What Does Tax Reform Mean For The Markets In 2018?

2017 ended up being a huge year for the U.S. stock market.  The rally in the stock market was unmistakably driven by the anticipated passing of tax reform and Congress delivered. However, the sheer magnitude of the stock market rally has presented investors with a moment of pause and a lot of unanswered questions as we enter into the first quarter of 2018. The two main questions being:

• What does tax reform mean for the markets in 2018?

• We are now in the second longest economic expansion of ALL TIME!!! I know what goes up, eventually comes down. Are we overdue for a major correction in the stock market?

Without a crystal ball, no one knows for sure. However, the purpose of this article is to identify indicators in the economy and the financial markets that may help us gauge the direction of the U.S. economy and equity markets as we progress through 2018.

Tax Reform: Uncharted Waters

While tax reform is a welcome friend for corporate America, we have to acknowledge that this also puts us in uncharted waters. Looking back, there has never been a time in history where the U.S. has injected fiscal stimulus (tax reform) into an economy that is already healthy. The last major tax reform was in the early 1980’s when the U.S. economy was trying to dig itself out of the long 1970’s recession.

When the economy is in a recession, the U.S. can either inject fiscal stimulus or monetary stimulus to get the economy growing again. The U.S. used monetary stimulus to dig us out of the Great Recession of 2008 – 2009. They lowered interest rates to basically 0%, pumped cash into the economy in the form of bond buying, and provided a financial back stop for the U.S. banking system.

These economic stimulus tools are similar to the concept of giving a patient in a hospital a shot of adrenaline. If a patient is flat lining, it provides that patient with a huge surge of energy. The patient’s body goes from 0% to 60%+ in under a minute. So what happens when you give someone who is completely healthy a shot of adrenaline? Do they go from 100% to 110%? My point is a healthy patient does not go from 100% to 160%. Both patients get a boost but the boost to the healthy patient is much lower as a percentage of where they started.

While we have never given the U.S. economy an adrenaline shot after a long economic expansion, I think it’s reasonable to apply the same general concept as our two hospital patients. Tax reform may very well lead to another year of positive returns for the stock market in 2018 but I think it’s very important for investors to set a reasonable expectation of return for the U.S. equity markets given the fact that we are injecting growth into an economy that is already at “full employment”.

Not Enough Workers

One of the greatest challenges that the U.S. economy may face in 2018 is a shortage of qualified workers. Prior to tax reform being passed, companies both large and small, have had plenty of job openings but have not been able to find the employees with the skills necessary to fill those positions.

For example, if Apple had 1000 job openings in November 2017 just to meet the current demand for their goods and services but in 2018, due to tax reform, consumers have more money to spend, and the demand for Apple products increases further, Apple may need to find another 2000 employee to meet the increase in demand. They are having trouble now finding the 1000 employees to meet their current demand, how are they going to find another 2000 quick enough in 2018 to meet the increase in demand? If they can’t make the phones, they can’t sell the phones. Fewer sales equals less revenue, which equals less net profit, which may lead to a lower appreciation rate of the stock price. For disclosure purposes, I’m not picking on Apple. I’m just highlighting an issue that may be common among the companies that make up the S&P 500 Index if tax reform leads to a spike in demand in 2018. If Wall Street is expecting accelerated earnings, how are the companies expected to deliver those enhanced earnings without the employees that they need to increase supply?

The unemployment rate in the U.S. is currently 4.1%. You have to go all the way back to the late 1960’s to find an employment rate below 4%. So we are essentially at “full employment”.

Rising Wages

The blue line in the chart above is also very important. The blue line represents wage growth. This answers the question: "Are people making more for doing the same amount of work?" If you look back historically on the chart, when the unemployment rate was falling, typically wage growth was increasing. It makes sense. When the economy is good and the job market is healthy, companies have to pay their employees more to keep them. Otherwise they will go work for a competitor, who has 10 job openings, and they get paid more. Wage growth is good for employees but it's bad for companies. For companies, employee wages are usually their largest expense. If you increase wages, you are increasing expenses, which decreases profits. Lower profits typically results in lower stock prices. Companies in 2017 had the luxury of strong demand but limited wage growth. My guess is you will begin to see meaningful wage growth in 2018 as companies see an increase in demand as a result of tax reform and end up having to raise wages to retain and attract employees. This is just another reason why 2018 may be a good year for the stock market but not a great one.

What Fuels GDP Growth?

Gross Domestic Product ("GDP") is the economic indicator that is used to measure how much the U.S. economy produces in a year. It's how we gauge whether our economy is growing or contracting. Since March 2009, the GDP growth rate has averaged about 2.2% per year. This is subpar by historic standards. In most economic expansions, GDP is growing at an annual rate of 4%+.

Before we get into what pieces of tax reform may help to increase the GDP growth rate, let us first look at what GDP is made of. Our GDP is comprised of 5 categories (for my fellow econ nerds that assign 4 categories to GDP, we split capital spending into two separate categories):

• Consumption or "Consumer Spending" 69.1%

• Government Spending (includes defense) 17.3%

• Investment (ex-housing) – "Business Spending 12.7%

• Housing 3.8%

• Net Exports -2.9%

Consumer Spending (+)

Consumer spending which makes up 69.1% of our GDP should increase as a result of tax reform in 2018. In general, if people have more discretionary income, they will spend all or a portion of it. Tax reform will lower the tax bill, for not all, but many U.S. households, increasing their disposable income.  Also, if we see an increase in wage growth in 2018, people will be taking home more in their paychecks, allowing them to spend more.

Dr James Kelly, the chief economist of JP Morgan, made a very interesting observation about the evolution of the tax bill. When the tax bills were in their proposed state, one for the Senate and a separate bill for the House, each bill to stay under the $1.5 Trillion 10 year debt cap reduced taxes by about $150 Billion dollars per year. 50% of the annual tax reduction was going to businesses with the other 50% going to individual tax payers.

In order to get the bill passed before the end of the year, Congress was forced to shift a larger proportion of the $150 billion in tax brakes per year to individual taxpayers. In the tax bill’s final form, Dr Kelly estimated that approximately 75% of the tax reductions were now being retained by individual taxpayers with only 25% going to businesses. With a larger proportion of the tax breaks going to individual taxpayers that could increase the amount of discretionary income available to the U.S. consumer.

Government Spending (Push)

The anticipated increase in government spending really stems from the Trump agenda that has been communicated. One of the items that he campaigned on was increasing government spending on infrastructure. At this point we do not have many details as to when the infrastructure spending will begin or how much will be spent. Whatever ends up happening, we are not forecasting a dramatic increase or decrease in government spending in 2018.

