Article: Ginnie Mae Funds for Your Retirement
Many people prefer to have some conservative holdings in their IRAs and other retirement accounts. This century has already produced two nasty bear markets (in 2000–2002 and 2007–2009). If a third downturn occurs, investors will be glad they held some defensive positions, which might minimize losses and possibly offer gains.
When it comes to playing defense, Ginnie Maes may merit consideration. The nickname comes from the formal name, Government National Mortgage Association, or GNMA. This agency promises investors the payment of principal and interest from residential mortgage loans insured or guaranteed by federal entities, such as the Federal Housing Authority and the Department of Veterans Affairs. Ginnie Mae mortgage bonds are the only mortgage securities with full federal backing.
Ginnie Mae securities might be considered the “safe option” for retirement investing. Yields are not enormous in today’s environment, but they may be relatively attractive. Typically, Ginnie Maes pay one to two percentage points of yield more than Treasuries. Why should supposedly safe Ginnie Maes pay more?
One answer rests with mortgage-backed securities. Most bonds lose value when interest rates rise but gain value when rates fall because their fixed yields become more attractive.
Mortgage-backed securities, including Ginnie Maes, also suffer losses when rates rise. However, rising rates can cause a slowdown in mortgage pre-payments because borrowers are less likely to refinance their loans. This slowdown means that Ginnie Mae investors have less money to reinvest at higher yields.
The opposite phenomenon affects mortgage securities when rates fall. More refinancing occurs as homeowners seek the lower loan rates. That means more cash flow to investors holding mortgage bonds and more money to reinvest at lower rates. Thus, mortgage-backed securities may lose more than conventional bonds when rates rise and gain less when rates fall.
Treasury securities and funds holding them pay interest that’s taxable at the federal level, but is generally exempt from state and local income taxes. Therefore, these holdings can be especially attractive to investors in high-tax areas.
Mortgage-backed securities, even federally backed Ginnie Maes, do not enjoy state or local tax exemption; they’re fully taxable at all levels of government. This relative disadvantage, along with the complexity and interest rate threats, may explain the higher yields (versus Treasuries) that Ginnie Maes offer to investors. Their tax treatment also might cause Ginnie Maes to be an appealing holding in retirement accounts where all the income taxes can be deferred until money is withdrawn.
Investors can often purchase individual Ginnie Mae bonds for around $25,000. Some retirees are pleased with these “pass-through” securities because they deliver monthly cash flow, reflecting the regular payments made on the underlying mortgages by homeowners. If you work with a savvy financial adviser or if you are willing to research Ginnie Maes on your own, this can be an astute choice.
That said, the Ginnie Mae market is complex, likely to lead to missteps by novice investors. Many people prefer owning shares of a fund and relying on the expertise of professionals to choose suitable Ginnie Maes. Diversification and a lengthy time frame might overcome interest rate concerns and deliver the benefits of relatively high yields. Many leading fund families, including Vanguard, Fidelity, and T. Rowe Price, have established Ginnie Mae mutual funds with performance records for investors to evaluate.
In terms of performance, Ginnie Mae funds generally had positive returns in 2008 when the stock market nosedived. The past is no guarantee of future results, but an encouraging track record might indicate that Ginnie Mae may be worth a place in a retirement portfolio.
Up With Housing
Article: Tax Credits Beat Tax Deductions
Many people prize tax deductions. The promise of a deduction can affect decisions in many areas, including charitable contributions, home buying, and investing in rental property.
However, tax deductions offer only partial relief because they reduce income, not the tax bill. The higher your income and tax bracket, the more you’ll benefit from a tax deduction.
Example 1: Heidi Jones has recently finished her education and joined the work force. With a modest income, Heidi is in a 15% tax bracket. If Heidi donates $1,000 to charity (and if she itemizes deductions on her tax return), Heidi will reduce her taxable income by $1,000. In a 15% bracket, she will save $150 in tax (15% times $1,000).
Example 2: Ken Larsen, a middle-aged executive, has a high salary, placing him in the 33% tax bracket. If Ken itemizes a $1,000 charitable contribution, he’ll save $330 (33% times $1,000), more than twice the amount of tax that Heidi saves for the same charitable gift.
Dollar for dollar
A tax credit, on the other hand, is a direct reduction of the tax you owe. If Heidi and Ken both receive a $1,000 tax credit, they’ll both trim their tax obligation by $1,000. Moreover, many tax credits have income limits and phaseouts, which effectively means they’re available to low- and middle-income taxpayers but not to people with relatively high incomes.
Here are some widely used tax credits.
Earned income tax credit
This credit is designed to help workers, including those with self-employment earnings, who have modest incomes. The good news is that the earned income tax credit (EITC) is refundable.
Example 1: Jim Carter files his 2017 tax return. Without the EITC, Jim would owe $500 in tax. Jim’s EITC amount is $1,200. Therefore, his $500 obligation is wiped out, and Jim would receive a check from the IRS for the $700 balance. (Most tax credits are not refundable, meaning that they do no more than offset any tax obligation.)
Besides having earned income, there are several other hurdles to clear to get the EITC. They include age (at least age 25, but under 65), investment income (no more than $3,450 in 2017), and filing status (married, filing separately, not eligible).
In addition, there are income limits for the EITC; those limits vary by filing status and by the number of qualifying children. (The definition of qualifying children is very broad for EITC purposes.) This year, for instance, a married couple filing a joint tax return with two qualifying children must have both earned income and adjusted gross income (AGI) of less than $50,597 to get this credit.
EITC amounts vary, as well. The 2017 maximum credit is $6,318 for a recipient with three or more qualifying children.
Child tax credit
For the child tax credit, the definition of a child is a bit more limited than it is for the EITC. Although the EITC can cover students under age 24, the child tax credit does not go beyond age 16. Other requirements apply.
