.  And, in fact, they do.  But...if you don't cross all the T's and dot all the I's you could lose your deductions or take deductions you aren't authorized.  Here are some things to watch for... 

  1.  If you make a cash contribution of $250 or more to a single charity you must receive a written acknowledgement from the charity.  The acknowledgement must be contemporaneous which in this case means you must receive it before you file your taxes.  The acknowledgement must include:
    1.  The amount of the contribution
    2. The fact that no goods or services were received in exchange for the contribution (or if goods or services were received then the amount must be listed and the charitable deduction must be reduced by the amount of the goods or services).
  2. Are you getting ready to deduct those raffle tickets you bought (you never win...do you)?  Sorry...the IRS specifically states that taxpayers who buy raffle tickets from a charity receive full consideration for their payments, and no deduction is allowed.  This position has been upheld in court so sorry no deduction for the raffle tickets.
  3.  If you're planning on deducting fees to participate in fundraising events be very careful.  Depending on how admission is calculated and stated you may get a partial deduction or no deduction at all.  The rules are pretty complicated but if you pay an entrance or admission fee that is equivalent to the price paid when the event is not a charitable event then no deduction.  If on the other hand, a stated "price" and charitable amount is listed then you may be able to deduct the charitable amount.  Again, this one is pretty tricky you might want to get professional advice.
  4.  How about deducting the services you contribute to charity?  If you mow the lawn at your Church every week you should be able to deduct the amount the Church would have paid to have the work done, right?  No, you can't.  You cannot deduct services as a charitable contribution. You can however deduct supplies so you could certainly deduct the money you spend on gas for your lawn mower.

On the surface, charitable contributions seem pretty simple.  Contribute to Charity...Deduct.  Not too complicated.  But, in reality like everything involving the Tax Code the details can be very confusing (and expensive).

 

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New Option for Parents of Special Needs Children

New Option for Parents of Special Needs Children

There were a lot of things in the "Cromnibus" budget law with which people took issue.  One thing that shouldn't be objectionable is the establishment of 529A plans.  The purpose of the 529A is to allow parents and others to accumulate assets for special needs children and subsequently use those assets without paying taxes (assuming qualified use).

529A plans will become "legal" in 2015 although you may not be able to get one next year.  The IRS has around 6 months to establish the rules to govern the accounts.  After that, the states will have to set up the plans...you will only be able to establish accounts through the state where you are a resident.  But, once they are established the plans should be a nice benefit for parents of special needs children.

Traditionally, if you wanted to accumulate assets for the future use of a special needs child you probably would need a trust.  Trusts were needed to make sure the funds did not disqualify the child for state benefits.  The 529A plan will accomplish the same thing...Assets available for the special needs child and the ability to qualify for state aid.  The 529A plan will also eliminate some of the "nasty" things that come with a trust.  The first is expense.  Trusts can be expensive to administer especially if a professional trustee is needed.  Trusts also need to pay taxes if they don't pay out all their income.  It appears that a 529A plan won't have this issue.  Finally, a gift to a trust is not eligible for the annual gift tax exclusion (currently $14,000) as the gift is not a gift of a present interest.  "Normal" 529 plans are not subject to this limitation so I assume that will be the case for 529A plans as well...we'll see.

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Refinancing Your House? Beware this Tax "Trap"

Refinancing Your House?  Beware this Tax "Trap"

This is a great time to refinance a house (if you haven't already done so).  Interest rates are at historic lows and you can lock in an interest rate for 30 years if you so desire.  But...if you plan on pulling out some equity to pay down credit cards or buy a car or do whatever you want, beware the IRS rules.

The bottom line is you can't continually take equity out of your house and deduct the mortgage interest.  The IRS (actually Congress) only allows you to deduct interest on the first $100,000 of home equity debt.  So, if you have $200,000 in home equity debt, you'll only get to deduct half your interest.

I can hear some of you already.  "I'm not taking a home equity line, I'm refinancing my mortgage.  This doesn't apply."  Sorry.  It does.  The IRS rules state that if you refinance a mortgage any amount over the loan balance when you refinance is home equity debt.  So, if you owe $100,000 on your house and refinance into a $300,000 mortgage and pull out $200,000 in equity, you'll only be able to deduct half your interest.

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Roth TSP? Action May Be Required

Roth TSP?  Action May Be Required

If you are active duty military and contribute to Roth TSP, you might have some homework to get done soon.  If you make "dollar-amount" (as opposed to a percentage of pay) contributions to Roth TSP you're the one with homework.

