Wise Wealth Management

Dennis Covington | Principal

Insights on the keys to enjoying a "healthy wealth".

Financial and Tax-Related Identity Theft - Part One

March 2017

Key Takeaways:

• A recent AICPA survey showed that over one-third of older adults and 22 percent of millennials fell victim to identity theft last year.
• With the combination of billions of e-documents, server and cloud-based databases, and sophisticated hackers, this trend will likely get much worse in the short term.
• You should take precautions now to protect your personal information and should enroll in credit monitoring services as a preventive measure. Most services are free or minimal cost.
• Capital Directions and your asset custodian (i.e., Schwab Institutional) dedicate lots of time to this issue and we continually evaluate and improve our procedures to protect your investment accounts.

With the 2015 revelation that the IRS data breach involved over 330,000 taxpayer records (the IRS originally reported only 104,000 records were compromised), and more breaches followed, the IRS is finally under sufficient pressure to implement some formal procedures to assist taxpayers who have experienced a governmental, corporate or other data breach.

Due to the massive credit card breaches at various financial institutions—Target, Home Depot and other retailers, as well as countless financial institutions; attacks on government agencies; and possibly the most sensational web fiasco, Ashley Madison—identity theft is now the most common consumer complaint, with over 10 million total identity theft cases per year and rapidly growing every year.

Identity theft is clearly a growing trend with very serious repercussions for consumers, web designers and webmasters, taxpayers, businesses, and government agencies. For taxpayers, a data breach can result in loss of funds, delayed tax refunds, cloned identities and/or damaged credit ratings—not to mention a massive time drain to sort out the extent of the thieves’ activities. And organizations that did not prevent the breach can face expensive lawsuits, loss of consumer trust and decreased revenue for retailers and other businesses. That’s an issue, even for those of you who own smaller businesses.

For one dollar, you can enroll in Experian’s credit monitoring service and review your current credit standing on all three credit bureaus: www.creditchecktotal.com. Enrollment and a review of your open credit accounts and personal data take less than 10 minutes and will give you a very good picture of whether or not you have been breached. If you suspect that your data has been breached (e.g., you see new credit card accounts that you did not open, or personal information has been altered), you should immediately contact all three major credit bureaus (Equifax, Experian and TransUnion) and alert them to the possibility of fraud. The next organizations to notify are the IRS and state tax authorities, since your tax accounts are also prime targets for hackers.

While all breaches are serious, the IRS breaches are some of the most worrisome, since the IRS houses hundreds of millions of highly confidential records (including Social Security numbers for all family members), which are a treasure trove for these sophisticated hackers. The thieves might also get access to taxpayers’ IRS account information from other data breaches discussed above.

Here are some precautions you can take to prevent identity theft cases:

• Enrolling in various credit monitoring services. Note that most people can get free credit monitoring services as a result of being a customer of Anthem, Target, Home Depot, or other retailers or financial institutions that experienced a credit card database breach.
• Shredding any unneeded personal files at home and at work.
• Protecting Social Security numbers on the web, over the phone and in letters, etc. Generally including the last four digits is fine for existing accounts.
• Preventing personal financial information from being shared over the phone unless you are positive who the other party is. A good rule of thumb for incoming calls associated with any accounts is to get the caller’s number, check the number out and return the call if it looks legitimate.
• Do not use public Wi-Fi networks when dealing with banking, investment and tax data. Use a secured virtual private network (VPN) and encrypt emails if personal information must be sent via the Internet.
• Obtain or review your umbrella insurance policy to determine whether the insurance company will cover costs to repair your credit and for problems caused by identity theft.
• The IRS also has a fairly useful page devoted to identity theft: https://www.irs.gov/individuals/identity-protection

Accessing any one of the many IRS systems or databases can be the Holy Grail of data for tech criminals. Access to taxpayers’ and dependents’ Social Security numbers, home and business addresses, and income sources can spell disaster for the victimized taxpayers whose records have been compromised—and can now be cloned. In Part 2 of this article, we’ll look more closely at identity theft issues affecting taxpayers and the IRS and specific actions to take after your data has been breached.