The maximum tax credit is $1,000 for each qualifying child. This credit phases out after the taxpayer’s income exceeds a threshold amount based on his or her income. The threshold amount depends on filing status—to get the maximum credit, for instance, a couple filing a joint return must have modified adjusted gross income (MAGI) of no more than $110,000. Above the threshold, the child tax credit drops by $50 per $1,000 of MAGI. Under a tax code provision known as the additional child tax credit, some of the credit may be refundable, depending on the amount of the taxpayer’s earned income.
Child and dependent care tax credit
As the name indicates, this credit has two broad applications. One is for taxpayers who have children under age 13 and the other is for those who have spouses, dependents, or certain other individuals who are physically or mentally incapable of self-care. Either way, the credit is a portion of amounts paid to a caregiver so that the taxpayer can go to work, actively look for work, or go to school.
To calculate this credit, start by finding the amount spent on qualifying care for a given calendar year. Here, the maximum amount that counts is $3,000 for one qualifying person and $6,000 for two or more people needing care.
However, this maximum credit amount may be limited for some individuals. The maximum amount is limited, in the case of a single individual, to the individual’s earned income for the year. In the case of a married individual, the maximum amount is limited to the lesser of the individual’s earned income or the earned income of the individual’s spouse. In addition, if the individual receives dependent care benefits that he or she excludes from income, the maximum credit amount is reduced by the amount of the dependent care benefits excluded.
This resulting amount is multiplied by a percentage that depends on your AGI. The minimum percentage, used by many who claim this credit, is 20%, which applies when AGI is $43,000 or more.
Example 2: Paul and Robin Scott, who have $100,000 in AGI, pay over $6,000 to caregivers for their two children this year. Therefore, the Scotts multiply the maximum amount ($6,000) by the minimum percentage (20%) to get $1,200, the amount of this tax credit they can claim. (Claimants may also be responsible for payroll tax reporting in some situations.)
More credits, more assistance
Many other tax credits are available, including some for higher education. For all of them, the rules go beyond these brief descriptions. Our office can help you plan to make the most of these dollar-for-dollar tax savers.
Article: R&D Tax Credits for Small Companies
Just as individuals get a dollar-for-dollar tax savings from tax credits, the same is true for businesses that qualify for tax credits. The Protecting Americans from Tax Hikes (PATH) Act of 2015, passed in 2016, expanded the ability of small companies to use the research and development (R&D) tax credit. The R&D credit is based not on the total amount a business spends on R&D, but on increases in R&D spending. Not only is a tax credit better than a tax deduction, but R&D costs not covered by the credit may not be immediately deductible.
The spending that counts for the R&D credit might be for in-house wages and supplies, as well as for outside contracts that are considered qualified research expenditures. Money spent on activities such as developing new or improved products, processes, or formulas; developing prototypes or models; developing new technology; and developing or applying for patents may qualify.
To obtain the R&D credit, diligent recordkeeping is required. Defining which outlays qualify as R&D can be a challenge, so companies should be able to support their claims. Moreover, certain small businesses may run into additional obstacles, such as the alternative minimum tax (AMT) and a lack of taxable income that prevents using tax credits currently.
Addressing the AMT
Generally, a company that owes the AMT cannot use the R&D tax credit to reduce its AMT obligation. However, in some cases, the PATH Act allows the R&D credit to offset the AMT. Eligible companies are sole proprietorships, partnerships, or nonpublic corporations with average annual gross receipts under $50 million for the prior three tax years. In the case of pass-through entities, partners and S corporation shareholders may be able to use the R&D credit against their individual AMT liability.
Offsetting payroll taxes
The R&D tax credit is nonrefundable, so it generally doesn’t help companies with no income tax liability. Another PATH provision addresses this problem for young companies that do substantial R&D yet have no tax liability to reduce. Eligible firms can use the credit to reduce payroll tax, rather than income tax.
To qualify, a corporation or partnership must have less than $5 million of gross receipts in the year of claiming the credit and no gross receipts in any year before the fourth preceding year. Thus, this tax break is mainly for startups. A company that qualifies can use up to $250,000 of R&D tax credits to reduce its employer share of Social Security payroll tax outlays, so cash can be retained. If current payroll tax doesn’t equal the amount of the R&D credit a company can claim, carryforwards may be possible.
The complexity of the R&D tax credit and the required recordkeeping may discourage small companies from claiming it. If your company is devoting resources to developing new products and technology, our office can determine if seeking this credit will be worthwhile and help you provide the necessary documentation.
Individuals. If you are not paying your 2017 income tax through withholding (or will not pay in enough tax during the year that way), pay the third installment of your 2017 estimated tax. Use Form 1040-ES.
Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in August if the monthly rule applies.
Corporations. Deposit the third installment of estimated income tax for 2017. Use the worksheet Form 1120-W to help estimate tax for the year.
Partnerships. File a 2016 calendar-year return (Form 1065). This due date applies only if you timely requested an automatic six-month extension. Provide each partner with a copy of their final or amended Schedule K1 (Form 1065) or substitute Schedule K1 (Form 1065).
S corporations. File a 2016 calendar-year income tax return (Form 1120S) and pay any tax due. This due date applies only if you timely requested an automatic six-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1120S) or a substitute Schedule K-1.
Individuals. If you have an automatic six-month extension to file your income tax return for 2016, file Form 1040, 1040A, or 1040EZ and pay any tax, interest, or penalties due.
Corporations. File a 2016 calendar-year income tax return (Form 1120) and pay any tax, interest, and penalties due. This due date applies only if you timely requested an automatic six-month extension.
Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in September if the monthly rule applies.
Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the third quarter of 2017. Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 13 to file the return.
For federal unemployment tax, deposit the tax owed through September if more than $500.
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