Republicans and Democrats Come Together – to Keep IRS From Competing with TurboTax

ProPublica.org for GantDaily.com writes: Last month, we detailed how Intuit, the maker of TurboTax, has fought a proposal that could make filing taxes easier and cheaper for millions of Americans.

As we noted, tax activist Grover Norquist and other conservatives have also opposed the proposal, called “return-free filing,” which would give many taxpayers the option to receive a pre-filled return that they could simply review, sign and send back, all for free. Return-free filing has been endorsed by many experts and adopted by several European countries.

As it turns out, Norquist has also recently weighed in on the side of the tax prep industry on another issue.

A House bill introduced earlier this year would bar the IRS from offering taxpayers software that would compete with programs like TurboTax. In March, Norquist and others wrote a letter to members of Congress that urged them to support the bill — what they called a “pro-taxpayer, anti-IRS power grab legislation.”

At issue is how Americans file their taxes and whether electronic filing can be offered directly through the IRS.

The bill is called the Free File Program Act, co-sponsored by Rep. Peter Roskam, R-Ill. and Rep. Ron Kind, D-Wisc. It declares that the IRS, with a few narrow exceptions, “may not establish, develop, sponsor, acquire, or make available” electronic filing service or tax software.

Roskam declined to comment. Spokespeople for Kind and Norquist did not immediately respond.

The bill would also make permanent the Free File program, a public-private partnership between the IRS and the tax software industry created in 2002 to offer some taxpayers free electronic filing.

The industry group behind the program boasts that almost all taxpayers can use software like TurboTax or more primitive electronic forms for free. But access to the more sophisticated software is limited by income. Only about 3.5 million taxpayers used Free File last year, according to a Treasury Department tally through the end of April.

The pact governing the partnership, which counts Intuit as a member, includes a sweet deal for the industry: In return for the companies offering free software to some, the IRS agreed not to develop its own free, online tax prep services. The current deal expires next year.

Intuit lobbied on an earlier version of Roskam’s bill that was introduced in 2011.

The company has spent over $11.5 million on lobbying on a range of issues in the past five years. That money buys high-profile help: Intuit’s lobbyists on the tax prep issue include former Sen. Tim Hutchinson, a Republican from Arkansas; former Rep. Pete Hoekstra, a Republican from Michigan and former Rep. Albert Wynn, a Democrat from Maryland. All three now work for the D.C. office of law firm Dickstein Shapiro. Neither the former lawmakers nor the law firm immediately responded to requests for comment. Intuit also did not respond to requests for comment.

Intuit has given money to the sponsors of the bill. Roskam has received $12,500 from Intuit’s political action committee and company executives in the last two election cycles. Kind has gotten $12,400.

Sen. Mark Pryor, D-Ark., introduced a companion bill in the Senate. Pryor received $3,000 from Intuit’s PAC in the last election cycle.

Another recent bill would actually institute a version of return-free filing, allowing many taxpayers to avoid paying for any prep.

On Friday, Rep. Bill Foster, D-Ill., introduced the bill to create a voluntary system under which an IRS website would offer individual taxpayers forms that are automatically populated with data from employers and other sources.

“Our tax code is complicated enough, we shouldn’t be asking taxpayers to submit information the IRS already has,” Foster said in a press release.

“Taxpayers spend an estimated 6.1 billion hours a year complying with the tax code and an average of over $200 on tax preparation fees,” according to the release. (More on those figures can be found in a 2012 report by the Taxpayer Advocate Service, an independent organization within the IRS.)

The bill is called the Autofill Act, and last week marks the second time Foster has introduced the legislation. A spokeswoman said Foster got interested in the issue after he became frustrated with the “redundant paperwork” needed to file his own taxes and discovered California had a state version of return-free filing. She said he will now be working to collect cosponsors and the bill is likely to be referred to the Ways and Means Committee.

This doesn’t mean an anxiety-free tax season is coming soon: similar bills introduced in the past haven’t gone anywhere.

Advisers Find New Estate-Tax Strategy

Arden Dale for the Wall St. Journal writes:  Wealthy taxpayers now can protect more of their estates from federal tax each year with a new strategy some advisers are starting to employ.

The American Taxpayer Relief Act of 2012 indexed the $5 million estate tax exemption to inflation and set a 40% tax rate. That means the size at which an estate becomes taxable will grow each year--likely by more than $100,000. Estates over $5.25 million are taxable in 2013.

Instead of leaving that extra $100,000 or so each year in an estate until the owner dies, advisers are urging some taxpayers to give that money away, either to a trust or as an outright gift. These gifts, whether securities, real estate, or shares in a business, ideally will rise in value over the years.

"You're moving more out of the estate--assuming the assets you transfer go up in value," said Don R. Weigandt, managing director for wealth advisory with J.P. Morgan Private Bank in Los Angeles.

In coming months, his group will start to talk to clients about the strategy, Mr. Weigandt said.

