Intuit Quickbooks Challenger XERO / Xero: A billion-dollar software company that had five years in stealth at the bottom of the planet

Hamish McKenzie for Pando Daily writes: Xero, a cloud-based accounting company that has so far raised $67 million in venture capital, had one hell of a stealth period. By spending its first five years operating only in New Zealand, the company was able to not only build up a strong product – “The Apple of accounting,” as its marketing line goes – but also test it on a sizable market of paying customers, all while evading the attention of legacy competitors. Now, as it is making a serious push in the US, Xero suddenly looks like a major threat to Intuit’s QuickBooks, the dominant player in accounting software, which is attempting to transform itself into an online business.

But that protracted “stealth” period in a quiet southern corner of the planet is not the only thing that’s unconventional about Xero. Because New Zealand’s venture capital sector is so undeveloped (read: barely existent), Xero’s founder and CEO Rod Drury had to think of creative options to raise money for the company. While the biggest venture deal possible in New Zealand at the time, 2007, was about $2 million, Drury had grand plans for Xero from day one. Fresh from selling his company AfterMail to Quest for $15 million in cash, he wanted to hire 50 people from the start and decided the company needed $15 million. He didn’t want to raise money from Silicon Valley VCs because he didn’t want to face the pressure of quickly selling the company to a large company, so he instead decided to list Xero on the New Zealand Stock Exchange.

The ploy worked. Xero got its $15 million, Drury set about building the company, and now, six years later, it has also pocketed major investments from Peter Thiel’s Valar Ventures fund and Matrix Capital, the most recent of which came in a November round that totaled $49 million. (Disclosure: Peter Thiel is an investor in PandoDaily.) That puts Xero’s total raise, including its takings from the New Zealand stock market, at more than $100 million. The company now has 160,000 customers worldwide and last year pulled in $39 million. It has an annualized run rate of $51 million for this year, and its performance on the New Zealand Stock Exchange has already seen it reach a valuation of about $1.4 billion, a faintly ridiculous sum given that the company still hasn’t turned a profit.

Xero founder and CEO Rod Drury

Rather than being a “change the world” kind of venture, Xero represents a calculated business move. Drury, a relaxed but enthusiastic interview presence who speaks in fast run-on sentences, theorized that the biggest monetization opportunity for an Internet was in serving small and medium sized businesses, which are willing to pay for products but were traditionally not well served by the first wave of software giants, such as the likes of Oracle and SAP, who focused on enterprise customers. For that SMB market segment, Drury believed accounting software was the killer app because it’s a hard problem to solve but it is an important, if utterly unsexy, part of any business. In an attempt to take the gloom out of accounting, Xero has taken a design-driven approach, attempting to make the process of invoicing and bill payments beautiful. At the same time, Xero has built tools for accountants into the platform, which differentiates it from the likes of FreshBooks andWave, who have also built compelling accounting products for small and medium-sized businesses. Xero has also opened up its platform to third-party developers and now hosts more than 200 add-ons through such providers. A deep integration with Box is on the way.

Drury, who at 47 is a seasoned veteran of tech, says working from New Zealand has been an advantage because Xero has access to the country’s top tech talent, which comes at a bargain compared to Silicon Valley, and doesn’t have to worry too much about losing them to the competition, but also because it has allowed Xero to develop deeper and more diverse relationships with countries outside of the US. By being based in a country of only 4 million people, Xero has also had to be globally focused from day one. Meanwhile, while American investors might first look askance at a company that comes from a tiny market in an isolated part of the world, any fears are quickly allayed by demonstrated knowledge and experience, Drury reckons. “Normally we are country bumpkins,” he says of investor perceptions of New Zealand companies, “but if you know what you’re doing it’s very clear.”

Xero’s global ambition and success in attracting top-dollar attention from the US have inspired some New Zealand entrepreneurs to also think big. Rollo Wenlock, the founder and CEO of video-editing platform WIP, says Xero has proven that being based in New Zealand is not necessarily a handicap for a startup. “It’s like, ‘I’m allowed to do that, that’s possible,’” Wenlock says of Xero’s bold global play. “You don’t have to second-guess yourself.” Drury’s example has pushed Wenlock’s ambitions higher. “If I’d done this five years ago, I might have been happy with a $5 million exit, and now I won’t be happy unless it’s at least a $100 million exit.”

To Drury himself, the company’s unfavorable geography seems scant impediment. Xero already has offices in Australia and the UK, and a year ago it set up shop in San Francisco, where it has 30 staffers. Drury plans to grow the San Francisco team to 200 employees within 18 months, which would make it roughly the same size as its Wellington headquarters. That office will play a very important role as Xero creeps towards the ultimate goal: an IPO.

Calling Xero a “global company that started in New Zealand,” Drury says he plans to list on a US stock exchange once it reaches $100 million in revenue, which he thinks will happen in the next couple of years. Having already experienced an acquisition with AfterMail, he wants more.

“When you’ve already been acquired, that’s not your goal,” he says. Gunning for the top is too much fun.