Investment - Business Spending (+)

Even though business spending only represents 12.7% of our GDP, we could see a sizable increase in spending by businesses in 2018 for the following reasons:

• Corporate tax rate is reduced from 35% to 21%

• The repatriation tax will allow companies to bring cash back from overseas at a low tax rate

• Prior to tax reform, companies already had historically high levels of cash on their balance sheet. What are they going to do with more cash? (See the chart below)

If having more cash was not a large enough incentive by itself for companies to spend money, the new tax rules allowing immediate expensing of the full cost of most assets purchased for the next five years should be. Under the current tax rules, when a business purchases a new piece of equipment, a fleet of trucks, office furniture, whatever it is, the IRS does not allow them to deduct 100% of purchase price in the year that they buy it. They have to follow a "depreciation schedule" and they can only realize a piece of that expense each year. The current tax rules put companies at a tax disadvantage because companies are always trying to shelter as much income as possible from taxation. If Company XYZ buys a piece of equipment that cost $1,000,000, the IRS may require Company XYZ to depreciate that expense over a 10 year period. Meaning they can only realize $100,000 in expenses each year over that 10 year period, even though they already paid the full $1,000,000 for that new piece of equipment.Under the new tax reform, if Company XYZ buys that same new piece of equipment for $1,000,000, they can deduct the full $1,000,000 expense against their income in 2018. Whoa!!! That's huge!! Yes it is and it's a big incentive for companies to spend money over the next five years.

Housing & Net Exports (Push)

We do not expect any significant change from either of these two categories and they represent the smallest portion of our total GDP.

Watch GDP In 2018

The GDP growth rate in 2018 may give us the first indication as to how many "extra innings" we have left in this already long bull market rally. If we do not see a meaningful acceleration in the annual growth rate of GDP above its 2.2% average rate, the rally could be very short lived. On the flip side, if due to tax reform consumer spending and business spending leaps forward in 2018 and 2019, we may be witnessing the longest economic expansion of all time. Time will tell.

Share Buybacks

You will undoubtedly hear a lot about “Share Buybacks” in 2018. Remember, U.S. corporations will most likely have piles of cash on their balance sheets. Instead of spending that money on hiring new employees, buying new equipment, or building a new plant, what else might they do with the cash? The answer, share buybacks.

If a public company like Nike has extra cash, they can go into the market, purchase their own stock, and then get rid of those outstanding shares. Basically it increases the earnings per share for the remaining shareholders.

Example: Let’s assume there are only 4 shares of Nike owned by 4 different people and Nike is worth $100,000. That means that each shareholder is entitled to 25% of that $100,000 or $25,000 each. Now because of tax reform, Nike has $50,000 of extra cash just sitting in its coffers that it otherwise would have paid to the government in taxes. Nike can go into the market with $50,000, purchase 2 shares back from 2 of the shareholders (assuming they would be willing to sell), and then “retire” those two outstanding shares. After that is done, there are 2 outstanding shares remaining but the value of Nike did not change. So the two remaining shareholders, without paying anything extra, now own 50% of Nike, and their shares are worth $50,000 each.

Share buyback may push stock prices higher from a simple math standpoint. If the formula is the value of the company divided by the number of shares outstanding, the fewer shares there are, assuming the value of the company stays the same, the price per share will go up.   The incentive for these share buybacks will most likely be there in 2018. Not only will companies have the cash but share buybacks are a way that public companies can reward their current shareholders..

Is The Stock Market Too Expensive?

The P/E ratio of the S&P 500 Index is another barometer that investors will need to keep a close eye on in 2018. P/E ratios help us to answer the questions: “Is the stock market cheap, fairly valued, or expensive at this point?” The “Forward P/E Ratio” divides the price of a stock by the estimated future 12 months of earnings. The average Forward P/E ratio for the S&P 500 Index between December 1989 – September 30, 2017 was 16.0. As of December 22, 2017, the Forward P/E ratio of the S&P 500 Index is 19.99. In other words, it’s running at 25% above its 25 year historic average. See the chart below:

Conclusion, the U.S. stock market is not “cheap” and it’s a stretch to even classify it as “fairly valued”. I think we are well into what I would consider “expensive territory”. What does that mean for investors? You have to stay on your toes!!

Now, we have an anomaly in the mix with tax reform and history does not speak to how this could play out. If tax reform leads to an acceleration in corporate earnings, that in turn could slow the steady climb in the P/E ratio of the S&P 500 because earnings are the denominator in the formula. If stock prices and earnings are accelerating at the same pace, the stock market can go up without a further acceleration of the P/E ratio. Thus, keeping the stock market from becoming more overpriced and further increasing the risk of owning stocks in the S&P 500.

Summary

In 2018, investors should keep a close eye on the U.S. GDP growth rate, the level of spending by corporations and consumers, the volume of share buybacks by U.S. companies, and the P/E ratio of the S&P 500 Index.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform Could Lead To A Spike In The Divorce Rate In 2018

The Tax Cut & Jobs Act that was recently passed has already caused taxpayers to accelerate certain financial decisions as we transition from the current tax laws to the new tax laws over the course of the next two years.

Current Tax Law: Alimony Is Tax Deductible

Under the current tax law, alimony payments are taxable income to the ex-spouse receiving the payments and they are tax deductible to the ex-spouse making the payments. When alimony is awarded pursuant to a divorce, it’s typically because there was a disparity in the level of income between the two spouses during the marriage. The ex-spouse paying the alimony, in most cases, is the higher income earning spouse both before and after the divorce finalized.

Let’s look at this in a real life example. Jim and Sarah have decided to get a divorce. Jim makes $300,000 per year and Sarah is a homemaker with $0 income. Pursuant to the divorce agreement, Jim will be required to pay Sarah $50,000 per year for 5 years. Jim will be able to deduct the $50,000 each year against his taxable income and Sarah will claim the $50,000 as taxable income on her tax return. Based on the 2018 Individual Tax Brackets, the top end of Jim’s income is in the 35% tax bracket. Thus, paying $50,000 in alimony really results in an “after-tax” expense to Jim of $32,500.

$50,000 x 35% = $17,500 (fed tax savings)

$50,000 – $17,500 = $32,500 (after tax expense to Jim)

Sarah will claim that $50,000 in alimony payments as income and let’s assume that the alimony payments are her only income for the year. Next year, as a single filer, Sarah will receive a standard deduction of $12,000, and the remainder of the $38,000 will be taxed at a blend of her 10% & 12% tax rate. As a result, Sarah will only pay about $4,400 in taxes on the $50,000 in alimony income.

To sum it all up, if the $50,000 is taxed to Sarah, approximately $4,400 will be paid to the IRS in taxes and she nets $45,600 in after tax income. However, if Jim was not able to deduct the alimony payments and had to pay tax on that $50,000, he would first have to pay the $17,500 in taxes to the IRS, and then he would hand Sarah a check for $32,500 after tax. Sarah is worse off because she received less after tax income. Jim would ultimately be worse off because he would need to part with more pre-tax income to create the same after tax benefit for Sarah. The IRS is the only one that wins.

Gaming The System

Since divorce agreements, in most states, are not required to adhere to predefined calculations for splitting assets, alimony payments, and in some cases child support, the tax game can be played when there is a high income earning spouse and alimony payments in the mix. In exchange for fewer assets or less child support, some divorce agreements have purposefully shifted more to alimony. The ex-spouse with the big income gets a bigger tax deduction and the ex-spouse receiving the alimony payment is able to take full advantage of their lower tax brackets and maximize their after tax income.

Alimony Is No Longer Deductible

To stop the tax game, included in the new tax bill was a provision that specifically states that alimony payments will no longer be deductible by the payor, nor reportable as income by the recipient, for divorce agreements signed after December 31, 2018.

The good news is this will not impact the ability to deduct alimony payments for divorce agreements that are currently in place. The bad news is for divorce agreements signed after December 31, 2018, the high income earner will no longer be able to deduct the alimony payments. That eliminates the tax arbitrage that has been used in the past to make the pie larger for both spouses. In general, if you shrink the size of the asset and income pie, it leaves more to fight about because each spouse is trying to preserve their standard of living as much as possible post-divorce.