Other advisers, like Carol G. Kroch, managing director, wealth and philanthropic planning at Wilmington Trust in Delaware, have already started to strategize with clients. The power of the exemption, Ms. Kroch noted, is "pretty dramatic when you think about how over time it's likely to grow."

Houston advisor Henry Bragg said he plans to recommend gifts based on the indexed estate tax to a retired chief executive of a public company and the man's mother.

The family has "multi-generational wealth issues," said Mr. Bragg, director of financial planning for Horizon Advisors, with around $205 million under management. The man and his wife, who have $30 million, stand to inherit more than $10 million from the mother, whose net worth is around $100 million. The family has about 19 trusts and several family partnerships.

"His mother is ready to gift the additional amount...he is not," Mr. Bragg said of client, who's not convinced he can afford to give away his money.

For many wealthy people, making these gifts each time the estate-tax threshold rises could be relatively painless. They can leverage steps they took at the end of 2012, as Congress weighed whether to cut back how much an individual can give away tax-free in a lifetime. Many set up trusts to hold gifts, and could simply "top off the trusts" with gifts as the tax is indexed, according to Mr. Weigandt and Ms. Kroch.

Indeed, those who make gifts to trusts that already exist face no legal fees and can keep the process simple. Some may just ask an adviser to wire money from one account into another. They must file a federal gift-tax return, however.

The gifts taxpayers make to take advantage of the indexed estate tax are separate from the annual exclusion gifts they can make each year. For 2013, a taxpayer can give unlimited gifts of up to $14,000 per recipient.

An important part of the strategy is to pick the right asset to give.

A good choice are those that are easy to transfer and value. For example, it's easy to give $100,000 shares of publicly traded stock, Ms. Kroch said. In contrast, it would be expensive to value a closely held business each year to give away its shares.

Also, clients should choose assets likely to rise in value, and that already have a fairly high tax cost basis. Heirs then don't have to pay as much capital-gains tax when they ultimately sell the gift. That can be a tough combination to find, as often the assets most likely to appreciate have a low cost basis as well.

"If you can only have one or the other, potential appreciation will save more future estate tax," Ms. Kroch said.

How much is the estate tax threshold likely to rise each year? An estimate is available.

Each year, the IRS announces adjustments to tax brackets, exemptions and other items, after it gets official government statistics on inflation. The Tax Policy Center uses projected inflation to estimate its impact on the estate tax.

"Since the exemption increases with inflation, it is projected to rise by a little over $100,00 a year for the next decade," said Ben Harris, senior research associate at Urban-Brookings Tax Policy Center.

What the Internet Sales Tax Means for Small Biz

Aditi Mukherji  for Findlaw writes: The days of tax-free online shopping may be numbered. The Senate is set to vote on a bill that would give states the power to collect sales tax on all Internet purchases.

If the bill passes, local governments could get up to $11 billion (yes, with a "b") per year in added revenue, The Washington Post reports.

Small businesses need to know about The Marketplace Fairness Act because it could affect the way they do business.

What Is the Marketplace Fairness Act?

The Marketplace Fairness Act would give all states the ability to collect taxes from allout-of-state online vendors that sell goods to their residents, the Post reports.

The bill isn't really a new tax liability because online purchases are already supposed to be taxed. If you live in a state that charges sales tax and buy something online tax-free, you're supposed to calculate the tax yourself and add it to your state tax bill.

Don't worry, no one else actually does it either. That's the gap that the bill is trying to fill.

Here's how the Marketplace Fairness Act could affect small businesses:

The Down Side: Tax Confusion

Since sales tax rules vary from state to state, collecting state and local sales taxes all around the country would require quite a bit of effort for online retailers, NPR reports. This isn't a big deal for big retailers, but it could be pretty burdensome for smaller online retailers.

From the perspective of big retailers like Amazon, the new burden on small businesses is a good thing -- it makes life tougher for smaller, would-be competitors.

The Up Side: Small Business Exemption

To protect small businesses from being overburdened, small businesses which generate less than $1 million in annual revenue will be exempt from collecting interstate sales tax, according to The Inquisitr. Basically, this gives a slight advantage to small startup websites over other higher revenue-generating competitors that would have to charge sales tax.

This isn't the first bill about an Internet sales tax. To weather the recession, nine states -- including New York, California, Pennsylvania and Texas -- have passed so-called "Amazon" taxes that require the online retailer to charge sales tax for customers who live in their states, the Post reports.

Unlike an "Amazon" tax, the pending Marketplace Fairness Act would cover all online retailers.

The bill is expected to pass in the Senate next week before it heads to the House, thePost reports. You can read the bill in its entirety at the Library of Congress' website.

Can I Claim a Foreign Exchange Student as a Dependent on My Taxes?

Mark Kennan for Demand Media writes: Hosting a foreign exchange student can be a gratifying and educational experience for your family as well as the exchange student: you all learn about new cultures and share experiences. However, no matter how much you feel like your foreign exchange student is "family," the Internal Revenue Service usually won't consider the student your dependent. But, you might get a charitable deduction.

