What You Can Do Before the Kiddie Tax Loophole Closes

When President Bush signed new legislation in May to limit gifts to children that take advantage of their lower tax rate, it was the second time in just over 12 months that Congress extended the reach of the so-called kiddie tax, which subjects a child’s income to his/her parents’ higher tax rate.

Maneuvering around the kiddie tax has helped parents save for college educations for years, and given the changes, it’s a good idea to consult a financial or tax adviser to discuss your options.

Congress apparently got fed up with a particular tax strategy used by wealthy families who transfer large piles of stock, mutual fund shares and other assets to their kids (who are typically in the lowest two income brackets of 10 percent and 15 percent) so they could sell those securities at a low capital gains rate. The top rate on long-term capital gains and qualified corporate dividends is 15 percent, but since 2003, those in the lowest two income brackets had a shot at a 5 percent capital gains, which is scheduled to drop to zero for those low-income taxpayers in 2008.

So here’s what’s happening this year and next. During 2007, investment income for a child 17 years old or younger (measured as of Dec. 31, 2007) above $1,700 is subject to his parents’ higher tax rate. (Before 2006’s changes in the law, the kiddie tax applied only to kids younger than 14.)

Starting in 2008, the age limit for the kiddie tax will rise to 18 and under, or 23 and under if the child is a full-time student. There are some exceptions for kids with paid jobs – the expanded provision applies only to children whose earned income does not exceed one-half of the amount of their support needs.

What you can do now

If you had put appreciated securities in your child’s name and the child is a full-time student under the age of 23 but at least 18, your child can sell those securities this year and still claim the 5 percent capital gains rate. There won’t be a zero capital gains rate available to your student next year, so you need to act before the end of the year to take advantage of the 5 percent rate before it becomes the parents’ 15 percent rate in 2008 via the kiddie tax.

You may also want to start or redouble your efforts in the 529 college savings plans you’ve set up for your kids. Qualified withdrawals for education are tax-free and therefore wouldn’t be subject to the kiddie tax. The same is true for qualified withdrawals from Coverdell education savings accounts.

Outside of 529 plans, you might consider investments that generate little or no taxable income such as municipal bonds.

Watch out for financial aid

Whatever gift and tax strategies you apply to your college savings strategy, make sure those assets don’t undermine any efforts your child is making to secure financial aid.


October 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by, a local member of FPA.

Couplepreneurs: Starting a Business with Your Better Half Can Reap Huge Rewards – And Unique Problems

It’s a familiar scene: A couple comes home after a long day at their respective workplaces. They spend their takeout dinner recapping the day and how much they hate their jobs. In a brainstorm, they decide to start a business where they’ll be able to determine every step of their future from now on.

After all, they love each other – why shouldn’t they be able to work and live together?

For many couples, this major decision is the ticket to wealth, self-determination and happiness. For others, it can lead to severe financial and relationship stress. Such a move takes more than planning – it requires a full assessment of your personalities and your money issues to determine whether working and living side-by-side is right for you. A good start is a visit to a trusted financial adviser.

Here are some key steps to consider:

Give yourselves a timetable to startup: You might be tempted to give notice tomorrow morning, but it’s much wiser to lay out a timetable over the coming months with specific components:

Study the viability of your business model: Talk about worst-case scenarios. Bring in some trusted advisers to ask tough questions of what you’re planning to do and the viability of your idea. Convincing each other you’ll make it work isn’t enough. You need to understand the marketplace you’re walking into and the roles each of you will fill in its success. Most of all be realistic about your workload and when you can get breaks.

Understand how your tax situation will change: Depending which business structure you choose – and you should get tax and legal advice on this before you start -- you will need to plan for income tax and self-employment tax and payroll taxes, if applicable. Payroll tax requirements are more stringent than income taxes.

Set a budget for your business and personal life: A planner can help you establish a budget for supporting your business as well as your life at home that will make cash flow more predictable. Conserving cash is critical in the startup phase of any business so critical long-term goals can be met. Couples need an emergency fund of six months to a year of expenses since successful businesses take months or years to turn a real profit. And if the two of you haven’t revised your estate plan to accommodate the business, it’s time to make that plan now.

Plan for your kids in the business. There may be very cost-effective ways to employ children in the business for work commensurate with their skills.

Get your insurance in order: Before you leave your current employer, figure out the cost of insurance you’ll need to take on for the entire family if you take on health, life, home, business, disability and if you’re over 50, long-term care coverage. These expenses may be enough to encourage one of you to stay at your old job at least for a while to keep those benefits going while the other devotes more time to the startup.

Set targets: Talk through critical milestones of the business – both good and bad. Do a proper business plan with income and cash projections. Decide what factors would lead to expansion or closing your doors. If you’re doing so well that potential buyers of the business start sniffing around, figure out a point in advance at which you’d sell.

Talk about an exit plan if you break up: It may be hard to imagine now, but a breakup of your relationship with no financial plan for the business can be devastating. Whether you’re married or living together, a successful business is an important source of wealth, and you need to plan for the day one side of the relationship wants out and potentially wants to buy the business or be bought out. If one spouse put more capital into the business than the other, provisions should be made to safeguard that investment.

Write it down: Documents and legal covenants are important – make sure you have the right ones in place.


October 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by, a local member of FPA.