The Reverse Mortgage as a financial planning tool

Vivian Dye, Atlantic Residential Mortgage for MinuteManNewsCenter writes: Reverse Mortgages are generally looked upon as a vehicle to assist a person in distress or to provide a solution for an immediate problem. But every now and then I have had clients for whom the reverse mortgage was initiated – not as a response to a financial problem – but as part of their long term retirement planning. So it was with particular interest that I read an article last year that documented the effectiveness of a reverse mortgage as a building block of a sophisticated long-term financial strategy.

The article was published in August, 2012 in the Journal of Financial Planning Accounting entitled “Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions.” The study was conducted by John Salter, Ph.D., CFP®, AIFA®; Shaun Pfeiffer; and Harold Evensky, CFP®, AIF®. The article talks to the value of incorporating a specific type of reverse mortgage – a HECM (Home Equity Conversion Mortgage) Saver — into your financial planning to offset the impact of the future ups and downs in the market on your other retirement assets.

The authors’ state: “Using home equity as a risk management tool in distribution planning may provide retirees with more efficient and effective distribution strategies. As this is a potentially important financial resource that often remains untapped, strategies that incorporate a prudent use of this resource also become important.” Their proposed strategy works by only borrowing from the HECM Saver during bear markets in order to avoid selling assets at depreciated prices, thereby allowing the assets to recover before selling — focusing on the line of credit option of the HECM Saver as a substitute for a source of cash.

They used their Saver strategy in 1,000 simulations testing its efficacy as a retirement savings strategy, using the credit line against a cash reserve bucket under different withdrawal and debt preference scenarios. “The Saver Reverse Mortgage provides an alternative to refill the cash bucket with no transaction cost, no tax consequences, and possible tax-deductible interest upon repayment. The strategy also allows a reduction in the cash reserve holdings, from as much as 24 months down to 6 months, because of the “standby” source of readily available cash in the reverse mortgage line of credit.”

The concept has intrigued me and I will talk more about their ideas but I would also like to take this several steps further and demonstrate how a well planned reverse mortgage can significantly enhance your retirement funding in years to come.

As the spotlight of the article shines on a specific reverse mortgage product, we should first address its features. The FHA insured HECM (Home Equity Conversion Mortgage) Saver was first made available in October 2010. It is almost identical to a traditional HECM Standard reverse mortgage except for three things: The first is that it has substantially lower up-front costs and secondly it, therefore, provides a lesser percentage of the available equity. The third difference today is that the HECM Standard is only available in the variable rate option whereas the Saver is currently available in both a variable and fixed rate option -- but only the variable rate option provides the benefits that make this a financial planning tool.

• The HECM Saver variable rate option has some important features: a non-cancelable line of credit, with the borrower in control over when, and if, he or she uses the line of credit. And, very significantly, the line of credit can be paid back at any time without a penalty or never paid back during their lifetime as long as they remain in their home as their principal residence. They must, however, maintain the home and pay taxes and insurance.

• The income received from the reverse mortgage is tax-free, and the interest, when paid, may be tax-deductible.

• The FHA-insured HECM Saver is a non-recourse loan—upon sale or death, the repayable debt of the mortgage will not exceed the home value.

• And key to this discussion and the further expansion is the fact that the unused line of credit grows in availability over time, independent of the home’s value, at the same effective interest rate that would accrue to an outstanding loan balance. 

You might be thinking about substituting a Home Equity Line of Credit (HELOC) in this strategy? The authors’ answer was that it didn’t have all the features that made the reverse mortgage so attractive: The reverse mortgage is non-cancelable (when always leaving a small amount “owed” in the line); borrower maintains payback control; there is no minimum payment requirement; and once established will not be frozen, reduced or canceled. The HELOC credit amount is established relative to the home’s value and does not automatically increase though the cost of living may increase over time. With the HECM Saver the unused line of credit grows independent of home value, the mortgage may not be cancelled or frozen, and there is the flexibility of payback.

What about going beyond the concept in this study -- imagine broadening this approach beyond a risk management strategy to think of it as the ultimate savings strategy — setting up a reverse mortgage and letting it sit and grow in cash availability over time — until such time as you would want to enhance your cash flow. All the same logic that made this an attractive selection in the research above, are at play in this scenario as well — the difference here is that you are making a decision to use the reverse mortgage as an investment in your future. You might well still select the HECM Saver option for all the logic already discussed and simply open your line of credit and sit back and watch it grow.

What would this growth look like? For example, if at age 66 you had a home valued at $1.5 million with no mortgage and simply wanted to establish a line of credit and let it grow for future requirements. Today, the FHA cap on the appraised value of your home is $625,500. Your initial line of credit would be an estimated $325,000 with the HECM Saver. However, at age 71 — without accessing any cash and just letting it grow in availability — it could be an estimated $445,000 – an increase of about 35 percent.

If you elect to pay your up-front costs out-of-pocket, then zero interest is being accumulated and you are simply building a future nest egg. You might even elect to do this with an existing mortgage — and pay the reverse mortgage at the rate that you were paying down the mortgage — and watching your line of credit grow as the loan balance diminishes.