CITIZEN OR RESIDENT

To claim anyone as your dependent, the person must be a U.S. citizen or a U.S. resident. Most foreign exchange student's won't meet that requirement, so you won't be able to claim the student as a dependent. For tax purposes, the student can be a resident either by having a green card or by being substantially present in the U.S. However, under the substantial presence test, you can't count days when the exchange student is in the U.S. under an "F" visa, used for students.

RELATIONSHIP TEST

Foreign exchange students also run into trouble when it comes to the relationship test. If you're hosting a non-relative, the only way you can claim the student is if the student meets the requirements to be a qualifying relative (instead of a qualifying child). Since the foreign exchange student isn't related to you, that means the student must live with you for the entire year, which is also unlikely to happen if you're just hosting for a semester. Even if you're hosting for an entire academic year, the student usually won't live with you for a full calendar year.

ADDITIONAL QUALIFYING RELATIVE CRITERIA

Even if you're still reading because your foreign exchange student somehow meets the criteria so far, there's still a few other hurdles to clear to count as a qualifying relative. First, you must provide more than half the student's support. Support includes food, education, rent, entertainment, medical care and other living expenses. Second, the student can't have more than the value of an exemption in income for the year, before any deductions are counted. As of 2013, each exemption is worth $3,900.

CHARITABLE DEDUCTION ALTERNATIVE

If the foreign exchange student doesn't count as a dependent, you might qualify to claim a charitable deduction for some of your costs. To qualify, the student must live with you under a written agree­ment with a qualified organi­zation as part of the organization's educational opportunities program; the student can't be your relative or your dependent; and the student must be a full-time student in 12th grade or lower. You're allowed to deduct $50 per month that the student lives with you. Any month that the student meets the requirements for at least 15 days counts as a full month.

The risk of borrowing money from your parents

Richard Montgomery for the Patriot Ledger writes: Reader question: Hello, Monty, I purchased my home in the summer of 2007 for $400,000. My folks took out a home equity loan for $80,0000, which reduced my interest rate. I am now regretting that decision. I need to sell my home, and I am not sure I will recuperate enough cash to pay off my parents' loan. If I were the only borrower involved, I would have gladly done a short sale. The idea of having poured in half a million without denting the principal is heart breaking to me. I'm a single woman and put all of my money into the interest for the last six years. How would you proceed? Thanks so much. Martha W.

Monty's answer: Hello, Martha, thanks for your question. My father once told me that money is easy to borrow, but hard to pay back.

Let us clarify a couple of points in your question. The only borrower involved with your loan is you. The money from your parents was a personal loan. They are not directly involved with your property or your mortgage; their involvement is with you as an individual. Had they asked you to sign a promissory note, you may view their loan differently.

Also, you have not “poured in half a million” into the house. Much of the value can be recovered when it sells. Assuming you invested $20,000 along with your parents, at 6% interest only on $300,000 for six years with 30 years amortization, about $108,000 went toward interest. Your income tax deduction for mortgage interest created tax savings each year. The situation you envision may not be as challenging as the one you are experiencing.

Diffusing the situation

It is not clear what has precipitated your concerns. Is the income you earned to qualify for the loan still flowing? If so, your situation is extremely different from the sale being forced on you due to losing your income. In either scenario, here are the initial steps to take:

Step 1. Develop a “short list” of real estate agents who work in your neighborhood. There is an article entitled “Choosing your real estate agent” at DearMonty.com that describes how to go about this task in such a way that greatly increases your chances of picking the right agent for you and your circumstances. For example, many agents avoid short sales. Some accept them but may not be qualified to handle them.

Step 2. Obtain three separate broker price opinions (BPO) of value on your home. They will all have different values. As a part of the agent selection process, agents prepare BPO’s to demonstrate their value to a potential customer. It gives them a chance to get face-to-face. It also gives you a chance to do the same with them. In your situation, I would not share any hint of your thoughts about the value of the home. Instead, make certain they understand you want to see the sold comparable data sheets they use in determining their opinion of your home's worth. Also ask for a detailed explanation of the market in your neighborhood in terms of competition, sales rate and future supply coming into the market, so you have a sense of neighborhood supply and demand. 

Step 3. Study the BPOs. Are some more thorough than others? Are the comparables truly comparable? The goal here is to understand these BPO’s as they will provide some confidence as to the true range of value of your home based on facts, not hearsay. Understanding the "range of value" or lowest likely price and the highest potential price is particularly important. You will have a much better sense about being underwater, and if so, the extent of your potential loss.

Step 4.  Go to your CPA (certified public accountant) or a credit counseling service armed with this information. A conversation and needs analysis may be an eye opener as you may be living above your means, and unwittingly involved your parents. Find out if this angle is a possibility.