If you don't change your contribution instructions your Roth TSP contributions will stop on 31 Jan 15. 

A change to DFAS that goes into effect on 1 Jan 15 will require that you change your contributions to a percentage of pay.  No Roth contributions will be made until the change is made...So, on 31 Jan the contributions stop.

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You're Vested...But Will You Get Your Matching Contributions?

You're Vested...But Will You Get Your Matching Contributions?

You've been with your company for a while.  In fact you are fully vested under the 401(k) plan.  You're thinking it might be time to think about going somewhere else or maybe hanging up your spurs.  Will you get your matching funds?

I know, some of you are indignantly stating, "Of course I will.  I'm vested."  That is a true statement...mostly.  You'll get the matching contributions from last year and earlier.  But, what about this year?

Depending on when your employer actually puts the matching funds into your 401(k) the answer might be "Not yet."

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401(k) Rollover Rule 2.75693

401(k) Rollover Rule 2.75693

O.K...the rule isn't really called 2.75693, but in a recent IRS Notice 2014-54 (trust me...you don't really want to read it) the IRS clarified the treatment of and perhaps even incentivized certain 401(k) contributions.

Some of you may be offered the option of contributing after-tax dollars to your 401(k) plan or 403(b) plan up to the annual Defined Contribution Limit of $52,000 (2014).  This is not a Roth Contribution but is more like a Non-Deductible IRA contribution.  So you could contribute $23,000 (if age 50 or older) in deductible dollars to your 401(k) and then IF your employer allows, make another $29,000 non-deductible contribution to the 401(k).  Why would you want to do this?

 

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Are You Focusing on the Right Thing? Returns Might Not Be the Most Important Part of Your Plan

b2ap3_thumbnail_Piggy-Bank_20141006-203132_1.jpgWhen I talk during one of my Financial Planning Presentations or to one of my clients about investments, before too long the topic of returns always comes up.  But, returns might not be the most important thing in regards to the success of your plan.  Now, don't get me wrong, returns do matter but if you are nearing retirement they become a little less important.

Over time, returns become very important as the difference increases geometrically.  In other words, as time passes the difference in the two portfolios grows.  But the converse is also true.  In the short-term differences in returns matter less.  To illustrate, take a look at this chart.  The chart illustrates two portfolios.  The first portfolio (blue line) represents $1,000 invested at 7%.  The second portfolio (orange line) represents $1,000 invested at 10%.  The time-frame is 10 years.  After 10 years the higher yielding portfolio is worth 28% more than the lower yielding portfolio.

b2ap3_thumbnail_Portfolio-Return-Difference.jpg

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Should You Pay Off Your Mortgage? 5 Things to Consider

Should You Pay Off Your Mortgage? 5 Things to Consider

"Should I pay off my mortgage early?" I get that question a lot either personally or through some of the financial sites I work for.  The answer, like most things is "It Depends."   Consider the following when you make your decision...

  1. Money is cheap right now (2014).  30 year mortgages are sitting right around 4% - 4.5%, depending on your location and situation.  While I can't predict the future, I suspect we'll see inflation rates in that range within the lifetime of most mortgages originated within the last couple of years.  If the inflation rate exceeds your mortgage rate, you're "making money".
  2. Liquidity matters.  If you sink all your money into your house, you'll be in a tough spot if you need income or have to pay for a big expense.  Once you're retired, qualifying for a mortgage or home equity line of credit will be more challenging than it is prior to retirement.
  3. There is a reason why there are so many reverse mortgage advertisements on TV.  Seniors find themselves in a situation where they need money and they can't qualify for a mortgage/HELOC (see #2 above).  They turn to a reverse mortgage.  While a reverse mortgage can fill a need and is a better option than many things, they are expensive.
  4. You'll still have "payments".  There is an old saying, "You never own your home, you just rent it from the Government."  You'll still have to pay for property taxes and insurance and those can add up.
  5.  You may have more net worth if you invest your money instead of paying off the mortgage early.  It will depend on your risk tolerance and the specifics of your mortgage.  The answer to this question can be calculated.

Mortgage evaluation should be offered as part of a Comprehensive Financial Plan.  It is something that we routinely do for our clients.

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SBP and Your Long-Term Care Insurance...It Really Does Have an Impact

Granted...probably no surprise there, but I found out something today that further convinces me that the standard GI issue family should think long and hard before turning down the Survivor Benefit Plan (SBP).