Thinking About Borrowing from Family or Friends? Do It The Right Way.

Whether it’s for a business, a home or a new car, there’s something very attractive about the idea of asking friends or family for a loan. Nobody’s worried about a credit check or the other lengthy documentation and you can still hang out with your lenders at the holidays.

In 2005, the National Association of Realtors reported that about 9 percent of first-time homebuyers made their purchase with help from a friend or relative, up from 5 percent in 1999. About 25 percent of new homebuyers get money from a relative or friend, a portion that’s remained fairly constant over the past decade.

Yet there are good and bad aspects to private loans. The good news first:

• Terms can be significantly friendlier than a borrower would qualify for in the open market. For example, the rate charged on the loan can be higher than the lender would receive in a deposit account but lower than the borrower would pay a commercial lender.
  
• They can require little or no collateral.
  
• It’s a way to keep money in the family.
  
• It’s a way for a borrower to be able to buy a home, a car or other critical assets even if they have a poor credit rating.
  
• There’s no loss of tax benefits to the borrower or lender if an agreement in the case of a mortgage loan is structured and reported properly.

Then the bad news:

• Unclear agreements can lead to missed payments or default.
  
• If the borrower dies suddenly, the lender’s investment may be lost if the agreement isn’t structured correctly. A properly executed promissory note is still an obligation of the estate, and may continue to be paid to an heir or other person or entity based on the terms as agreed.
  
• Jealous relatives could say they weren’t treated fairly.
  
• Disagreements between borrower and lender could kill an important relationship.
  

The best arrangements are formal – written in proper legal language, notarized and recorded in the county where the property resides. A financial adviser can talk to both parties about what such loans – particularly real estate loans – can mean for their respective finances. It also makes sense for both parties to visit their respective tax professionals to make sure they know the correct ways to document the loan transaction over time for tax purposes.

A detailed document – prepared with the help of an attorney – can also lay out specific scenarios if either the borrower or the lender has to break or alter their agreement. Such trained experts can talk you through the benefits and pitfalls of a private loan arrangement as it affects your particular situation (either as lender or borrower) and specific laws and requirements in your state you have to follow if both borrower and lender are going to derive tax advantages from the agreement.

Generally, any private loan transaction should include a promissory note that establishes how the debt will be repaid. That’s true for business loans or loans for most types of property. In the case of a business loan, it makes sense for the potential borrower to get specific advice on how lenders in their business will be treated not only in terms of repayment, but default.

In the case of a loan made for real estate, a mortgage or “deed of trust” statement (depending on the state you live in) or an agreement specific to the type of loan that binds the property as collateral for the promissory note will be necessary. It basically says that if you don’t fulfill all the terms in the agreement the lender has the right to foreclose or repossess the property.

Even if a friend or relative makes an offer of help, it’s proper for the borrower to take the initiative to structure the arrangement in a way that’s responsible and beneficial to both. If a relative is drawing income from the loan, special provisions should be made for prepayment and other contingencies.

The most important thing to remember and plan for? When two people who are close to each other enter into such an arrangement, the most valuable thing really isn’t the money. It’s the relationship.

October 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by, a local member of FPA.

How Your Personality Affects Your Financial Decision-making

The recent volatility in the stock market has everyone a little jumpy. If you’ve never worked with a planner before, one of the first things he or she will do is make you fill out a risk analysis questionnaire.

Why is risk analysis important before you make decisions with your money? Risk tolerance is an important part of investing – everyone knows that. But the real value of answering a lot of questions about your risk tolerance is to tell you what you don’t know – how the sources of your money, the way you made it, how outside forces have shaped your view of it and how you’re handling it now will inform every decision you make about it in the future.

The most important thing a risk questionnaire can tell is what’s important about money to you. Trained financial advisers can determine your money personality through a process of questioning discovery. Planners can then guide investors within their money personality. Do you want certainty, are you willing to take a little risk or let it roll because “you can always make more of it?”

A financial planner tries to see through the static to find out what you really need to create a solid financial life. But it might make sense to ask yourself a few questions before you and your planner sit down:


1. What’s important about money?
2. What do I do with my money?
3. If money was absolutely not an issue, what would I do with my life?
4. Has the way I’ve made my money – through work, marriage or inheritance – affected the way I think about it in a particular way?
5. How much debt do I have and how do I feel about it?
6. Am I more concerned about maintaining the value of my initial investment or making a profit from it?
7. Am I willing to give up that stability for the chance at long-term growth?
8. What am I most likely to enjoy spending money on?
9. How would I feel if the value of my investment dropped for several months?
10. How would I feel if the value of my investment dropped for several years?
11. If I had to list three things I really wanted to do with my money, what would they be?
12. What does retirement mean to me? Does it mean quitting work entirely and doing whatever 13. I want to do or working in a new career full- or part-time?
14. Do I want kids? Do I understand the financial commitment?
15. If I have kids, do I expect them to pay their own way through college or will I pay all or part of it? What kind of shape am I in to afford their college education?
16. How’s my health and my health insurance coverage?
17. What kind of physical and financial shape are my parents in?

One of the toughest aspects of getting a financial plan going is recognizing how your personal style, mindset, and life situation might affect your investment decisions. A financial professional will understand this challenge and can help you think through your choices. Your resulting portfolio should feel like a perfect fit for you!


September 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by, a local member of FPA.