Taking responsibility is the key

To proceed this far will take some of your time, but there is no easy answer. Having this information is critical to your ability to make sound decisions. I expect you have the intellectual and financial resources to create and execute a plan where you can work out of this and not disappoint your parents. This is how I recommend proceeding.

It’s 2013, Do You Know What Your Annually Adjusted State Tax Bracket Is?

Bloomberg BNA writes: State individual income tax rates can affect all sorts of behavior during the tax year, such as where the taxpayer chooses to carry on business, or where he chooses to live. Annual indexed changes to other elements such as the standard deduction and personal exemption amounts can affect taxpayer’s deductible expenses or willingness to donate to charity.

But as a recent report by the Tax Foundation makes clear, finding this basic tax rate information on state tax department websites is difficult or impossible in some jurisdictions. Annual indexing adjustments to tax bracket amounts is another complicating factor.

Thirty-four states have statute-based income tax brackets which are not indexed and thus do not vary from year to year. While this may seem transparent, as taxpayers don’t have to worry about varying rates and can predict their tax liability in advance, there is a hidden downside to static tax brackets—inflation. 

As salaries increase with inflation, the fixed income brackets do not, causing taxes to go up disproportionately. This “bracket creep” is not always apparent to taxpayers, becoming a hidden tax increase that hides behind the often opaque wall of the tax code. 

However, even those states which recognize this problem and index for inflation must also be aware of the need for transparency in income tax brackets. The seventeen states which index income tax brackets for inflation publicize their rate changes at varying times in the year, as shown in the chart below. Often the rates are not published at the same time of year, or in the same format as the year before, leaving taxpayers confused and unsure about their tax liability for that year.

Below is a cheat sheet for those seeking to remain current on the latest state inflation adjustments.

For more information about the importance of indexing for inflation, see the August 2011 policy brief from the Institute on Taxation and Economic Policy (ITEP).

States	Indexed Tax Brackets, Standard Deduction, and Personal Exemption	Indexed Personal Exemption Only	2012 Tax Information	2013 Tax Information	Notes
Arkansas	X			Estimated Tax Form – 1/13
California	X		Press Release – 8/12	2013 rates not yet released
Idaho	X		Website –April 2012	Estimated tax form not yet released	Uses personal exemption amounts provided by the federal code
Iowa	X			Tax Rate Schedule – 11/12
Maine	X		Tax Alert Publication – 10/11	Tax Alert Publication – 1/13
Massachusetts		X			Personal exemptions amounts have not changed since 2008
Michigan		X	Income Tax Return Form – 10/12	Not yet released
Minnesota	X		Press Release – 12/11	Press Release - 12/12	Uses personal exemption amounts provided by the federal code
Montana	X			2013 rates not yet released	2013 exemption amount released on 2013 estimated tax form
Nebraska		X	Estimated Tax Form – 12/11	Estimated Tax Form – 11/12
North Dakota	X			Estimated Tax Form – No date published	Uses personal exemption amounts provided by the federal code
Ohio			News Release – August 2012	Estimated Tax Form – 10/12
Oregon	X			Estimated Tax Form – 12/12
Rhode Island	X			Tax Advisory – 12/12
South Carolina	X			Estimated Tax Form – 9/12	Uses personal exemption amounts provided by the federal code
Vermont	X			Estimated Tax Form – No date published	Uses personal exemption amounts provided by the federal code
Wisconsin	X		Estimated Tax Form – 11/11	Estimated Tax Form – 1/13

By Melissa Fernley, chart by Martelli-Yndee Borieux

South Carolina 529 College Savings Plan Tops Morningstar's List of Cheapest Plans

Susanna Kim for ABC News writes: According to a new Morningstar report released this week, 529 college-savings plans are getting cheaper as fees decrease and choices increase. With the soaring cost of higher education, planning for children's education has taken on new importance.

The report evaluated all 86 U.S. 529 plans, which, as of Dec. 31, 2012, had more than $166 billion in total assets under management, a rise of 25 percent in 2012 from 2011.

Almost every state offers a 529, named after Section 529 of the Internal Revenue Code, which details how those who contribute to these investment plans don't have to pay taxes on proceeds. Benefactors, including parents and grandparents, can start a plan for a named beneficiary as soon as the child is born.

Read more: Morningstar Lists Best 529 College-Savings Plans

Laura Lutton, director of funds research for Morningstar, said there have been "meaningful declines in cost" for these plans.

"This is a sign that the 529 industry is maturing, and states are being more aggressive in how they negotiate with money managers," Lutton said.

And as with other funds, Lutton said decreasing fees were a consistent predictor of performance.

"The less you pay, the more likely you are to outperform in the long term," she said.

A 529 plan, however, might not be for everyone. Lutton said parents should consider two questions when investing in a 529. First, even though the fees are dropping, if you?re putting in less than $2,000, which Lutton said was a low threshold, you might be better off investing your money elsewhere.