What might that scenario look like? For example, if at age 66 you had the same home with the FHA appraised value capped at $625,500 but with a $90,000 mortgage and wanted to both establish a line of credit for future requirements and pay down on your existing mortgage with the HECM Saver. At the closing of the Saver, your existing mortgage becomes part of your Saver loan balance and you could simply make payments against it at potentially the same dollar amount you were previously (or another amount of your choosing). Because you have a mortgage balance, your initial line of credit would be an estimated $235,000. In 5 years, with making consistent payments on your loan balance equivalent to your previous payments – and without accessing any cash and just letting the credit line grow in availability – your line of credit could be an estimated $349,000.

But, there is no requirement to make loan payments at all as long as you are in compliance with the terms of the reverse mortgage which include payment of your homeowner’s insurance and property taxes during the life of the loan and keeping up with repairs. And if you do elect a variable rate plan and decide you don’t want to wait to access your money, you can either draw down periodically from the credit line or for a very small fee, set up a regular payment plan. It can be very flexible to meet your requirements.

If you are in a home that you see as your primary residence looking out in the future, then these are concepts that deserve your serious consideration. A first step would be a discussion with a trusted mortgage professional to better understand your choices. This is in addition to any other advice you have chosen to seek from your accountant, lawyer, financial planner or children to discuss the reverse mortgage program in general and the concepts suggested in this article. In addition, you will be required to meet with a HECM counselor (in person or on the telephone) to discuss program eligibility requirements, financial implications and alternatives and loan repayment. A reverse mortgage is clearly a significant opportunity to have your home equity contribute to your retirement planning. This process will assist you in determining if this should be an integral part of your financial plan.

It's a 401(k) World and It Basically Sucks

Matthew Yglesias for Slate writes: I like the metaphor in Tom Friedman's latest column, arguing that we now live in a 401(k) world. But I wish he'd spelled it out in greater detail, because the problem with living in a 401(k) world is that Planet 401(k) is a pretty sucky planet. Here's the essential shape of 401(k) as a backbone of the retirement system:

— Poor people get absolutely nothing.

— Wealthy people who would have had large savings anyway get a nice tax cut that offers no meaningful incentive effect.

— For people in the middle, the quantity of subsidy you receive is linked to the marginal tax rate you pay—in other words, it's inverse to need.

— A small minority of middle-class people manage to file the paperwork to save an adequate amount and then select a prudent low-fee, broadly diversified fund as their savings vehicle.

— Most middle-class savers end up either undersaving, overtrading, investing in excessively high-fee vehicles or some combination of the three.

— A small number of highly compensated folks now have lucrative careers offering bad investment products to a middle-class mass market based on their ability to swindle people.

Congratulations, America! Across a very wide range of products there's a strong case for a large dose of consumer sovereignty. People should buy the shoes and sandwiches and shirts they want. They should watch the shows they want to watch. Get the furniture and appliances they like, and pick their own hairstylists and their own favorite grocery stores. Tastes differ, so even though competition and choice will rarely lead to a perfect outcome it's going to lead to a much better outcome than trying to have a Shoe Commission tell everyone how many shoes they need and what they should cost and look like.

Middle class retirement savings isn't like that. We know roughly how much people need to put away in order to retire with a standard of living they'll be comfortable with. And we definitely know what kind of investment vehicles are most appropriate for middle class savers. And we have abundant evidence that, left to their own devices, a very large share of middle class savers will make the wrong choices. What's more, because of the nature of the right choices it's obvious that the dominant business strategy for vendors of middle class investment products is to dedicate your time and energy to developing and marketing inferior products, since the essence of superior products in this field is that they're less remunerative.

In other words: A disaster. What's needed is a much more forceful, much more statist approach to forced savings, whether that's quasi-savings in the form of higher taxes and more Social Security benefits or something like a Singapore-style system where "private" savings are pooled into a state-run investment fund.

Now since we are in fact living in a 401(k) world, here's some advice. You've got to save a lot of money for retirement. More than you think. More than you want to. And you need to put that money in a broadly diversified, low-fee fund. And you have to keep it there. Don't panic when the market plunged and sell. In fact, unless you're planning on retiring in the next decade, don't even check how it's doing. Just buy and hold and shift into something less volatile when you're near retirement. Vanguard has these good Target 20XX funds that automatically shift you into less volatile products as you get closer to your target retirement date, allowing you to do even more ignoring of the state of your investments. Which is good. The only way for anyone to make any money managing your savings is to try and trick you into making trades you shouldn't make, or buying products you shouldn't buy.

401(k) Report: Fewer Matches, Fewer Plans

Donald Jay Korn for OnWallStreet writes: Since 2009, the number of companies that match 401(k) contributions has decreased by almost 7%.  "Not only are companies cutting the 401(k) match, an almost equal percentage of companies are terminating their 401(k) plans,” Brett Goldstein, director of retirement planning at Jericho, New York-based American Investment Planners, which did the survey, said in a statement. Goldstein added that approximately 6% of 401(k) plans have been terminated since 2009, attributing the cutbacks to the stock market crash of 2008 and the accompanying recession.

“I think these trends will continue as companies look for ways to cut expenses,” Goldstein said. “Insurance premiums for coverage such as health and liability will continue to rise. Other costs such as rent, taxes and utility costs will also continue to increase. As companies look for ways to reduce their expenses, their 401(k) plans seem to be one cost that employers are cutting to be more profitable.”