For couples that have been sitting on the fence about getting divorced, this could be the catalyst to start the process in 2018 to make sure they have a signed agreement prior to December 31, 2018.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: Changes To 529 Accounts & Coverdell IRA's

Included in the new tab bill were some changes to the tax treatment of 529 accounts and Coverdell IRA's. Traditionally, if you used the balance in the 529 account to pay for a "qualified expense", the earnings portion of the account was tax and penalty free which is the largest benefit to using a 529 account as a savings vehicle for college.So what's the change? Prior to the Tax Cuts and Jobs Act (tax reform), qualified distributions were only allowed for certain expenses associated with the account beneficiary's college education. Starting in 2018, 529 plans can also be used to pay for qualified expenses for elementary, middle school, and high school.

Kindergarten – 12th Grade Expenses

Tax reform included a provision that will allow owners of 529 account to take tax-free distributions from 529 accounts for K – 12 expenses for the beneficiary named on the account. This is new for 529 accounts. Prior to this provision, 529 accounts could only be used for college expenses. Now 529 account holders can distribute up to $10,000 per student per year for K – 12 qualified expenses. Another important note, this is not limited to expenses associated with private schools. K – 12 qualified expense will be allowed for:

• Private School

• Public School

• Religious Schools

• Homeschooling

529 Accounts Will Largely Replace Coverdell IRA's

Prior to this rule change, the only option that parents had to save and accumulate money tax-free to K – 12 expenses for their children were Coverdell IRA's. But Coverdell IRA's had a lot of hang ups

• Contributions were limited to $2,000 per year

• You could only contribute to a Coverdell IRA if your income was below certain limits

• You could not contribution to the Coverdell IRA after your child turned 18

• Account balance had to be spend by the time the student was age 30

By contrast, 529 accounts offer a lot more flexibility and higher contributions limits. For example, 529 accounts have no contribution limits. The only limits that account owners need to be aware of are the "gifting limits" since contributions to 529 accounts are considered a "gift" to the beneficiary listed on the account. In 2018, the annual gift exclusion will be $15,000. However, 529 accounts have a provision that allow account owners to make a "5 year election". This election allows account owners to make an upfront contribution of up to 5 times the annual gift exclusion for each beneficiary without trigger the need to file a gift tax return. In 2018, a married couple could contribution up to $150,000 for each child to a 529 account without trigger a gift tax return.If I have a child in private school, they are in 6th grade, and I'm paying $20,000 in tuition each year, that means I have $140,000 that I'm going to spend in tuition between 6th grade – 12th grade and then I have college tuition to pile on top of that amount. Instead of saving that money in an after-tax investment account which is not tax sheltered and I pay capital gains tax when I liquidate the account to pay those expenses, why not setup a 529 account and shelter that huge dollar amount from income tax? It will probably saves me thousands, if not tens of thousands of dollars in taxes, in taxes over the long run. Plus, if I live in a state that allows tax deductions for 529 contributions, I get that benefit as well.

Income Limits and Tax Deductions

Unlike Coverdell IRA's, 529 accounts do not have income restrictions for making contributions. Plus, some states have a state tax deduction for contributions to 529 account. In New York, a married couple filing joint, receive a state tax deduction for up to $10,000 for contribution to 529 account. A quick note, that is $10,000 in aggregate, not $10,000 per child or per account.

Rollovers Count Toward State Tax Deductions

Here is a fun fact. If you live in New York and you have a 529 account established in another state for your child, if you rollover the balance into a NYS 529 account, the rollover balance counts toward your $10,000 annual NYS state tax deduction. Also, you can rollover balances in Coverdell IRA's into 529 accounts and my guess is many people will elect to do so now that 529 account can be used for K – 12 expenses.

Contributions Beyond Age 18

Unlike Coverdell IRA's which restrict contributions once the child reaches age 18, 529 accounts have no age restriction for contributions. We will often encourage clients to continue to contribute their child's 529 account while they are attending college for the sole purpose of continuing to capture the state tax deduction. If you receive the tuition bill in the mail today for $10,000, you can send in a $10,000 check to your 529 account provider as a current year contribution, as soon as the check clears the account you can turn around and request a qualified withdrawal from the account for the tuition bill, and pay the bill with the cash that was distributed from the 529 account. A little extra work but if you live in NYS and you are in a high tax bracket that $10,000 deduction could save you $600 - $700 in state taxes.

What Happens If There Is Money Left In The 529 Account?

If there is money left over in a 529 account after the child has graduated from college, there are a number of options available. For more on this, see our article "5 Options For Money Left Over In College 529 Plans"

Qualified Expenses

The most frequent question that I get is "what is considered a qualified expense for purposes of tax-free withdrawals from a 529 account?" Here is a list of the most common:

• Tuition

• Room & Board

• Technology Items: Computers, Printers, Required Software

• Supplies: Books, Notebooks, Pens, Etc.

Just as important, here are a list of expense that are NOT considered a "qualified expense" for purposes of tax free withdrawals from a 529 account:

• Transportation & Travel: Expense of going back and forth from school / college

• Student Loan Repayment

• General Electronics and Cell Phone Plans

• Sports and Fitness Club Memberships

• Insurance

If there is ever a question as to where or not an expense is a qualified expense or not, I would recommend that you contact the provider of your 529 account before making the withdrawal form your 529 account. If you take a withdrawal for an expense that is not a "qualified expenses" you will pay income taxes and a 10% penalty on the earnings portion of the withdrawal.

Do I Have To Close My Coverdell IRA?

While 529 accounts have a number of advantages compared to Coverdell IRA's, current owners of Coverdell IRAs will not be required to close their accounts. They will continue to operate as they were intended. Like 529 accounts, Coverdell IRA withdrawals will also qualify for the tax-free distributions for K – 12 expenses including the provision for expenses associated with homeschooling.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Pass-Through Income Will Be Taxed For Small Business Owners

While one of the most significant changes incorporated in the new legislation was reducing the corporate tax rate from the current 35% rate to a 21% rate in 2018, the tax bill also contains a big tax break for small business owners. Unlike large corporations that are taxed at a flat rate, most small businesses, are "pass-through" entities, meaning that the profits from the business flow through to the business owner's personal tax return and then are taxed at ordinary income tax rates.While pass-through income will continue to be taxed at ordinary income tax rates, many small business owners will be eligible to deduct 20% of their "qualified business income" (QBI) starting in 2018. In other words, some pass-through entities will only be taxes on 80% of their pass-through income.

Pass-through entities include

Sole proprietorships

Partnerships

LLCs

S-Corps

Unanswered Questions

I wanted to write this article to give our readers the framework of what we know at this point about the treatment of the pass-through income in 2018. However, as many accountants will acknowledge, there seems to be more questions at this point then there are answers. The IRS will need to begin issuing guidance at the beginning of 2018 to clear up many of the unanswered questions as to who will be eligible and not eligible for the new 20% deduction.

Above or Below "The Line"

This 20% deduction will be a below-the-line deduction which is an important piece to understand. Tax lingo makes my head spin as well, so let's pause for a second to understand the difference between an "above-the-line deduction" and a "below-the-line deduction".The "line" refers to the AGI line on your tax return which is the bottom line on the first page of your Form 1040. While both above-the-line and below-the-line deductions reduce your taxable income, it's important to understand the difference between the two.