"I think there are a lot of parents who sign up for 529s with the best of intentions, and they don't end up contributing. Fees end up eating into their balance over the years," she said.

Second, parents should find out whether they live in a state with a tax benefit. Some states offer tax benefits, such as tax-deductible contributions, or funds matched by the state, for residents who purchase a 529 plan that originates in that state,

Only a handful of states allow benefactors to apply that state's tax benefit to any 529 plan, called tax parity, regardless of whether the benefactor lives in that state. Those states include Kansas, Missouri, Arizona, Maine and Pennsylvania.

Here are the 15 "cheapest" 529 plans, based on the average total expense ratio for that plan:

SOUTH CAROLINA

1.

Future Scholar 529 (Direct)

Average total expense ratio: 0.13 percent

NEW YORK

2.

New York's 529 Program (Direct)

Average total expense ratio: 0.17 percent

MICHIGAN

3.

Michigan Education Savings Program

Average total expense ratio: 0.25 percent

WISCONSIN

4.

EdVest 529 Plan

Average total expense ratio: 0.25 percent

UTAH

5.

Utah Educational Savings Plan

Average total expense ratio: 0.25 percent

IOWA

6.

College Savings Iowa 529 Plan

Average total expense ratio: 0.28 percent

NEVADA

7.

The Vanguard 529 College Savings Plan

Average total expense ratio: 0.29 percent

GEORGIA

8.

Path2College 529 Plan

Average total expense ratio: 0.34 percent

OHIO

9.

CollegeAdvantage 529 Savings Plan

Average total expense ratio: 0.35 percent

MISSOURI

10.

MOST Missouri's 529 Plan

Average total expense ratio: 0.35 percent

CALIFORNIA

11.

ScholarShare College Savings Plan

Average total expense ratio: 0.36

NORTH CAROLINA

12.

National College Savings Program

Average total expense ratio: 0.37 percent

ALABAMA

13.

CollegeCounts 529 Fund

Average total expense ratio: 0.38 percent

CONNECTICUT

14.

Connecticut Higher Education Trust

Average total expense ratio: 0.40 percent

ILLINOIS

15.

Bright Start College Savings (Direct)

Average total expense ratio: 0.41 percent

Not All ETFs Are Created Equal

David Fabian for Seeking Alpha writes: Since I entered the investment world many years ago I have been recommending exchange-traded funds to my clients because I believe that they are one of the best ways to access the capital markets for retail investors. ETFs are diversified, liquid, low-cost, global, transparent, and flexible. Today ETFs are revolutionizing the investment landscape the same way that mutual funds did many decades ago.

When it comes to the world of exchange-traded funds investors must be savvy about selecting the right investment to meet their goals while keeping in mind expenses, strategy, underlying holdings, tax ramifications, and other factors. Rarely are two ETFs created that are exactly alike, which is why it's important to thoroughly research and vet each ETF before you purchase it to make sure you understand what you are buying.

Expenses Matter

ETFs are touted for their low internal expense ratios which typically range anywhere between 0.04% to over 2.00% annually. But often times you will find ETFs with similar strategies charging vastly different fees. One of the most widely publicized examples of this is the expense comparison between the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard FTSE Emerging Markets ETF (VWO). EEM has an expense ratio of 0.66%, while VWO charges just 0.18%. Put simply, EEM is over 3.5x more expensive than VWO.

As you can see on the overlay chart above, the performance of VWO vs. EEM is very similar over the last year with the Vanguard fund having a slight edge in total return. This may be attributable to its lower expenses, but the underlying holdings also play a part as well. While these two funds both invest in a diversified mix of emerging market stocks, their underlying indexes are slightly different - EEM tracks the MSCI index while VWO tracks the FTSE index. This may be one reason an investor would choose EEM over VWO when looking at these international regions.

In addition, many brokers such as Fidelity and TD Ameritrade are now offering commission free trading on a select group of ETFs which may provide you with some additional incentive to pick one fund over another. At the end of the day it's important to research and understand all of the expenses that you will incur with the purchase of an ETF so that you get the best bang for your buck.

Taxes Matter

One of the hidden pitfalls of investing in certain commodity related ETFs is the tax ramifications of their legal structure. What I am talking about here is the difference between an ETF that is structured as a trust that generates a 1099 vs. being structured as a partnership that generates a K-1. One of the largest ETFs in the commodity space that is structured as a partnership is the United States Oil Fund (USO) which has nearly $1 billion in total assets. This fund is designed to track the daily price movement of West Texas Intermediate Crude Oil.

First time investors in USO, who haven't done their homework, will be surprised when they receive a K-1 in the first quarter of the new year for partnership income that doesn't correlate to their dividends or capital gains. The reason for this is that the fund must be structured as a partnership in order to participate in buying commodity futures contracts. When you purchase USO you are considered to be participating in the gains or losses of the partnership and thus receive a K-1 statement that must be dealt with on your tax return. This creates a tax headache for retail investors that can be easily avoided by purchasing the iPath S&P GSCI Crude Oil Total Return ETN (OIL).