How will these trends impact financial advisors? “Financial advisors can use this information to help business owners manage their 401(k)s,” Goldstein said. With such advice, employers may be able to change the plan to be more cost-effective, instead of terminating the plan.
“Financial advisors also may be able to help employees,” Goldstein said. Without company-sponsored retirement plans such as 401(k)s to help save for retirement, employees must set aside their own money for retirement and develop their own investment strategies. He recommended that employees work with a trusted financial advisor who can help set up alternative plans such as IRAs, Roth IRAs and annuities.

“To make matters worse, the number of traditional defined benefit pension plans decreased by 15% in 2011," Goldstein stated. As employers terminate retirement plans, financial advisors will find more clients and prospects who need help in accumulating ample nest eggs for a comfortable retirement. Clients with 401(k) plans but no employer match may seek advice about whether to make unmatched contributions or invest elsewhere, perhaps through Roth IRAs or tax-efficient vehicles.

According to the 401(k) Performance Survey, 42% of businesses did not match participants’ 401(k) contributions in 2011. "Clearly, as businesses look for ways to lower expenses and improve bottom lines, it is not surprising that businesses have stopped matching,” Goldstein stated. “I have been studying this trend for the past four years and don't see the trend abating any time soon.”

3 Quick Tips For Staying Connected To Your 401(k)

Adam Wren for Forbes writes: You’ve had a 401(k) for years, your money goes in each month, the statements arrive each quarter, and you don’t think about it much. You’re not alone.  Complacency is common, but there are tactics within your reach to stay engaged and be sure your money is optimized amid today’s dynamic financial environment. Consider these different approaches to avoid the status quo and get the most out of your investments.

Just Three Minutes a Year

Make a note to check in with your financial advisor at least once a year about your allocations. Add a reminder to your work and home calendars, or set an annual recurring reminder in your smartphone. You can also associate it with an annual event like Tax Day. It’s of course best to meet more frequently and in person. But if you can’t seem to follow through on face-to-face meetings, try this quick trick: Log on to your 401(k) site and do a screen grab or a copy and paste of your current investment allocations, as well as other potential allocations available to you. Email your advisor and ask him or her to review your setup and make any recommended adjustments to align with the current economic climate.

Take That Raise and Sock It

For many Americans, a raise translates to more discretionary income. But rather than increasing your spending, you could consider diverting all or some of your annual raises directly to your 401(k). Many plans offer an automatic deduction from each paycheck. If you feel like you need some of the money to cover expenses, consider putting away a small portion per raise into your account. Even 1 percent helps.

Consolidate

With the average American holding 10.8 jobs between the ages of 18 and 42, 401(k)s can pile up like old business cards. A strategy for keeping closer tabs on the status of your investments is to keep them clean and simple, so that you can monitor and manage your money more easily. One way to do this is to rollover 401(k)s from old jobs into your latest 401(k). That way, you only have to worry about keeping tabs on one password and one statement.

Whatever works best for you, the most important thing is to consider all strategies and take a proactive, informed approach to your 401(k).

The pros and cons of putting your kids to work from a Tax perspective....

Michele Knight, CPA and owner of Knight Accounting & Technology for Summit Daily writes:  I won’t argue the pros and cons of choosing to spend every waking moment with your spouse, there are a few perks from a tax perspective. To be clear, I don’t advocate hiring your spouse or children in name only. If you are going to hire a loved one, whether it be a spouse or child, he or she needs to be a bona fide employee, otherwise the IRS can reverse any of the benefits you receive. If you are a business owner and your spouse is willing and able to work for your company, there are a few benefits that may help seal the deal.

As long as your spouse or child is a legitimate employee, you can take deductions for his or her meals and travel. It’s a common misconception that if you are a sole proprietor and your spouse runs errands for your company that you can deduct his or her travel expenses. If your spouse is not an employee or owner, you cannot. For example, if you travel to a conference, you can deduct your airfare, but not your spouse’s, the full cost of the hotel and your portion of the meals. So, by hiring your spouse or by making him or her an owner of the business, you can now fully deduct both yours and your spouse’s portion of the trip and take a larger deduction for a trip you would’ve taken anyway.

The same deduction rules apply to your spouse’s mileage. Quite often, I see small businesses for which the spouse is the primary errand runner, but he or she cannot legitimately deduct those miles. Adding your spouse to the payroll can greatly increase your deductions, often for expenses you were incurring anyway. Meals and entertainment also fit into this category. Any time you have a business meal with your employees (also known as your spouse or kids), you can now deduct the cost as long as you discuss business during the meal.

Medical insurance benefits are another good reason to hire a family member. If your company pays 100 percent of its employees’ health benefits, but only 50 percent of employees’ family benefits, then the owner is subject to the same rules. But, if your spouse becomes a bona fide employee, then the business can pay 100 percent of his or her health insurance premiums. Needless to say, as insurance costs continue to rise, the tax savings from this benefit could be substantial.