Above-The-Line Deductions

Above-the-line deductions happen on the first page of your tax return. These deductions reduce your gross income to eventually reach your AGI (adjusted gross income) for the year. Above-the-line deductions include:

• Contributions to health savings accounts

• Contributions to retirement plans

• Deduction for one-half of the self-employment taxes

• Health insurance premiums paid

• Alimony paid, student loan interest, and a few others

The AGI is important because the AGI is used to determine your eligibility for certain tax credits and it will also have an impact on which below-the-line deductions you are eligible for. In general, the lower your AGI is, the more deductions and credits you are eligible to receive.

Below-The-Line Deductions

Below-the-line deductions are reported on lines that come after the AGI calculation. They are comprised mainly of your “standard deduction” or “itemized deductions” and “personal exemptions” (most of which will be gone starting in 2018). The 20% deduction for qualified business income will fall into this below-the-line category. It will lower the income of small business owners but it will not lower their AGI.

However, it was stated in the tax legislation that even though the 20% qualified business deduction will be a below –the-line deduction it will not be considered an “itemized deduction”. This is a huge win!!! Why? If it’s not an itemized deduction, then small business owners can claim the 20% qualified business income deduction and still claim the standard deduction. This is an important note because many small business owners may end up taking the standard deduction for the first time in 2018 due to all of the deductions and tax exemptions that were eliminated in the new tax bill. The tax bill took away a lot of big deductions:

• Capped state and local taxes at $10,000 (this includes state income taxes and property taxes)

• Eliminated personal exemptions ($4,050 for each individual) (Eliminated in 2018)

  • Family of 4 = $4,050 x 4 = $16,200 (Eliminated in 2018)

• Miscellaneous itemized deductions subject to 2% of AGI floor (Eliminated in 2018)

Restrictions On The 20% Deduction

If life were easy, you could just assume that I'm a sole proprietor, I make $100,000 all in pass-through income, so I will get a $20,000 deduction and only have to pay tax on $80,000 of my income. For many small business owners it may be that easy but what's a tax law without a list of restrictions.The restriction were put in place to prevent business owners from reclassifying their W2 wages into 100% pass-through income to take advantage of the 20% deduction . They also wanted to restrict employees from leaving their company as a W2 employee, starting a sole proprietorship, and entering into a sub-contractor relationship with their old employer just to reclassify their W2 wages into 100% pass-through income.

S-Corps

Qualified business income will specifically exclude "reasonable compensation" paid to the owner-employee of an S-corp. While it would seem like an obvious reaction by S-corp owners to reduce their W2 wages in 2018 to create more pass through income, they will still have to adhere to the "reasonable compensation" restriction that exists today.

Partnerships & LLCs

Qualified business income will specifically exclude guaranteed payments associated with partnerships and LLCs. This creates a grey area for these entities. Partnerships do not have a “reasonable compensation” requirement like S-corps since companies taxed as partnerships are not allowed to pay W2 wages to the owners. Also the owners of partnerships are not required to take guaranteed payments. My guess is, and this is only a guess, that as we get further into 2018, the IRS may require partnerships to classify a percentage of a owners total compensation as a “guaranteed payment” similar to the “reasonable compensation” restriction that S-corps currently adhere too. Otherwise, partnerships can voluntarily eliminate guaranteed payments and take the 20% deduction on 100% of the pass-through income.

This may also prompt some S-corps to look at changing their structure to a partnership or LLC. For high income earners, S-corps have an advantage over the partnership structure in that the owners do not pay self-employment tax on the pass-through income that is distribution to the owner over and above their W2 wages. However, S-corp owners will have to weigh the self-employment tax benefit against the option of changing their corporate structure to a partnership and potentially receiving a 20% deduction on 100% of their income.

Sole Proprietors

Sole proprietors do not have "reasonable compensation" requirement or "guaranteed payments" so it would seem that 100% of the income generated by sole proprietors will count as qualified business income. Unless the IRS decides to enact a "reasonable compensation" requirement for sole proprietors in 2018, similar to S-corps. Before everyone runs from a single member LLC to a sole proprietorship, remember, a sole proprietorship offers no liability barrier between the owner and liabilities that could arise from the business.

Income Restrictions

There are limits that are imposed on the 20% deduction based on how much the owner makes in “taxable income”. The thresholds are set at the following amounts:

Individual: $157,500

Married: $315,000

The thresholds are based on each business owner’s income level, not on the total taxable income of the business. We need help from the IRS to better define what is considered “taxable income” for purposes of this phase out threshold. As of right now, it seems that “taxable income” will be defined as the taxpayer’s own taxable income (not AGI) less deductions.

If the owner’s taxable income is below this threshold, then the calculation is a simple 20% deduction of the pass-through income. If the owner’s taxable income exceeds the threshold, the qualified business deduction is calculated as follows:

The LESSER of:

20% of its business income OR 50% of the total wages paid by the business to its employees

Let’s look at this in a real life situation. A manufacturing company has a net profit of $2M in 2018 and pays $500,000 in wages to its employees during the year. That company would only be able to take the qualified business income deduction for $250,000 since 50% of the total employee wages ($500,000 x 50% = $250,000) are less than 20% of the net income of the business ($2M x 20% = $400,000).

This creates another grey area because it seems that the additional calculation is triggered by the taxable income of each individual owner but the calculation is based on the total profitability and wages paid by the company. For the owners that required this special calculation for exceeding the threshold, how is their portion of the lower deduction amount allocated? Multiplying the lower total deduction amount by the percent of their ownership? Just more unanswered questions.:

Restrictions For "Service Business"

There will be restrictions on the 20% deduction for pass-through entities that are considered a "service business" under IRC Section 1202(e)(3)(A). The businesses specifically included in this definition as a services business are:

• Health

• Law

• Accounting

• Actuarial Sciences

• Performing Arts

• Consulting

• Athletics

• Financial Services

• Any other trade or business where the principal asset of the business is the reputation or skill of 1 or more of its employees

In a last minute change to the regulations, to their favor, engineers and architects were excluded from the definition of “service businesses”.

This is another grey area. Many small businesses that fall outside of the categories listed above will undoubtedly be asking the question: “Am I considered a service business or not?” Outside of the industries specifically listed in the tax bill, we really need more guidance from the IRS.

If you are a “services business”, when the tax reform was being negotiated it looked like service businesses were going to be completely excluded from the 20% deduction. However, the final regulations were more kind and instead implemented a phase out of the 20% deduction for owners of service businesses over a specified income threshold. The restriction will only apply to those whose “taxable income” exceeds the following thresholds:

Individual: $157,500

Married: $315,000

If you are a consultant or owner of a services business and your taxable income is below these thresholds, it would seem at this point that you will be able to capture the 20% deduction for your pass-through income. As mentioned above, we need help from the IRS to clarify the definition of “taxable income”.

Phase Out For Service Businesses

The amounts listed above: $157,500 for individual and $315,000 for a married couple filing joint, are where the thresholds for the phase out begins. The service business owners whose income rises above those thresholds will phase out of the 20% deduction over the next $50,000 of taxable income for individual filers and $100,000 of taxable income for married filing joint. This means that the 20% pass-through deduction is completely gone by the following income levels:

Individual: $207,500

Married: $415,000

Any taxpayer’s falling in between the threshold and the phase out limit will receive a portion of the 20% deduction.