OIL is structured as an exchange-traded note which means that it is an unsubordinated debt instrument that tracks the return of a specified index. While there are pluses and minuses of investing in ETFs vs. ETNs, the advantage in this case of purchasing OIL is that you do not receive the K-1 that you would with USO. In addition, as you can see by the chart below the two funds' performance (overlaid) is nearly identical. So you are receiving the same total return over time in OIL without the additional tax burden.

First time investors in ETNs should note that the performance and assets backing these notes are only as good as the financial stability of the issuer (in this case Barclays PLC).

Be Careful With Leverage

If there is one thing I have seen time and again devastate individual investors' portfolios, it is the use of leveraged exchange-traded funds. These sophisticated trading tools magnify the performance effect of the price movement of the underlying index, usually 2 or 3 times. Leveraged ETFs can be either long or short and in my opinion are best served in the portfolios of hedge funds, high frequency traders, and investment banks. These institutions have sophisticated trading patterns, disciplined risk management strategies, and investment mandates that allow them to utilize leveraged funds in a way that very few retail investors can duplicate. They can trade in and out of these vehicles with millions of dollars at lightning speed.

Another side effect of leverage is how its compounding effect over time erodes the tracking efficiency of the underlying index. Leveraged ETFs are only designed to track the DAILY price movement of an underlying index. Thus, investors should not expect that a 10% move in an index for a 2x leveraged ETF over a three month time frame is going to correlate perfectly to a 20% return.

One of the most well-known leveraged funds is the ProShares Ultra S&P 500 Index (SSO). Its investment objective is to track 2x the daily price performance of the S&P 500 Index. While there is nothing structurally wrong with this fund, I find its volatility to be far more dangerous than productive for most investors.

If you are considering purchasing a 10% allocation to SSO, I would recommend that you instead allocate 20% to either the SPDR S&P 500 (SPY) or the iShares Core S&P 500 ETF (IVV). Both of these funds give you single beta exposure to the same index without the added level of volatility and risk. Obviously there are situations where that wouldn't be possible given your portfolios' makeup and allocations, but it is an example of how you can accomplish a similar objective by increasing your exposure.

The Final Word

My advice for both professional and retail investors is to always thoroughly research any new investment before you decide to add it to your portfolio so that you understands its pros and cons. With the ETF universe growing so large there are generally many different ways to accomplish the same objective using different investment vehicles or strategies.

Additional disclosure: David Fabian, Fabian Capital Management, and/or its clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.  Fabian states, "Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article."

ATRA: What the New Estate Tax Law Means to You

Jeramie Fortenberry writes: President Obama signed the American Taxpayer Relief Act of 2012 (ATRA) on January 2, 2013. Whether ATRA is a “relief” to taxpayers depends on how you look at it. Things aren’t as good as they were under prior law, but they aren’t as bad as they could have been if Congress had not acted.

On the plus side, ATRA set the exemption for federal estate, gift, and generation-skipping transfer taxes at $5 million, indexed for inflation since 2011. It also made portability a permanent feature of the tax law.  For 2013, that means that taxpayers can pass $5.25 million ($10.5 for a married couple using credit shelter trusts or portability) to the next generation free of all transfer taxes.

But not all changes were positive. ATRA raised the maximum transfer tax rate from 35 percent to 40 percent.  ATRA also added a 39.6 percent high income tax bracket and raised the capital gains rate to 20 percent for taxpayers with income in excess of the high-earner threshold ($400,000 for single filers, $450,000 for joint filers, and $425,000 for heads of households). These higher tax rates are in addition to the 3.8 percent tax on net investment income required under the Patient Protection and Affordable Care Act.

How ATRA Affects Estate Planning in 2013 and Beyond

ATRA didn’t make any revolutionary changes to the way estate tax planning is done. Many of the same techniques that worked in 2012 still work under ATRA. But ATRA did affect the estate planning environment in several ways:

• Unlike its predecessors, ATRA is permanent. There is no automatic sunset provision that will cause ATRA to expire automatically if not extended. ATRA gives a much-needed reprieve from the uncertainty that has plagued estate and gift tax planning for the past decade.
• Very wealthy taxpayers who haven’t already used their exemption still have an opportunity to do so through lifetime gifting. Even though ATRA doesn’t automatically sunset, Congress may still lower the exemption or raise the tax rates. The only way to lock in the current favorable exemption is to fund the exemption amount now. Making the transfer now will also move all future appreciation out of the taxpayer’s estate.
• Very wealthy taxpayers might also consider making taxable gifts in excess of their exemption amount. Due to the tax inclusive nature of the estate tax, lifetime transfers are more tax-efficient than transfers that take place at death.
• Given the higher capital gains rates, the use of intentionally-defective grantor trusts (which allow the grantor to continue to pay the tax on completed gifts) may no longer be the right choice. If the transferee is in a lower tax bracket, the better choice may be to terminate the grantor trust status.  This would allow the beneficiaries to pay tax on the trust income at lower rates (assuming that the grantor’s spouse is not a co-beneficiary of the trust). The trust could make distributions to the beneficiaries to cover the additional tax liability.