Life insurance is another potential deduction, though it’s a bit more complicated. Employers can deduct the premiums for the first $50,000 of employer-paid, group-term coverage, and that benefit is tax free to the employee. But the caveat is that the business cannot deduct this expense for any employee who owns 2 percent or more of the company. So, while it might not work for the primary owner, if you add a family member as an employee and don’t give them ownership, he or she would be eligible for this deduction.

Like most tax deductions, you need to weigh out the costs of adding the benefit versus the true tax deduction. But if you sit down with your accountant and go through these potential benefits, there should be a clear answer as to whether it will benefit you to make your spouse a part of the business.

Windfall Income Tax Planning

Michael Cohn for Accounting Today writes:  You receive a call from a very excited client: your lawyer client settled a large case. Or your client won a large judgment. Or your client won the lottery. Now your client is about to receive a very large check: $1,000,000. $5,000,000. More? That’s the good news.

The bad news is that it is ordinary income, and large lump sums of ordinary income are taxed at the highest marginal rates and do not have easy tax planning “solutions.”

What alternatives should you help your client consider? In this discussion we will use $1,000,000, since you can multiply that figure by as much as necessary to make it interesting, and we will assume that all of it is in the maximum federal (and state) income tax brackets.

First, if at all possible, see if your client can split the receipt of the funds between this year and next year. Of course be sure that deferral does not jeopardize receipt of the funds or significantly reduce the value of the second year’s payment (due to the time value of money).

Why do this? Usually not because the client is likely to be in a lower bracket in the later year. Instead, this is because the best tax technique—a pension—works best when there are contributions in multiple years.

Second, seriously consider simply paying the tax and pocketing the difference. On $1,000,000 the tax will be 39.6% federal, leaving $604,000. In the highest taxed state, California, the tax would be (13.3% x (100 – 39.6 = ) 60.4% = ) 8.0332% net, meaning a total of 47.6332%, leaving $523,668.

The advantage of this approach is the KISS principle: Keep It Simple. Your client can put the $604,000 (or $523,668) in the bank; in tax-free muni bonds; in first trust deeds on real property; or your client can buy a building, depending upon investment preference, all without worrying about “tax structuring.”

Third, the most conservative tax structure is a pension plan. How much of a deduction can your client get? Probably a lot more than you think. A 45-year-old with a same-age spouse, both of whom have past service, can probably achieve a deduction of $320,000. The figure increases to $530,000 for a 55-year-old. There are ways to increase those figures. And there is a method that might allow that figure to triple in certain situations. (Of course, 99% of all plan consulting firms are not up to this task.) Pension plans are so safe and so important that it does not make sense to discuss other options until this one has been fully exhausted.

Fourth, a captive insurance company can be an attractive structure. A premium of as little as $400,000 can be economically appropriate, given the costs involved. And a premium of as much as $1,200,000 can be received by your client’s insurance company without incurring an income tax under Internal Revenue Code Section 831(b).

Of course, compared to the $3,500 per year cost of a third party administrator for a two-person pension plan, the captive costs run 10 to 20 times as much. However, in the right situations, this can be a terrific result in terms of risk management, estate and gift tax planning, asset protection planning, and income tax planning.

Fifth, a charitable limited liability company is a way to get a deduction of 85 percent or so of the funds. This is primarily of interest to people who have a favorite charity that they would like to support. However, for those people, this is a wonderful result. The client ends up with an LLC that is full of money that can be used for investment, including loans for business opportunities; and the charity receives a steady stream of revenue for its membership interest.

Sixth, a charitable lead annuity trust, or CLAT, can create a large percentage deduction. For example, contributing $1,000,000 to a 20-year term 5% payout generates an 88.436% deduction. For a 10-year term, the deduction is 46.853%. The cost of the upfront deduction is that the client is taxable on the trust’s earnings. However, that cost can be mitigated by investing the trust corpus into muni bonds. Although it is not currently easy to find muni bonds at 5%, even if the bonds generate only generate a significant portion of the 5% payout this can be an excellent result, especially for a client who is interested in a particular charity and/or trying to fund his or her own family foundation. This structure is also attractive psychologically: the client gets a large upfront deduction and then, at the end of 10 or 20 years, gets all of the assets back, probably at a time when the client will appreciate them even more.

Seventh, a charitable remainder unitrust, CRUT, for the lives of two people both age 65 provides a 34% charitable deduction. The deduction increases to 49% if the couple are both age 75. Like the CLAT, this works well as a part of an overall tax plan for the client with the windfall. The advantage to the CRUT is that the client retains the income for life, which is especially attractive for clients who either have no children or whose children have already been otherwise provided for.

Eighth, investment in an oil or gas drilling partnership typically results in a deduction of 100 percent of the investment. The primary challenge is the economics, not the tax results.

Ninth, investments in real estate involving agriculture—such as grapes, avocados and pistachios—gives the advantage of the upside historically associated with land plus the heavy tax benefits provided by Congress to farmers.

Finally, when all else fails, buy a good building and use component depreciation. Depending upon the building, you may be able to depreciate up to 40 percent of the value of the building within the first five years.