Since the thresholds are assessed based on the taxpayer’s own taxable income and not the total income of the business, a service business could be in a situation, like in an accounting firm, where the partners with the largest ownership percentage may not qualify for 20% deduction but the younger partners may qualify for the deduction because their income is lower.

Tax Planning For 2018

It's an understatement to say that most small business owners will need to spend a lot of time with their accountant in the first quarter of 2018 to determine the best of course of action for their company and their personal tax situation.While we are still waiting for clarification on a number of very important items associated with the 20% deduction for qualified business income, hopefully this article has provided our small business owners with a preview of things to come in 2018.

Disclosure: I'm a Certified Financial Planner® but not an accountant. The information contained in this article was generated from hours and hours of personal research on the topic. I advise each of our readers to consult with your personal tax advisor for tax advice.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: Summary Of The Changes

The conference version of the tax bill was released on Friday. The House and the Senate will be voting to approve the updated tax bill this week with what seems to be wide spread support from the Republican party which is all they need to sign the bill into law before Christmas. Most of the changes will not take effect until 2018 with new tax rates for individuals set to expire in 2025. At which time the tax rates and brackets will return to their current state. Here is a run down of some of the main changes baked into the updated tax bill:

Individual Tax Rates

They are keeping 7 tax brackets with only minor changes to percentages in each bracket. The top tax bracket was reduced from 39.6% to 37%.

Capital Gains Rates

There were no changes to the capital gains rates and they threw out the controversial mandatory FIFO rule for calculating capital gains tax when selling securities.

Standard Deduction and Personal Exemptions

They did double the standard deduction limits. Single tax payers will receive a $12,000 standard deduction and married couples filing joint will receive a $24,000 standard deduction.The personal exemptions are eliminated.

Mortgage Interest Deduction

New mortgages would be capped at $750,000 for purposes of the home mortgage interest deduction.

State and Local Tax Deductions

State and local tax deduction will remain but will be capped at $10,000. An ouch for New York State. That $10,000 can be a combination of your property tax and either sales or income tax (whichever is larger or will get you to the cap of $10,000).Oh and you cannot prepay your 2018 state income taxes in 2017 to avoid the cap. They made it clear that if you prepay your 2018 state income taxes in 2017, you will not be able to deduct them in 2017.

Medical Expense Deductions

Medical expense deductions will remain for 2017 and 2018 and they lowered the AGI threshold to 7.5%. Beginning in 2019, the threshold will change back to the 10% threshold.

Miscellaneous Expense Deductions

Under the current rules, you are able to deduct miscellaneous expenses that exceed 2% of your AGI. That was eliminated. This includes unreimbursed business expenses and home office expenses.

A Few Quick Ones

Student Loan Interest: Still deductible

Teacher Out-of-Pocket Expenses: Still deductible

Tuition Waivers: Still not taxable

Fringe Benefits (including moving expenses): Will be taxable starting in 2018 (except for military)

Child Tax Credit: Doubled to $2,000 per child

Gain Exclusion On Sale Of Primary Residence: No Change

Obamacare Individual Mandate: Eliminated

Corporate AMT: Eliminated

Individual AMT: Remains but exemption is increased: Individuals: $70,300 Married: $109,400

Corporate Tax Rate: Drops to 21% in 2018

Federal Estate Tax: Remains but exemption limit doubles

Alimony

For divorce agreements signed after December 31, 2018, alimony will no longer be deducible. This only applies to divorce agreements executed or modified after December 31, 2018.

529 Plans

Under current tax law, you do not pay taxes on the earnings for distributions from 529 accounts for qualified college expenses. The new tax reform allows 529 account owners to distribute up to $10,000 per student for public, private and religious elementary and secondary schools, as well as home school students.

Pass-Through Income For Business

This is still a little cloudy but in general under the conference bill, owners of pass-through companies and sole proprietors will be taxed at their individual tax rates less a 20% deduction for business-related income, subject to certain wage limits and exceptions. The deduction would be disallowed for businesses offering "professional services" above a threshold amount; phase-ins begin at $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Attention Middle Class: The End Is Near

I'm not a fan of conspiracy theories and I'm not a fan of "doom and gloom" articles. However, I feel compelled to write this article because I want people to be aware of a trend that is unfolding right now in our economy. This trend will strengthen over time, we will cheer for it as it's happening, but like many great things in history, it may have an unintended consequence. I fear that the unintended consequence of this new trend will be the elimination of the U.S. middle class.

More Profits

I’m an investment advisor so I naturally love a strong bull market that results in large investment gains for our clients. The stock market generally goes up when companies are more profitable than the consensus expects. Higher profits equal higher stock prices which equal more wealth for investors. Corporations have become laser-focused on findings new ways to increase profits. This is important because businesses that struggle to make profits and have constant losses are not so successful and will probably end up shutting down in the near future, according to websites like https://www.laraedo.com/signs-that-my-business-is-ripe-for-a-shutdown/. The equation for net profit is easy:

Revenue – Expenses = Net Profit

Let me ask you this question: What is typically a company’s largest expense?

Answer: Payroll. Said another way, the employees. Salaries, benefits, the building to house the employees, training, workers comp, payroll taxes, and the list goes on and on. If you are the owner of a company that makes cell phones and I told you that I have a way that you can make TWICE as many cell phones with HALF the number of employees, what do you think is going to happen to profits? Up!!! In a big way.

The scenario that I just described is not something that might happen in the future, it’s something that is happening right now. Here is the data to support it.

The chart below compares the 10 largest companies in the S&P 500 Index in 1990 to the 10 largest companies in the S&P 500 in 2016. First, you may notice that none of the companies that were the largest in 1990 remained on the list in 2016. But here is the trend that I want to point out. When you look at the 10 largest companies in 1990, they produced $368 Billion dollars of revenue and employed 1.4 Million workers. Fast forward to 2016, the top 10 largest companies produced $1.2 Trillion dollars in revenue and employed about 1.6 Million workers. Now let’s do some quick math, between 1990 and 2016 the gross revenue of the largest 10 companies in the S&P 500 increased by 239% but the number of workers employed by those companies only increased by 14%. Companies are already doing more with less people.

Just when you thought things were going good for the company, I now come to you, the owner of the company, and tell you I have a way to make profits double within the next 3 years. Are you interested? Of course you are. All we have to do is buy these three machines that will replace another 50% of the employees. These machines work 24 hours a day, don’t need health insurance, don’t get sick, and we can move to a smaller building which will reduce rent by 60%. How is that possible? Welcome to the party…..artificial intelligence.

Not A Terminator Movie

What do we think of when we hear the words “artificial intelligence”? Terminators!! Fortunately for us that’s not the artificial intelligence that I’m referring too. But a machine that thinks and learns from its mistakes? The human mind is not as unique as we would like to think it is. Just take a Myers Briggs personality test. You answer 100 questions and then it tells you how you react to things, what annoys you, what your strengths are, how you communicate, and what you have difficulties with. It’s kind of scary as you read the results and realize “Yup. That’s me”

Think about it. Google may know more about you than your spouse. What do you want for Christmas? Your spouse may not know but Google knows all of the items that you looked at over the past 3 months, what items you spent the most time looking at, did you click on the description to read more, and what other items did you look at after you click on the initial item. It tells Google how you search for information. Also Google acknowledges that we all search for things differently and what we are searching for tells Google more about us. Essentially Google learns at little bit more about you every time you search for something via their website.