Perhaps the biggest takeaway is that the vast majority of Americans need not be concerned with federal transfer tax issues. Only individuals with gross estates (defined very broadly) worth more than $5.25 million are potentially subject to estate tax. This means that most people can forget about estate tax planning and focus on what truly motivates them, including:

• Ensuring that their assets are distributed to the people that they want to have them and at the time that they want them to have them;
• Protecting estate assets from actual or potential creditors of family members and loved ones (or from their own bad decisions);
• Planning for the possibility of their own incapacity; and
• Protecting assets from frivolous lawsuits.

These non-tax goals are at the heart of most estate planning decisions for everyday clients. Advisors can now focus on accomplishing these goals without the unnecessary complication of estate tax planning.

What ATRA Didn’t Do

ATRA is also significant for what it doesn’t include. President Obama’s budget proposals (including the recently-released budget proposal for 2014) continue to include provisions that would curtail the use of taxpayer-friendly planning techniques.  Specifically, the President would:

• Require a minimum term for grantor-retained annuity trusts (GRATs);
• Limit the duration of the generation-skipping transfer (GST) tax exemption;
• Include the assets of an intentionally-defective grantor trust in the grantor’s estate; and
• Impose additional consistency and reporting requirements relating to basis in property inherited from a decedent.

Whether any of these proposals will become law is a matter of speculation. It seems clear that the Obama administration will continue to propose these changes, especially in a time when the issue of tax reform pervades most political discussions. But for now, there are still opportunities for estate tax planning for taxpayers with estates that exceed the $5.25 million (2013) threshold.

Estate planning with portability: not a panacea

Lauren A. Jenkins, David Shayne and William M. "Bill" Rich for Holland & Knight write: When Congress resolved the fiscal cliff crisis early this year, it brought permanence to estate, gift and generation-skipping transfer tax laws that had been in flux for over a decade. In short, the American Taxpayer Relief Act of 2012 (ATRA): (1) solidified the applicable exclusion amount at $5 million (as adjusted for inflation), (2) set the transfer tax rate at 40%, and (3) made permanent certain transfer tax provisions, such as portability.

Background on Portability

Since its initial enactment in 2011, portability has received a lot of press as a method to simplify the common estate plan. Before portability, the common estate plan for a married couple with a taxable estate was to create a "credit shelter trust" at the death of the first spouse. That trust would be funded with the deceased spouse's applicable exclusion amount (also known as "exemption amount"). This planning technique sheltered the deceased spouse's exemption amount, permitting the allocated assets, including any appreciation, to escape estate tax at the surviving spouse's death. Therefore, although the credit shelter trust could be used to benefit the surviving spouse and children, its assets would never be subject to estate tax so long as the assets remained in trust.

Portability provides couples with the ability to transfer a deceased spouse's unused exclusion amount (DSUEA) to the surviving spouse. The surviving spouse may use the DSUEA to make gifts during the surviving spouse's lifetime and at death.

Example: John and Jen are a married couple with a combined estate of $7 million. John dies first, leaving all of his assets to Jen, outright and free of trust. If a portability election is made on John's estate tax return, Jen will receive his $5 million exemption. Jen will then have a $7 million estate and a combined exemption of $10 million (her own $5 million exemption and John's $5 million DSUEA), which she can apply against gifts and her estate.

The portability election is made by filing an estate tax return at the first spouse's death and is available for spouses dying after December 31, 2010. As a result, it cannot be used for a spouse who died before that date.

Planning Issues Affected by Portability

The main benefit of portability is its simplicity. Couples whose estates are valued below the combined exemption amount can direct that all assets pass to the surviving spouse. As long as the estate tax return is filed on the first spouse's death, they no longer will lose the first spouse's exemption. The surviving spouse will be able to use both exemptions.

Portability also offers potential income tax benefits. Assets included in an estate receive a new basis for capital gain tax purposes based on the value at the owner's death. In other words, if a person purchased stock for $100 and at his death it was worth $500, the stock would have a new basis of $500 for determining gain and loss.

Under portability, assets receive two basis adjustments: once at the death of the first spouse and then again at the death of the surviving spouse. Conversely, assets held in a credit shelter trust do not receive a basis adjustment at the surviving spouse's death, because they are not includible in the surviving spouse's estate. The second basis adjustment could result in significant income tax savings if the assets appreciate considerably between the death of the first spouse and surviving spouse.

It is important to note that the DSUEA will not increase for inflation. As a result, the surviving spouse's exemption and DSUEA will need to cover all appreciation of the assets if the surviving spouse wants to avoid estate tax at death.