When your client is about to receive a windfall of ordinary income, you need to review the list of alternatives. Leave your preconceptions at the door. Some clients will prefer to simply pay the tax. Some will be satisfied with a pension plan. But some few will want a meticulous analysis of all of the alternatives and will, in the end, surprise you by allocating funds to many of them.

Tax Hit if Parents pay Kid's Student Loan?

Don Taylor for BankRate.com / Fox Business writes:   Dear Dr. Don,  My daughter has $145,000 in student loan debt. We have some savings and want to pay $110,000 toward the loan. Is there a tax consequence for any of us? The interest rate on her loan is 6.9%. She graduates at the end of May.

Thanks,
-Sharma's Senior

Dear Sharma's Senior,

I don't get it. What have you been waiting for? Why did you make her take out the loans in the first place? Did you want to make sure she was going to graduate? It would have been better for you to make the tuition payments directly to the school, which wouldn't be considered gifting. But I guess that is history since she's graduating soon, and you've written your last tuition check.

The issue is that you'd face a potential gift tax, since you are planning to give your daughter more than the annual gift tax exclusion. That's $14,000 for the 2013 tax year or $28,000 for a married couple filing jointly who elects to split gifts. If you split gifts, you each must file Internal Revenue Service Form 709, even if half of the split gift is less than the amount of the annual exclusion.

Either way, the money you give to your daughter over the annual exclusion amount also requires that you both file Form 709. You won't owe tax on the gift in the 2013 tax year, but your lifetime unified credit for gifting is reduced by the amount of the gift tax. If you don't do your own tax returns, work with your tax professional to make sure you did this correctly.

There may be a way to set up a 529 account to pay off loans taken out this year for this year's qualified higher education expenses. Section 529 plans let you make gifts larger than the annual exclusion limit for a beneficiary and treat it as if you made it over five calendar years for gift tax purposes.

You would set up a 529 account if there were state income tax benefits associated with making such contributions to the plan. There are also gifting implications here, and you would have to be able to contribute to a plan that has minimum holding periods short enough that it would allow you to pay off the loans she took out this year for qualified higher education expenses she incurred this year with money from the 529 college savings plan. I'd work with a tax professional on this aspect of gifting too.

Advisers Look To Limit Trust Taxes

Arden Dale for the Wall St Journal writes: Faced with higher tax rates on dividends, capital gains and income, some advisers say clients who own trusts may want to consider two strategies to limit their tax liabilities.  Advisers say trust owners should weed out investments that can incur a hefty tax hit, while others can lower their taxes by tweaking the trusts to pay out more to beneficiaries who are in lower brackets.

Adviser Marilyn Bergen in Portland, Ore., said she thinks both strategies can work.

Under the new federal tax regime, for example, Oregonians with trusts could end up paying 53.3% tax on trust income once state taxes are added, she said. Last week, Ms. Bergen and an attorney gave a talk on this issue to a local chapter of financial planners.

"Even in states where there is no state income tax, the rules have changed enough that trustees and advisers should take another look at how trusts should be managed," said Ms. Bergen, a financial planner at Confluence Wealth Management LLC, with $390 million under management.

Indeed, with the enactment of the American Taxpayer Relief Act of 2012, trusts now face higher tax liabilities. Trusts with more than $11,950 in income 2013 must pay the top tax rates for income, dividends and capital gains. In contrast, individual taxpayers don't trigger those rates until they report more than $400,000 in taxable income ($450,000 for joint filers). The top income-tax bracket is 39.6%, while the top rate for long-term capital gains and dividends is now 20%.

An obvious place to start to reduce taxes in a trust is to look at the investments it holds.

Advisers say trustees should consider alternatives to dividend-paying stocks and other highly taxed securities--such as emerging-market debt funds, REIT mutual funds and international bond funds.

As replacement options, trust owners may want to consider insurance products and private placements, which are non-public offerings of company shares, said attorney Diana Zeydel, of Greenberg Traurig. She chairs the Miami law firm's trusts and estate department.

And as always, savvy trustees will continue to work hard to balance capital gains and losses to reduce the net tax burden, said attorney Michael Puzo, chair of the private client group at Hemenway & Barnes LLP in Boston. "Here, the 3.8% surtax adds nothing conceptually, just makes the stakes higher than they were before," he said.

One widely used method to limit a trust's tax liabilities is to bunch capital gains into a given year to avoid hitting the top bracket in the next year.

If removing some investments from a trust isn't an option, trust beneficiaries can help reduce the tax hit.

The beneficiary is taxed, not the trust, when he or she gets a distribution. So it may be possible to lower overall taxes by paying out more to a beneficiary who's in a lower tax bracket.

Recently, a widow in her mid-70s sat down with North Carolina adviser David Blain to talk about a trust she has that holds about $650,000 in exchange-traded funds. It pays her expenses from the $21,000 or so that it earns in interest and dividends. The woman is in the 25% tax bracket.

Until now, the trust has not paid out principal. After talking with Mr. Blain, though, the woman decided the trust should pay 5% of its principal to her each year. Her son, who will inherit whatever is left in the trust at her death, was part of this conversation.

However, a delicate balance has to be struck with this kind of adjustment.