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The Charitable Remainder Trust - Having your cake and eating it too!

February 2017

Key Takeaways:

• CRTs are an ideal strategy when selling highly appreciated assets such as marketable securities, real estate and certain closely held businesses.
• A myriad of benefits can be secured with a CRT—an immediate charitable deduction, avoided tax upon sale of the asset, a lifetime stream of income and a meaningful charitable gift at death.
• CRTs provide many benefits for both taxpayers and their favorite charities.

The American Taxpayer Relief Act of 2012 increased the highest marginal tax rates on ordinary income from 35 percent to 39.6 percent, and on capital gains and qualified dividends from 15 percent to 20 percent. In addition, the Health Care and Education Reconciliation Act of 2010 imposed a 3.8 percent Medicare tax, for the first time, on non-wage income. This tax applies to investment income, including interest, capital gains, dividends, and rental income.

As many of you know, President Trump has proposed lower tax rates across the board, including taxes on capital gain income and ordinary income rates. In addition, the 3.8 percent Obamacare Medicare tax on net investment income may also be on the chopping block.

Whether or not the proposed tax changes tax place, CRTs should remain a smart strategy for generous taxpayers planning to sell appreciated assets such as marketable securities, real estate and certain closely held businesses.

Under the current rules, many taxpayers selling such assets will incur a federal tax of 20 percent on their capital gains, plus an additional 3.8 percent Medicare tax. This combined tax rate of 23.8 percent represents an increase of over 58 percent from the 15 percent tax rate that would have been imposed prior to January 2013. For many taxpayers, the 23.8 percent federal tax rate increased further due to the imposition of state income taxes that, on average, added an additional 5 percent to 10 percent to their tax bills.

The power of CRTs: Real-world example

A CRT is an extremely effective financial planning technique for taxpayers planning a sale of highly appreciated assets. In this context, a CRT will allow you to reduce your current (and often future) income tax liability, increase their charitable contributions and deductions, and secure an annual income stream for the rest of their lives.

The following example illustrates the power of a CRT and the benefits it provides to both the taxpayer and charity.

Barry is a recently retired executive from a Fortune 500 company. He and his wife, Linda, have accumulated significant assets, consisting primarily of qualified retirement plan assets, a diversified taxable investment portfolio and a rental real estate property they’ve owned for over 20 years. Upon reaching their current ages of 65 and 64, respectively, they decided to sell their investment real estate and relieve themselves of the significant management and maintenance responsibilities that such rental properties often require.

The six-unit apartment building is valued at $750,000. With an adjusted income tax basis of $200,000 (purchase price, adjusted for capital improvements and depreciation over time), Barry and Linda will recognize a capital gain of $550,000 at the time of sale. This will create a capital gain tax liability of $143,000 (at 20 percent federal and 6 percent state tax rates), plus $20,900 from the 3.8 percent Medicare tax on capital gains.

Instead of selling the rental real estate outright, Barry and Linda contribute the real estate to a CRT while retaining a 5 percent unitrust interest. This entitles them to a distribution from the trust of 5 percent of the trust assets each year for the balance of their lifetimes. Upon sale of the real estate, the $163,900 of combined capital gain and Medicare investment taxes are avoided, thereby preserving the entire $750,000 of sale proceeds for reinvestment by the CRT. As a result, the 5 percent unitrust will produce an initial distribution to Barry and Linda of $37,500, and assuming the underlying CRT assets grow at a rate in excess of the 5 percent unitrust amount, Barry and Linda’s unitrust payments will increase over time, providing a hedge against inflation.

In addition, Barry and Linda receive a charitable income tax deduction that’s equal to the present value of the charitable remainder interest that will pass to charity after both pass away. Based on their joint life expectancy, as well as on the IRS-provided rate on the projected return over time on the CRT assets and the 5 percent unitrust payment, Barry and Linda will receive a charitable deduction of $248,100, immediately saving them $113,134 in taxes (based on 39.6 percent federal and 6 percent state tax rates).