Example: Miles and Lila, a married couple with a combined estate of $6 million, decide to use portability planning. Lila dies first and leaves her entire $3 million estate to Miles. Her executor makes a portability election, so Miles receives her $5 million exemption. Miles now has a total exemption of $10 million and an estate of $6 million. As long as Miles's estate does not increase in value to over $10 million, it will not have to pay estate tax at his death. On the other hand, if Miles lives another 30 years, it is unlikely that the combined exclusion will be sufficient to protect his estate from tax due to appreciation of his assets and no inflation adjustment of the DSUEA.

As indicated above, for the surviving spouse to acquire DSUEA, the first spouse's estate must timely file a federal estate tax return and make the portability election even if no return is otherwise required. Moreover, the IRS can challenge the reported DSUEA even after the statute of limitations has expired for the IRS to assess estate tax. Therefore, the DSUEA can be adjusted long after the initial estate tax return was filed.

Portability is not an all or nothing proposition. It may well be advantageous to leave assets to a credit shelter trust using less than the entire available exclusion, for example, to cover the applicable state estate tax exemption. The balance of the exclusion could then be left to the spouse.

A surviving spouse can only use the DSUEA of his or her last predeceased spouse. If Sarah survives a second spouse, only his exemption can be added to hers. Nevertheless, she can use the first spouse's exemption for gifts she makes before the death of her second husband.

Although the current law is considered permanent, Congress could change or eliminate portability in the future. As a result, relying solely on portability could cause adverse transfer tax consequences if the exemption decreases or portability is abolished.

Planning Issues Not Affected by Portability

Portability does provide an opportunity for couples to use both spouses' exemption without having to create a credit shelter trust. However, it does not eliminate the need for trust planning due to: (1) state estate taxes, (2) multigenerational tax planning, and (3) non-tax considerations.

1. State Estate Taxes. Portability does not apply to state estate or inheritance tax in any of the 21 states and the District of Columbia that impose such tax. State estate tax is imposed on residents of jurisdictions with a state estate tax and non-residents who own real property and tangible personal property, such as automobiles and art, in these jurisdictions. The result is that the surviving spouse's estate is likely to incur a substantially greater state estate tax than when the first deceased spouse sheltered his or her exemption as with a credit shelter trust. For example, if each spouse has $5 million and one of them leaves the state exempt amount in trust or to children and the rest to the surviving spouse as opposed to leaving all of the assets to the surviving spouse, the state estate tax savings would likely vary, e.g.: New Jersey $102,600; Rhode Island $138,344; Washington, D.C., Maryland, Massachusetts and New York $151,200; Oregon $155,000; Connecticut $220,800; Maine $240,000; Delaware $363,600; Washington $365,000; Hawaii $392,000; Vermont $396,400; Illinois $470,852; and North Carolina $1,067,600. In other words, the larger the tax rate and exemption, the greater the benefit in making use of the latter in the first estate.
2. Multigenerational Planning. Couples that intend to pass wealth to future generations cannot rely on portability, because the federal generation-skipping transfer tax or GST exemption is not portable. Accordingly, if more than the exemption passes to the surviving spouse who leaves more than that amount to grandchildren or the like, an additional 40% GST tax will be incurred. Wasting the GST exemption could cost the family $2.1 million at today's rates.
3. Non-Tax Considerations. Although tax planning is an important component of estate planning, there are a myriad of other reasons for creating trusts.

• Blended Families. Couples may feel more comfortable with assets being held in trust in a blended family. Trust planning can prevent future conflicts in such situations as the remarriage of the surviving spouse, preservation of assets for the children of a prior marriage or the relationships among the blended family members, to name a few.
• Under-Age Beneficiaries. Many people are reluctant to leave their estates to those they consider immature financially. For them trust planning is often the answer.
• Avoiding Probate. States differ with respect to the complexity and cost associated with their probate laws. In states where court supervision is required, couples should still consider creating and funding trusts during life to avoid probate of assets that cannot be held jointly or distributed by beneficiary designations, such as certain closely held business interests.
• Substance Abuse/Disability Issues. Many times, the estate plan is created before a couple is aware of potential problems facing a beneficiary. Leaving assets outright to persons who have substance abuse issues or suffer from disabilities may be doing them a disservice. The inheritance may be used to bankroll a serious addiction, or, depending upon the disability, may prevent the beneficiary from receiving government benefits.
• Asset Protection. Trust planning offers asset protection benefits that the beneficiaries cannot create for themselves. By holding assets in trust, the trust can be used for the beneficiary's benefit while preventing the beneficiary's creditors from seizing the inheritance. Even a beneficiary who is considered financially trustworthy may have unexpected creditor issues due to an accident or divorce.
• Multigenerational planning.Often a couple wishes to keep their estate in the family. Trusts can provide that assurance.

Conclusion

Portability offers couples another planning option, and, depending upon the situation, may provide additional flexibility. Nevertheless, portability does not cure all estate planning ills and can be dangerous if relied upon without consultation with an estate planner.