"The danger with this is, we want to lower taxes so as to give as much income as possible to a kid, but the grandkids may be saying, 'Wait, that's coming to me, don't give it all to her,'" said Mr. Blain, a financial planner in New Bern, N.C., whose eponymous firm has around $70 million under management.

While changing the investments in the trust or paying a trust beneficiary bigger distributions may help cut tax liabilities, some trusts simply can't be touched.

It "may be impossible, if the trust is very rigid," said attorney Edward F. Koren, of Holland & Knight in Tampa, Fla., and chair of its private wealth services. A trustee can't make changes to a trust unless the documents expressly permit it, he said.

Should you let the IRS do your taxes for you?

Jeffrey A. Eisenach for the Daily Caller writes: It’s an annual tradition that around the end of tax season, lawmakers and policy experts discuss ways to make the tax code and tax system more efficient for taxpayers. While much of the discussion this year surrounded the potential for once-in-a-generation tax reform, some participants have focused on making the filing process itself easier.

Today, the majority of individual tax returns are filed electronically, rather than by mail. Electronic filing saves taxpayers money and reduces the likelihood that they will make mistakes. All taxpayers can access free fillable forms to quickly input their data, and 70 percent of taxpayers can use software and file electronically for free thanks to a voluntary public-private partnership between tax-preparation companies and the IRS.

For some, the next obvious step is to get the private sector out of the way altogether. Under so-called “return-free” proposals, the government would prepare individuals’ tax returns, annually sending a pre-filled form for a taxpayer to review and approve. Proponents say a government-run system would be simple, painless and convenient, and would significantly reduce errors in the tax-filing process. If you believe this, I have some opportunities in the solar-panel business I’d like to talk to you about.

The truth is that a return-free system only sounds good until you think about it. When you do, it doesn’t take long to understand why we need to keep the government out of the tax-preparation business.

To begin with, creating a return-free system would require the largest and most ambitious information technology upgrade in IRS history. Given the sheer scale and complexity of its operations and its status as a government agency, it is perhaps not surprising that the IRS has had a poor track record when it comes to designing and implementing technology modernization programs, including delays, cost overruns and outright failures. The most optimistic estimates are that creating a return-free system would cost hundreds of millions of dollars and take several years — but history suggests it could cost billions and take a decade or more.

Even if a return-free system could be implemented, the benefits would fall far short of the costs. Anyone who has ever done business with a government agency knows that, first, many IRS-prepared tax returns will have errors and, second, trying to get those errors corrected will be a nightmare. Then there is the problem of privacy: Each year, the IRS mails tens of thousands of refund checks and other documents to the wrong addresses. Under return-free, thousands of completed tax returns would be delivered to the wrong people.

Experience abroad confirms these fears are well placed. Such problems have been commonplace in foreign countries that have tried to implement return-free — despite the fact that their tax codes are far simpler than ours. For example, the United Kingdom’s government-provided online filing program has been plagued by technical and operational difficulties, and British taxpayers have faced problems ranging from security breaches to overpayments, lost tax notices and delays in returns. In response, British authorities are now considering adopting a system similar to the U.S. “free file” model. 

Can I Claim a New Roof as a Tax Deduction?

Alia Nikolakopulos for Demand Media writes: The cost of a new roof is an expense investment that most property owners hope they can get some relief from at tax time. However, the IRS does not allow full deductions for this type of expense when it is incurred. In fact, depending on how the property is classified, the cost of a new roof may not be deductible as an expense at all.

PERSONAL RESIDENCE

The cost of a roof installed on an owner’s personal residence is not deductible as an expense in the year the expense incurs, but rather added on to the initial cost of the property and accounted for when the home is disposed of or sold. This addition increases the owner’s cost basis in the home. Cost basis is recovered at the time of sale by offsetting it with the sales price of the home. When cost basis is increased during ownership, any potential gain at the time of sale is minimized.

COST BASIS

An owner’s cost basis in personal property includes the purchase price of the home, plus additions for other costs incurred to acquire the property, and throughout the ownership of the home. Examples of additions to cost basis outside of the purchase price include title fees, transfer taxes, city or town assessments for utility lines or sidewalks and long-term improvements or repairs made to the home. The costs of minor repairs, such as painting or carpet replacement, are not generally included in cost basis calculations.

RENTAL OR INVESTMENT PROPERTY

For owners of residential or commercial rental property held for investment, the tax laws for deducting new roofs are different. The IRS requires that the value of property held for investment purposes be depreciated over a period of time. In addition to depreciating the basic cost basis value of the property, this law extends to long-term capital improvements made to the property, including new roofs. A deduction for depreciation is taken as an expense beginning in the first year the cost is incurred.

DEPRECIATION

Unlike personal residences, the cost of new roofs installed on investment property is not added to the cost basis of the property, except when the new roof is added before the property is placed in service. If the new roof is installed after the investment property has already been in service, the new roof will be listed as a separate asset in connection with the property. In this instance, the basic depreciation schedule for the new roof will match the same basic recovery period for the property, depending on the classification of the unit. If the property is a residential rental property, the recovery period is 27.5 years, and if the property is held for commercial rental purposes, the recovery period is 40 years. Unless an alternative depreciation method is used, the cost of the new roof will be divided equally into the number of years in the recovery period, and the result will be deducted as a depreciation expense each year until the roof is fully depreciated, or until the property is sold or disposed of.