The unitrust payments Barry and Linda receive each year will be subject to tax according to a four-tier system carrying out ordinary income first, followed by capital gains, tax-exempt income and finally a return of principal. As a result, their actual tax liability on the unitrust payments they receive will ultimately depend on how the underlying sale proceeds are invested and on the specific types of income the assets generate over time.

Finally, upon the second spouse’s death, the assets remaining in the CRT will pass to one or more charitable beneficiaries. If the CRT assets earned the same percentage return as the 5 percent unitrust payout to Barry and Linda, $750,000 would pass to charity at that time. To the extent the assets produce a higher total rate of return, more assets will be available to charity. For example, if the CRT earned an 8 percent total return over the term of the trust, at Barry and Linda’s joint life expectancy of 23 years, $1,480,000 would pass to charity.


The use of CRTs by astute advisors and their clients will increase dramatically in the years to come. The benefits of CRTs are significant:

• Avoidance of capital gain and Medicare tax on investment income upon the sale of appreciated assets
• Securing an immediate charitable income tax deduction
• Providing an additional source of lifetime income in the form of an annual unitrust payment
• Providing a meaningful charitable gift upon death

Your family wins, your favorite charities win and the IRS loses—that’s a win-win-win scenario, and about as close as you can get to having your cake and eating it too!

Article courtesy of CEG Worldwide, LLC, 2017 www.cegworldwide.com | info@cegworldwide.com


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Why Should We Invest Internationally?

Dennis Covington was recently featured in a video series where advisors answer common client questions.

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Britain's Exit from EU

July 2016

You’ve heard us say before that “markets don’t like uncertainty”. Events that create uncertainty invariably lead equity markets to trade lower in the short term and Britain’s exit (Brexit) from the Europe Union (EU) definitely qualifies as that type of an event.

The uncertainty created by Brexit creates some very basic questions:
• How long will the uncertainty last?
• How will it impact trading around the globe?
• Will other countries exit the EU?
• How will it impact the global economy?

Brexit will require the U.K. to renegotiate their trade agreements with other countries. History shows this will take years to complete. In 1973, Britain first joined the predecessor organization to the EU, the European Communities. In 1979, the European Monetary System was launched. In 1993, the Treaty on the European Union was signed. The Euro currency was launched in 1999, but most countries didn’t replace their national currencies with the Euro until 2002. Great Britain never adopted the Euro.

In the short run, we can expect more day-to-day volatility of stock prices, as well as currencies, which can particularly impact the international stocks we all own. We can definitely count on the financial press to exploit this new “crisis” with breaking news alerts and special reports aimed at driving up ratings.

When events like this happen, we find it helpful to think about the companies that make up “the market”, rather than just “the market” itself.
• Does Brexit impact the number of Coca-Cola’s that Europeans will drink post-Brexit?
• Will BMW or Mercedes sell fewer vehicles?
• Is it possible that foreigners will actually buy more from Great Britain since their currency has devalued?
• Are you truly thinking differently about where, and on what, you will spend your money this morning?

Capitalism is the free enterprise system in which the world’s businesses are controlled by private owners for profit, rather than by the state. Capitalism has shown amazing resiliency to weather uncertain times created by world wars, assassinations, natural disasters, economic recessions, credit downgrades, housing crises, etc. and march onward to reward investors who invest or lend their capital to these businesses. Our faith in this system and our belief that clients will be rewarded is not shaken by Brexit. History and data are certainly on our side.

The outcome of the Brexit referendum was always expected to be very close. On balance, the market anticipated a “Remain” vote. When this didn’t happen, the opening market prices reflected the outcome. However, we do not believe it is prudent to make changes in response to this new information. Changes to your long-term strategy should only be made based on changes in your own personal situation and your goals.

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