 

I was trying to place Long-Term Care Insurance (LTCI) for someone.  I received quotes from the Federal LTCI program and talked to my trusty LTCI specialist.  The commercial market couldn't match what the Federal LTCI program could provide.  Comparing comparable benefits the least expensive commercial product was nearly $1,200 (43%) per year more.  The most expensive policy was nearly $2,000 (73%) per year more expensive.  Why?

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Inheritance and Estate Taxes...Do You Know the Difference?

Inheritance and Estate Taxes...Do You Know the Difference?

Maybe it is my age or the age of people I talk to, but I'm getting a lot of questions about "transfer taxes".  I'm getting questions from both those who are getting ready to transfer assets and those who are getting ready to receive assets.  In general, there are three potential transfer taxes.  They are:

  1. Estate Taxes
  2. Inheritance Taxes
  3. Gift Taxes

Estate Taxes

Estate taxes are paid by the estate and are paid regardless of who receives the funds (with the notable exception of spouses). 

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Employer Stock in Your 401(k)? Check This Out

Employer Stock in Your 401(k)?  Check This Out

Do you have employer stock in your 401(k) (or other qualified plan)?  Did you know that you are eligible for special tax treatment concerning that stock?  You are.  Employer stock is eligible for what is called Net Unrealized Appreciation (NUA).  NUA is a little complicated, but understanding it can significantly affect your tax bill...normally in a good direction.

Here is how it works...

  • When you leave the company you have the option of taking a distribution of the employer's stock without selling it.  In other words, you get the stock certificates (well, you would if anyone received stock certificates anymore).
  • You will owe taxes (taxed as ordinary income) on the basis of the distributed stock, not the fair market value.  As a reminder, the basis is what you paid for the stock.  Also, remember, if you withdraw the money before 59 1/2 you will owe penalties as well (under most circumstances)
  • When you sell the stock, the difference between the selling price and the basis will be taxed as a capital gain and the capital gain will be considered long term.
  • As of this writing, long-term capital gains are taxed at 0%, 15% or 20% (plus ObamaCare Surtaxes if applicable).  Those tax rates will be lower for the taxpayer than if the gain were taxed as ordinary income.

Now, like always, there is at least one way you can mess up and here is the big one.

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You might need a QTIP (Psst...It's not for your ears)

Dob2ap3_thumbnail_Last-Will.jpg you need a QTIP?  Do you have one?  What is one?  O.K.  A QTIP is a Qualified Terminal Interest Property (QTIP) Trust.  A QTIP is a relatively common estate planning tool and may be appropriate for some retired Senior Military Officers.  What makes a QTIP useful are its characteristics.

  1. A QTIP can allow you to take full advantage of your Estate Tax Exemption
  2. A QTIP can allow you to provide for your surviving spouse
  3. After your spouse's death, a QTIP ensures that your remaining assets flow to who you designated prior to your death

A QTIP can be established either by the instructions in your Will or through your Living (revocable) Trust documents.  The establishing documents will state that some or all of your assets will flow to the QTIP trust (remember, your Will or Trust don't over-ride the beneficiary designations on your retirement accounts or insurance policies).

Once funded the trust document can direct how the surviving spouse will be supported.  A relatively common arrangement is for the QTIP to pay all income (interest, dividends, etc) to the surviving spouse or spouse's trust.  Additionally, the trust document can direct that the trustee (normally not the spouse) has the discretion to spend trust assets, called corpus, for the spouse's Health, Education, Maintenance and Support (called HEMS).  There can be specifications on when the trustee can pay for HEMS.

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Here is One I Bet You've Never Heard Of: Filial Responsibility

Elderly Woman (Happy)A pretty standard "laugh line" in Sitcoms goes something like this, "Be quiet Dad or I'll put you in a home".  Junior might want to think twice about acting on that threat, especially if he lives about 1/2 of the States in the United States.  That is because in these States there are laws on the books that can make Junior responsible for Unpaid Long-Term Care Expenses or for "undeserved" MEDICAID payments.  This is because these states have Filial Support Laws.

Filial Support Laws, in their different forms, require that a child (and even in some cases a grandchild) provide support for his/her parents.  In some states, it can even be a crime not to do so.  These Laws can come into effect in a couple of different situations.