What about a machine that can respond to questions and it sounds just like a person when it speaks? Oh and it speaks perfect English. No more overseas call centers with people you can’t understand. With most call centers, there are probably 20 questions that represent 80% of all the questions asked. If the machine is unable to answer the question, it automatically routes that call to a living, breathing person. The programmers of the machines are notified when a question triggers a transfer to a live person, they listen to the call, and then update the software to be able to answer the question the next time it is asked. The easy math, this could reduce the number of customer service representatives that the company needs to employ by 80%. Oh and the number of employees will continue to decrease as the machines learn to answer more questions and the software gets more sophisticated.

While a company may go this direction to reduce expenses, we as the consumer will also champion this change. Think about how painful it is to call the cable company. What if I told you that when you call you won’t have to wait on hold, the “person” that you are speaking to will know how to resolve your problem, and you will be off the phone in less than 2 minutes. Time is a valuable commodity to us. Fix my problem and fix it quickly. If a machine can do that better than a real person, be my guest. If companies want it and we as the consumer want it, how fast do you think it’s going to happen?

I Can't Be Replaced By A Machine.....Wrong

While we will cheer how the new A.I. technology saves us time and makes life easier, many of us will have the hubris that “a machine can’t do what I do?”. While a machine may not be able to replace 100% of what you do, could it replace 50%? It’s going to be presented like this, “you know all of those daily tasks that you don’t like to do: paperwork, scanning forms, payroll, and preparing financial reports for the weekly managers meeting. Well you don’t have to do those anymore.” Yes!!!! Oh and more good news you don’t have to train a new employee to complete those tasks and wonder if they are going to leave a year from now and have to train someone else.

Programming a machine to complete a task is not too different from training a new employee. When you hire a new employee many of them may know very little about your industry, they have no idea how your company operates, how to answer tough questions from prospects, etc. You have to train them or “program” them. Then they learn on the job from there. The value of having 20 years of experience is you have seen many difficult situations throughout your career and you learned from your past experiences. The next time the same or similar problem surfaces you know how to react. Normally what you do is you teach those lessons to each new manager and employee over and over again. That takes time. What if you only had to teach that lesson one more time and every new employee already knew how to react in the same tough situation? That’s artificial intelligence.

My point, this trend will not be limited to just manufacturing or customer services. This new technology will eventually impact each of our careers in some way, shape, or form.

3 Stages

I expect this to happen in three stages.

Stage 1: Companies do MORE with only a FEW MORE employees

Stage 2: Companies do MORE with the SAME number of employees

Stage 3: Companies do MORE with LESS employees

We are already through Stage 1 and we are entering Stage 2. How long will it be before we reach stage 3? That’s anyone’s guess. But with most evolution, Stage 1 takes the longest and the following stages evolve more rapidly. If Stage 1 took 16 years, my guess would be that stage 3 will be here a lot sooner than we think.

So What Happens To All Of The Employees?

The million dollar question and I don't know the answer. If I had to guess, the current middle class is going to be divided into two. Half of the middle class is going move up into the "upper class" and the other half will be "unemployed". The level of education will be the dividing line. Companies will continue to do more with less people. The only way to stop it is to tell companies that need to stop trying to be more profitable. Good luck. Our entire economy is built on the premise that you should accumulate as much as you can as fast as you can.

War and Conflict

When I look back in history, major conflicts arise when there is a large deviation between the “Have’s” and the “Have Not’s”. The fancy name that is used today is “income inequality”. When you have a robust middle class, everyone has something to lose if a conflict arises because that conflict generally disrupts the current system, uncertainty prevails, the economy goes into a recession, people lose their job, and they in turn cannot make their mortgage payment.

If instead, a majority of the population is unemployed and they can’t find a job because the jobs don’t exist anymore, that group of individuals has nothing to lose by burning the current system to the ground and rebuilding a new one from the ashes. I know that sounds dark but there is no arguing the gap between the Have’s and the Have Not’s is getting larger. Just look at the labor participation rate:

The Labor Participation Rate answers the question, how many people in the U.S. that could be working either are working or are looking for work? If there are individuals who could work, don’t have a job, and stop looking for work, they drop out of the labor force which decrease the labor participation rate because there are less citizens participating on the work force. As you can see in the chart above, in 2006 the labor participation rate was around 66%, and while we continue to experience one of the longest economic expansions of all time, the labor participation rate is still lower now than it was prior to the beginning of the economic recovery. Remember we are in an expansion and it has dropped by about 3%. What do you think will happen when we hit the next recession? While the baby boomer generation has had an impact on these numbers as you can see based on the large percentage of that decrease attributed to an “aging population”. Traditionally when someone retires, the company will promote the person below them and then hire another person to fill there spot. As many of us know, that’s not how it works anymore. Now that key employee retires, the company promotes one person into their role, but instead of hiring a new employee they just redistribute the work to the current staff. If anything, the baby boomer generation moving into retirement has made this transition to “do more with less people” easier on companies because they don’t have to fire anyone.

Tax Reform Will Accelerate The Trend

If you combine tax reform with the current 4.1% employment rate, I would expect this to accelerate the development of artificial intelligence. Companies are going to have cash from the tax savings to reinvest into new technologies which includes artificial intelligence. If the economy continues to grow at its current 2% pace or accelerates, one would expect consumption to increase which increases the demand for products and services. With the unemployment rate at 4.1%, we are already at "full employment". There are not enough qualified workers for companies to hire to meet the increase in demand for their product or service. The answer, let's accelerate the development of artificial intelligence that will allow the company to enter Phase 2 which is "Do MORE with the SAME number of workers".

People Will Cheer

These advances in technology are potentially setting the stage for levels of profitability that companies have only dreamed of. Higher profits traditionally equal higher stock prices. Investors will cheer this!! It may even lead us to the longest economic expansion of all time. In the short term, investors may have a lot to be excited about but we may look back years from now and realize that we were unintentionally cheering for the end of the middle class as we know it.

Again, this article is not meant to be a “dark cloud” or a new conspiracy theory but rather to keep our readers aware of the world that is changing rapidly around us. Like many of the economic challenges that the U.S. economy has experienced in the past, the hazard was in plain view, but investors failed to see it because they got caught up in the moment. When investing, it’s ok to take advantage of short term gains but never lose sight of the big picture.

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

A Lesson From Bitcoin

I'm not writing this article to predict whether Bitcoin is going to $0 or $50,000. I have no idea whether it's going to go up or down from here. But I have had countless conversations with clients and friends over the past few weeks which starts like this "What do you think about Bitcoin?"

My response is, before you make any type of investment, you should be able to answer the following questions. If you can't answer these questions with confidence, you probably should not be investing in it.

"Explain It To Me In 30 Seconds"

Investing is as much of an art as it is a science which is why you can ask three different investment advisors about the same investment and get three different answers. While the full analysis of an investment can be complex and require a thorough understanding of markets, equity analysis, and financial reports, seasoned veterans have mastered their craft and have a way of simplifying the process. One of the lessons that I learned from my mentor and that I continue to apply to selecting investments today is "If you can't explain it to me in less than 30 seconds, I don't want to have anything to do with it."Before investing in anything, you should:

• Develop an investment thesis

• Identify the risks

• Identify competitors

• Know at what price to sell at

Let's look at each of these items and how they apply to the Bitcoin situation.

Develop an investment thesis

An investment thesis answers the question, why are you committing money to that particular investment? When buying a stock, you try to identify companies that have strong management, good cash flow, a promising new product or service, expanding market share, and a competitive advantage with the expectation that the company will outperform a given benchmark.

“Because I think it will go up” is not an investment thesis. You have to include in your investment thesis items that can be measured. If for example, I decide to invest in a cell phone company because they are expected to expand into China, India, and increase their market share over the next 3 years by 50%. I have identified a clear and measurable reason why I have chosen to invest in that company.

Bitcoin poses a challenge in this sense. When you invest in a company, you are essentially investing in the future cash flow that is expected to be produced by that company. Which is why the price to earnings ratio is often used to determine if a company is “reasonably priced”. Bitcoin is a currency that does not produce future cash flow so what metrics can you build into an investment thesis that will allow you to measure your expected outcome? I have yet to hear a good answer to that question. An “expert” making a prediction that Bitcoin is going to $30,000 is not a great metric to use. Remember, price appreciation is a by product of the improvement of the underlying financial drivers of an investment. If you can’t identify what those financial drivers are, price is irrelevant.

Identify the risks

Before making any investment, you should be able to take out a sheet of paper and list of the risks to your investment thesis. If you don’t know the risks, how do you know when to get out of that investment? In my cell phone company example, I bought that stock because I expected that company to gain 50% of the cell phone market share in China & India over the next 3 years. What are the risks to that investment thesis?

• Currency risk: The value of the U.S. dollar increases versus the local currency decreasing profits

• Execution risk: They do not successfully execute their strategy. It takes 5 years instead of 3.

• Political risk: The Chinese government assumes ownership of the company

• Market risk: The global economy goes into a recession

• Competitor risk: Another reputable cell phone company enters that market

• Management risk: The current CEO leaves the company and the new CEO takes the company in a different direction

• Cash flow risk: The company takes on too much debt trying to expand and has to scale back

While everyone goes into a new investment with the hopes and dreams that it is the next Apple, you have to be able to identify what could send your great investment tumbling to the ground.

Can you list all of the risks associated with Bitcoin? It could go to zero but that’s true of any investment. With many new technologies, services, currencies, and medical devices, you have too unfortunately accept the fact that all of the risks associated with that investment are probably not known. It does not necessarily mean it’s a bad investment since most breakthrough technology and products are met with resistance and then uniformly accepted by the masses down the road. But it does imply that the investment comes with a much higher level of risk because a greater number of unknowns exists and you have to be able to live with the fact that it has just as much of a chance of going up by 100% as it does going to zero. While this line of thinking may not completely deter you from making a particular investment, it will hopefully influence the amount that you decide to commit to riskier investments.

Identify Competitors

When identifying competitors, my first question is usually "how large are the barriers to entry into are particular product or market?" The larger the barriers to entry, the longer it takes competitors to catch up to the market leaders. It would seem in the case of Bitcoin, that the barriers to entry for cryptocurrencies are fairly low. I'm already starting to hear the buzz at holiday parties about "ICO's" which stands for Initial Coin Offering. If I were looking to invest in Bitcoin, I would be asking the questions:

• Who are the other main stream cryptocurrencies?

• Do they have a competitive advantage over Bitcoin?

• What would entice someone to switch from Bitcoin to another cryptocurrency?

• How large is the cyptocurrency market?

• Will regulations eventually come into play and create barriers to entry?

How many people that invested in Bitcoin do you think can answer these questions? My guess is not many. That in itself is risky.

Knowing At What Price To Sell

Of all the investment criteria that I have listed so far, I think this one is the most problematic when it comes to Bitcoin. When making any investment, you have to be able to answer the question: “Based on all of the information that I have today, at what price should I sell it at?” If I own a rental property and it’s fair market value is $250,000 and I collect $15,000 per year in rent, if someone offered me $300,000 to buy my rental property should I sell it? To answer that question, I would map out all of the income that I expect to receive from that property over my lifetime and apply a reasonable appreciation rate of the property value itself. It’s a similar process in evaluating a stock. You are looking at the annual earnings of the company and what you expect those earnings to be in the future. Both of these examples, like most investments, generate future cash flow and have reasonable appreciation rates that can be applied. With Bitcoin, as I mentioned earlier, there is no future cash flow. It’s value right now is being set based on what the next person is willing to buy it for. If one day people wake up and decide I don’t want to buy your Bitcoin or provide you with any good or services in exchange for your Bitcoin, there is nothing there. There are no earnings, there are no products, there are no services, there are no brick and mortar buildings, it’s vapor. With traditional currency, like the U.S. dollar, you have the taxing power and the assets of the United States government confirming that the dollar bill in your hand is worth something

So if I decide to buy Bitcoin today at $14,000 per coin, at what dollar amount should I sell it because it has become overvalued? I have no idea how anyone answers that question at this point. That’s problematic because if I start to make money, the difficult decision is “when do I get out?” When investing, it’s very easy to sell investments that have lost money. It’s emotionally much more difficult to sell your winners. So again, if I buy Bitcoin today and it goes to $30,000, do I sell it? Does it keep going to $50,000? I have absolutely nothing to based that on and that’s a problem.

Remember The Tulips

The single most important take away from this articles is "make sure you understand what you are investing in". If you can't explain it in less than 30 seconds, you probably should not be investing in it. Specific to Bitcoin, I use the saying, history does not repeat itself but it does rhyme. Some of the rhyming took place in the 1600's in the form of the Tulip bubble. In the Netherlands, during the Tulip mania, the cost of a tulip equaled to the cost of a house. Don't believe it? Just take a stroll down history lane. Here's the article: Tulip Mania

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Do I Make Too Much To Qualify For Financial Aid?

If you have children that are college-bound at some point you will begin the painful process of calculating how much college will cost for both you and them. However, you might be less worried about the financial aspects of your child going to college after viewing some of the Bloomsburg student apartments for rent on the market at the moment. Anyway, I have heard the statement, "well they will just have to take loans" but what parents don't realize is loans are a form of financial aid. Loans are not a given. Whether your children plan to attend a public college or private college, both have formulas to determine how much a family is expected to pay out of pocket before you even reach any "financial aid" which includes loans.

College Costs Are Increasing By 6.5% Per Year

The rise in the cost of college has outpaced the inflation rate of most other household costs over the past three decades.

college costs

To put this in perspective, if you have a 3 year old child and the cost of tuition / room & board for a state school is currently $25,000 by the time that child turns 17, the cost for one year of tuition / room & board will be $60,372. Multiply that by 4 years for a bachelor's degree: $241,488. Ouch!!! Which leads you to the next question, how much of that $60,372 per year will I have to pay out of pocket?

FAFSA vs CSS Profile Form

Public schools and private school have a different calculation for how much “aid” you qualify for. Public or state schools go by the FAFSA standards. Private schools use the “CSS Profile” form. The FAFSA form is fairly straight forward and is applied universally for state colleges. However, private schools are not required to follow the FAFSA financial aid guidelines which is why they have the separate CSS Profile form. By comparison the CSS profile form requests more financial information.