  1. The parent's income is too high to qualify for MEDICAID, but the income is not sufficient to cover Long-Term Care expenses.  Over time, the underpayment becomes large enough that the Long-Term Care facility decides to file suite against the child for payment
  2. Whether by mistake or on purpose the parent doesn't declare all assets (like Cash Value of Life Insurance) when filing for MEDICAID.  The State later finds out and sues the child for the amount the State paid for Long-Term Care.
  3. The parent is indigent and sues the child for support (it has happened)

Most the laws require that the parent spends down assets and truly be unable to pay the bills (in the first case) prior to the child being sued.  In the second case, the Omnibus Budget Act of 1993 has rules that "compel agencies to collect back funds they've expended on MEDICAID services from families if they discover the families have assets available."  From what I understand, this generally only applies to assets that the parents possessed and they transferred ownership to the children...but I'm not guaranteeing that.

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Understanding Your Investment Options: REITs

Understanding Your Investment Options: REITs

One of the asset classes you might want to consider in your overall asset allocation is Real Estate.  One of the ways you can access Real Estate in your portfolio is through Real Estate Investment Trusts also called REITs (pronounced like beets).

What are REITs?

REITs, like many other investment options are a basket.  In the case of REITs the basket holds real estate and normally it holds commercial real estate.  REITs can also hold mortgages.  The REITs then collect income in the form of rent and capital gains if the property appreciates or in the case of REITs that hold mortgages the income will include interest payments.

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Inherit the Family Home? What are the Tax Consequences?

House2A lot of the readers of this blog, including Senior Military Officers, often need to deal with the tax and financial consequences of inheriting the Family Home.  If Mom and Dad have owned this home for a long time, there is going to be a big capital gain (and big tax bill), right?  Probably not.  Here is one of few times where the IRS tax rules (technically the rules start with the laws the Congress writes) are actually in your favor.

Income taxes will be due on the amount that the sale price exceeds the basis in the property.  So what is the basis in the property?  Normally, the basis "steps-up" to the fair market value (FMV) of the property on the date of death (this is true of all assets including securities).  There are certain circumstances where the executor of the estate can elect to set the basis of the property based on the FMV of the property 9 months after death.  This is normally accomplished when Estate Tax is a concern.

Here's an example...

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GPO Is Not a Really Fast Car

Social SecurityHave you heard of the Government Pension Offset (GPO)?  If you have worked for a Government entity (Federal, State or Local) where you did not pay Social Security taxes you might be subject to it.  So...this could apply to GS employees who were covered under CSRS (Civil Service Retirement System)...If you are covered by FERS you're probably o.k.

Specifically, GPO applies to your spousal/widow(er)'s benefits (The social security you would receive based on your spouse's earnings).  If you didn't pay into Social Security, your spousal and widow(er)'s benefits will be reduced in relation to your Government Pension.  Your social security benefits (spousal/widow(er)'s) benefits will be reduced by two-thirds of your Government Pension.  For example...

Your Government Pension is $900

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Extra Social Security for All My Friends

Social SecurityIf you recently retired from the military or have been in for 15 years or so you may have more Social Security benefits than your income would indicate.   If you served in the military in the timeframe of 1957 - 2001 your earnings will be "beefed up".  Now all this assumes that you served honorably and in some cases served a minimum amount (2 years).  But here are a couple of the details...

For those who served between 1957 - 1977 your earnings will...

    • Be increased by $300 for each quarter in which you receive military bas pay
    • Social Security will add benefits when you file (which you probably already did)

For those who served between 1978 - 2001 your earnings will...

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Get Efficient! Do More With Less (Keep More With Less Tax)

Form 1040Do you think about taxes before you make investments?  You should.  Controlling your tax bill is easier when you think about taxes before you "buy".  What I'm talking about is tax efficient investing.  Today, I'm going to discuss a basic level of tax efficient investing...selecting tax-efficient Mutual Funds and ETFs.

When you look at a Mutual Fund's (or ETF's) advertising materials you will normally see the fund's returns.  You will see the same or similar numbers on many "independent" fund ranking sites.  But, what you're not seeing is the after-tax return and the difference can be significant.

The reason comes down to how the fund earns its money.  If a fund is actively managed, then normally there are more transactions and because of those transactions capital gains are recognized throughout the year.  The capital gains will be distributed to the mutual fund shareholders in December and those distributions are taxable (assuming the funds are held in a taxable account).  On the other hand, a passive/index fund will not have as many transactions and have lower capital gains to distribute in December.

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But Wait! There's More! Tax-Efficient Investing

MarketIn my last post, I talked about how a non-deductible Traditional IRA can be an effective tool to minimize taxes especially when the assets in the IRA "throw-off" a significant amount of income and the income is taxed at your marginal rate.  What if that isn't the case?  Well...that is the topic for this post.  What if you were to deposit your Large-Cap Stock Funds into a Traditional IRA?  Let's take a look.

First the assumptions that I'll use.

  • We will use the average return of the S&P 500 from 1950 -2009
    • The total return is 11%
    • 3.6% of the total return is from dividends
  • The dividends are "Qualified" so they are taxed at 15% (current tax code)
  • The marginal tax rate throughout the scenarios is 25%
  • IRA distributions are taxed at the marginal rate
  • For this illustration ObamaCare Surtaxes are ignored

In the first scenario, you can contribute $5,500 to a tax-deductible Traditional IRA or $4,125 ($5,500 - $5,500 x 25%) to a taxable account.  So which one wins?  The ability to contribute pre-tax dollars to the Traditional IRA outweighs the lower tax rate paid on the investments in the taxable account every year.  After 30 years the after-tax account values are ...

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No Respect! The Much Maligned Non-Deductible IRA

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A lot of Senior Military Officers at some point in their career lifetime find (or think) that they have limited retirement plan options.

While on Active Duty they are most likely not eligible to contribute to a Traditional IRA  and take a tax deduction.  They may be eligible to contribute to a Roth IRA and their spouse may be able to contribute to a deductible Traditional IRA.

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Roth TSP/401(k)…Thought it Through?

 Invest after-tax income now and pay ZERO taxes when you retire! Sounds pretty enticing doesn’t it? This is the promise of the Roth Account whether TSP, 401(k) or 403(b). For some of you it makes sense. For some of you it doesn’t. Fortunately, there are some Rules of Thumb…

  • If your tax bracket is lower now than it will be in retirement, then chose the Roth
  • If you are above the threshold to contribute to a Roth IRA, contribute to the Roth
  • If you don’t have a Roth Account you’ll pay a huge hit on taxes in retirement…so take the Roth

 

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Just What is a Retirement Account?

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When is a retirement account not a retirement account? No…this is not a question like “Who is buried in Grant’s tomb?”. A retirement account is not a retirement account when it is an inherited Individual Retirement Account (actually an IRA is technically called an Individual Retirement Arrangement).

This was recently determined in a Supreme Court ruling. In a unanimous decision the Supreme Court ruled that while inherited IRAs maintain the word retirement in their name, they are not retirement accounts.

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TSP/401(k) Loan? Step Away From the Paperwork, Please…

Let’s say you’re sitting on $10,000 of Credit Card debt and you can take a loan from your TSP/401(k) to pay it off. The credit card is at 12% interest and the interest on the loan from your retirement plan is only 7%. Take the loan right? Simple math…7% interest is less than 12% interest so take the lower rate. Well, you’ve not finished reading the “story problem”. Your not sure of the train from Philadelphia’s speed (so to speak).

 There is more to the story problem. The first issue is opportunity cost and the second (and bigger issue) is tax ramifications. Let’s look at the numbers.

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Give away $14,000, No Problem! Right?

If you spend much time reading financial publications (you know the names) or watching financial TV shows, you’ve probably heard, “You can give away $14,000 to anyone in a year and have ZERO gift tax ramifications and if you’re married your spouse can too!” I b2ap3_thumbnail_charity-2_20140701-112953_1.jpgdon’t know how many times I have heard that. The problem is, it isn’t exactly true.

The reality is that you can gift up to $14,000 in a present interest per year and exclude the gift from any gift tax. What is a present interest? It means the person who receives the gift can use the money now. If you put the money into something where the recipient can’t get the money now, you lose the exemption and the gift becomes potentially subject to gift tax (since the current lifetime Unified Tax Credit is large most people won’t owe taxes) and you must file a gift tax return.

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Some Money Talk for Your Graduate

b2ap3_thumbnail_college-student_20140702-015050_1.jpgI passed by my first Graduation party this weekend. And so it begins…. For the next few weeks high school and college seniors will celebrate moving to the next stage of their life. Here are a couple of ideas/thoughts for your grad (You might find a nugget too).

Start Now! The number one determinate of how much your grad will have to spend in retirement is when the he/she starts investing/saving. There are a lot of different examples of how waiting to start investing for retirement limits funds available. Here is another one. Let’s assume your grad can invest $2,000 per year and will earn 7% throughout his/her earning years (until age 65). What are the results if the grad delays?