For example, for couples that are divorced, the FAFSA form only takes into consideration the income and assets of the parent that the child lives with for more than six months out of the year. This excludes the income and assets of the parent that the child does not live with for the majority of the year which could have a positive impact on the financial aid calculation. However, the CSS profile form, for children with divorced parents, requests and takes into consideration the income and assets of both parents regardless of their marital status.

Expected Family Contribution

Both the FAFSA and CSS Profile form result in an "Expected Family Contribution" (EFC). That is the amount the family is expected to pay out of pocket for their child's college expense before the financial aid package begins. Below is a EFC award chart based on the following criteria:

• FAFSA Criteria

• 2 Parent Household

• 1 Child Attending College

• 1 Child At Home

• State of Residence: NY

• Oldest Parent: 49 year old

income versus financial aid

As you can see in the chart, income has the largest impact on the amount of financial aid. If a married couple has $150,000 in AGI but has no assets, their EFC is already $29,265. For example, if tuition / room and board is $25,000 for SUNY Albany that means they would receive no financial aid.

Student Loans Are A Form Of Financial Aid

Most parents don't realize the federal student loans are considered "financial aid". While "grant" money is truly "free money" from the government to pay for college, federal loans make up about 32% of the financial aid packages for the 2016 – 2017 school year. See the chart below:

grants and student loans

Start Planning Now

The cost of college is increasing and the amount of financial aid is declining. According to The College Board, between 2010 – 2016, federal financial aid declined by 25% while tuition and fees increased by 13% at four-year public colleges and 12% at private colleges. This unfortunate trend now requires parents to start running estimated EFC calculation when their children are still in elementary school so there is a plan for paying for the college costs not covered by financial aid. 

About Michael.........

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

How Much Should I Budget For Health Care Costs In Retirement?

The number is higher than you think.  When you total up the deductibles and premiums for Medicare part A, B, and D, that alone can cost a married couple $7,000 per year.  We look at that figure as the baseline number. That $7,000 does not account for the additional costs associated with co-insurance, co-pays, dental costs, or Medigap insurance premiums which can quickly increase the overall cost to $10,000+ per year.

Tough to believe? Allow me to walk you through the numbers for a married couple.

Medicare Part A:  $2,632 Per Year

Part A covers inpatient hospital stays, skilled nursing facility stays, some home health visits, and hospice care.  While Part A does not have an annual premium, it does have an annual deductible for each spouse.  That deductible for 2017 is $1,316 per person.

Medicare Part B:  $3,582

Part B covers physician visits, outpatient services, preventive services, and some home health visits.  The standard monthly premium is $134 per person but it could be higher depending on your income level in retirement.   There is also a deductible of $183 per year for each spouse.

Medicare Part D:  $816

Part D covers outpatient prescription drugs through private plans that contract with Medicare.  Enrollment in Part D is voluntary. The benefit helps pay for enrollees’ drug costs after a deductible is met (where applicable), and offers catastrophic coverage for very high drug costs.  Part D coverage is actually provided by private health insurance companies.   The premium varies based on your income and the types of prescriptions that you are taking.  The national average in 2017 for Part D premiums is $34 per person.

If you total up just these three items, you reach $7,030 in premiums and deductibles for the year.  Then you start adding in dental cost, Medigap insurance premiums, co-insurance for Medicare benefits, and it quickly gets a married couple over that $10,000 threshold in health and dental cost each year. Medicare published a report that in 2011, Medicare beneficiaries spent $5,368 out of their own pockets for health care spending, on average.  See the table below.

Start Planning Now

Fidelity Investments published a study that found that the average 65 year old will pay $240,000 in out-of-pocket costs for health care during retirement, not including potential long-term-care costs.   While that seems like an extreme number, just take the $10,000 that we used above, multiply that by 20 year in retirement, and you get to $200,000 without taking into consideration inflation and other important variable that will add to the overall cost.

Bottom line, you have to make sure you are budgeting for these expenses in retirement.  While most individuals focus on paying off the mortgage prior to retirement, very few are aware that the cost of health care in retirement may be equal to or greater than your mortgage payment.  When we are create retirement projections for clients we typically included $10,000 to $15,000 in annual expenses to cover health care cost for a married couple and $5,000 – $7,500 for an individual.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Reform: Your Company May Voluntarily Terminate Your Retirement Plan

Make no mistake, your company retirement plan is at risk if the proposed tax reform is passed.  But wait…..didn’t Trump tweet on October 23, 2017 that “there will be NO change to your 401(k)”?  He did tweet that, however, while the tax reform might not directly alter the contribution limits to employer sponsored retirement plans, the new tax rates will produce a “disincentive” for companies to sponsor and make employer contributions to their plans.

What Are Pre-Tax Contributions Worth?

Remember, the main incentive of making contributions to employer sponsored retirement plans is moving income that would have been taxed now at a higher tax rate into the retirement years, when for most individuals, their income will be lower and that income will be taxed at a lower rate.   If you have a business owner or executive that is paying 45% in taxes on the upper end of the income, there is a large incentive for that business owner to sponsor a retirement plan.  They can take that income off of the table now and then realize that income in retirement at a lower rate.

This situation also benefits the employees of these companies.  Due to non-discrimination rules, if the owner or executives are receiving contributions from the company to their retirement accounts, the company is required to make employer contributions to the rest of the employees to pass testing. This is why safe harbor plans have become so popular in the 401(k) market.

But what happens if the tax reform is passed and the business owners tax rate drops from 45% to 25%?  You would have to make the case that when the business owner retires 5+ years from now that their tax rate will be below 25%.  That is a very difficult case to make.

An Incentive NOT To Contribute To Retirement Plans

This creates an incentive for business owners NOT to contribution to employer sponsored retirement plans.  Just doing the simple math, it would make sense for the business owner to stop contributing to their company sponsored retirement plan, pay tax on the income at a lower rate, and then accumulate those assets in a taxable account.  When they withdraw the money from that taxable account in retirement, they will realize most of that income as long term capital gains which are more favorable than ordinary income tax rates. 

If the owner is not contributing to the plan, here are the questions they are going to ask themselves: 

• Why am I paying to sponsor this plan for the company if I’m not using it?

• Why make an employer contribution to the plan if I don’t have to?

This does not just impact 401(k) plans. This impacts all employer sponsored retirement plans: Simple IRA’s, SEP IRA’s, Solo(k) Plans, Pension Plans, 457 Plans, etc.

Where Does That Leave Employees?

For these reasons, as soon as tax reform is passed, in a very short time period, you will most likely see companies terminate their retirement plans or at a minimum, lower or stop the employer contributions to the plan.  That leaves the employees in a boat, in the middle of the ocean, without a paddle.  Without a 401(k) plan, how are employees expected to save enough to retire?  They would be forced to use IRA’s which have much lower contribution limits and IRA’s don’t have employer contributions.

Employees all over the United States will become the unintended victim of tax reform.  While the tax reform may not specifically place limitations on 401(k) plans, I’m sure they are aware that just by lowering the corporate tax rate from 35% to 20% and allowing all pass through business income to be taxes at a flat 25% tax rate, the pre-tax contributions to retirement plans will automatically go down dramatically by creating an environment that deters high income earners from deferring income into retirement plans.   This is a complete bomb in the making for the middle class.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.