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Death & Taxes

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We’ve all heard the saying. “The only things certain in life are Death and Taxes.” But, surprisingly, most of us don’t really understand taxes when a death occurs. So, let me see if I can shed some light on some of it for you…But first, let me state that I am talking about FEDERAL taxation. Every state is different. So here we go.

Estate Taxes. Taxes are due on an estate if it exceeds the Unified Credit in effect at the time of death (technically it is calculated a differently).

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Four Tax Tips for Your College Student Home to Work

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Time for the college kids to come home…and get a job! There are some tax issues you may want to be aware of.

  1. ROTC Summer Camp. ROTC benefits while a student (tuition and stipend) are tax free. Income earned while attending summer camp, on the other hand, is taxable income subject to income tax and payroll taxes (FICA).
  2. Tips. If your college student is working where tips are earned, those tips are subject to taxation as well. If the child receives tips, he or she must keep a daily log to be able to report them. Your child must report $20 or more in cash tips in any one month to his/her employer. And the total tips for the year must be reported on your child’s tax return.

 

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Inter-Generational Asset Ownership…Good Idea?

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Recently I’ve run into a few situations where inter-generational asset ownership is an idea or a reality that someone is dealing with. Is it a good idea? Generally, I think it isn’t and here is why…

  • Liability Exposure. Let’s say you decide to add your only child to your investment account as a co-owner. If “Junior” is in a car accident and sued for more than the liability limit on his auto insurance policy, your investment account is subject to forfeiture as a portion of the settlement of the lawsuit (since the account is also his).

 

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Beware the Short Sale Tax Bite

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Due to the financial crisis/great recession many Americans found themselves under water on their mortgage — they owed more than the house was worth. One way out of this situation was to execute a “short-sale”. In a short sale the lender agrees to accept the proceeds from the sale of the house as payoff for the loan. Any remaining debt was forgiven. Fortunately, a lot of homeowners are now back above water, but some of you may still be considering a short-sale. But, before you do you need to realize that the tax treatment of a short-sale changed on 1 Jan 14.

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SBP & DIC

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Look at that! A title with no actual words in it. I was teaching at an ETAP for transitioning senior military officers and senior NCO’s the other day and a question came up about Survivor Benefits Plan (SBP) and Dependency and Indemnity Compensation (DIC). The question concerned how they interacted and whether that might make it worth “skipping” SBP. Let’s take a look.

First of all, DIC is not automatic. It is a Veterans Administration (VA) Benefit and your surviving spouse must apply for it. If DIC is awarded, SBP payments are reduced dollar for dollar by the amount of DIC received. This is a “good” thing as DIC (like all VA benefits) is tax-free. That means the surviving spouse will have more money available to live on.

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Increase Investment Returns by 3%…Interested?

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If you could potentially increase the return on your investments, would you be interested? A White Paper recently published by Vanguard postulates that a Financial Advisor can add up to 3% to your portfolio’s return. This is significant as Vanguard has always been a champion of the Do It Yourself investor. But, Vanguard remains true to its roots and doesn’t imply that Advisors can pick investments with any great ability. Vanguard predicts the increase based on things you may not have thought of. Here are the amounts and areas where Advisors can increase your return

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Maximize Your Social Security Benefits

Almost 80% of Americans take their Social Security Benefits early. Why? I don’t know for sure, but I bet most of them don’t put much thought into it. Let me put it this way…If I offered you a Savings Account that paid 7.43% interest with no risk would you want it? That is essentially what Social Security pays, but yet many Americans take their benefits early. Here are some other concepts you might want to understand before you take Social Security.

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Disclaimer

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by C.L. Sheldon & Company, LLC ), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from C.L. Sheldon & Company, LLC . To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. C.L. Sheldon & Company, LLC is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the C.L. Sheldon & Company, LLC ’s current written disclosure statement discussing our advisory services and fees is available for review upon request. DISCLAIMER OF TAX ADVICE: Any discussion contained herein cannot be considered to be tax advice. Actual tax advice would require a detailed and careful analysis of the facts and applicable law, which we expect would be time consuming and costly. We have not made and have not been asked to make that type of analysis in connection with any advice given in this blog post. As a result, we are required to advise you that any Federal tax advice rendered in this blog is not intended or written to be used and cannot be used for the purpose of avoiding penalties that may be imposed by the IRS. In the event you would like us to perform the type of analysis that is necessary for us to provide an opinion, that does not require the above disclaimer, as always, please feel free to contact us.

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