IRS Takes a Bite Out of Bitcoin

Robert W Wood for Forbes writes: Bitcoin is virtual currency much in the news these days. It’s peer-to-peer so there’s no central bank or government. But if you think that means the IRS won’t get a piece, think again.

The IRS already gets a piece where you swap one product or service for another, as the IRS explains at its Bartering Tax Center. Soon the IRS may have a Bitcoin Center too. The Treasury unit called FinCEN, the Financial Crimes Enforcement Network, already has rules about Bitcoin and the IRS is likely to follow.

In the meantime, the tax rules seem pretty clear. If you provide services or sell goods for Bitcoin, you have income. If you exchange Bitcoins for cash, whether you have gain may depend on whether Bitcoin is really currency or commodity. The latter seems more likely, meaning you have gain to the extent of the appreciation in your Bitcoin.

Income is income, whether you get it in cash or in kind. Bitcoin may be accepted as currency and may not be easy to trace but so are trades and barters. When you barter or swap one item for another, both parties have tax consequences. That’s so even if one party wants credit for later.

Trade or barter dollars allow you to barter when one party wants goods or services and the other wants credit for the future. Earning trade or barter dollars through a barter exchange is considered taxable income, just as if your product or service was sold for cash. And even trades are still taxed.

Plumbing for dental work? The IRS taxes it. You name the swap, it’s income to both sides just like cash. Both must report the fair market value of goods or services received on their tax returns. See Do You Barter? The IRS Wants Its Cut. 

Most casual barter exchanges probably aren’t on the tax radar. Most Bitcoin transactions aren’t either. But even simple trades trigger multiple tax rules. If you receive $1,000 of dental work for your gardening services, you have $1,000 of income.

If you swap your wristwatch for a painting, it’s two separate taxable transactions. Say you inherited the watch from your uncle when it was worth $5,000. If it’s doubled in value to $10,000 and the painting is also worth $10,000, you have $5,000 of income. (Section 1031 exchanges of some business and investment property can be tax-free, but that’s no help here.)

How will the IRS know about your swap? They probably won’t unless you receive a Form 1099. Still, the IRS says you must report any income on your return regardless of whether you receive a Form 1099. See IRS Form 1099: God Particle Of The Tax System. 

The FinCEN rules say Bitcoin exchanges and Bitcoin miners should register as Money Services Businesses (MSBs) and comply with anti-money laundering regulations. Ordinary Bitcoin users don’t have to register just to purchase goods and services. But will Forms 1099 and other nettlesome signs of civilization soon bite Bitcoin? Yes, and probably soon.

IRS Updates Excludable or Deductible Foreign Housing Expenses for 2013

 The IRS has updated the foreign housing expense exclusion/deduction amounts for 2013. The maximum housing expenses for 2013 is $29,280 for a taxpayer who meets the tax home test and either the bona fide resident or physical presence test for the entire tax year. The adjusted limitation applies in lieu of the otherwise applicable limitation and is provided for each location on a daily and full-year basis.

The adjusted limitations apply to tax years beginning on or after January 1, 2013. Taxpayers may, however, elect to apply the 2013 adjusted limitations to the 2012 tax year, in lieu of the adjusted limitations provided in Notice 2012-19, 2012-1 CB 440, if the 2013 limitations are higher. The IRS anticipates that future annual notices providing adjustments to housing expense limitations will make a similar election available for housing expenses incurred in the immediately preceding year.

IRS and snooping: Finding a loophole

The New Burn Sun Journal/StarDem.com writes: Unless they decided to file for extensions, most people have put the 2013 income-tax filing deadline behind them.

Of course, there's probably some sting remaining. This isn't the Internal Revenue Service's most popular time of the year. And this year, the IRS gave the public new reason for frustration and suspicion.

Agency lawyers have claimed they don't need a search warrant to read email and social media messages from citizens.

Newly released documents show that the IRS has taken the position that Americans enjoy “generally no privacy” in electronic communications including email, Facebook chats and Twitter direct messages,Cnet.com reported.

The documents, obtained by the American Civil Liberties Union, show the IRS position is that those messages lose Fourth Amendment protections once they've been sent from an individual's computer. That means the IRS can obtain them in tax investigations without needing a search warrant signed by a judge.

Part of the problem is that the federal law that governs law enforcement access to email, the Electronic Communications Privacy Act of 1986, is hopelessly outdated. The law requires a warrant if email is stored on a provider's server for 180 days or less, but there is no such requirement for older messages.

A federal appeals court ruled in 2010 that the government must obtain a probable cause warrant before compelling email providers to turn over messages, but some providers aren't following the ruling.

Some lawmakers have criticized the IRS for its position on email searches, but the public would be better served if Congress concentrated on updating the privacy act.

Despite the suggestion of the IRS, people do believe that they're protected from government snooping on their electronic communications. It's time that privacy laws catch up with rapidly changing technology and assure Americans of those protections.

Retirement Planning Can Help High Earners Avoid Big Tax Hit

Sharon Epperson for CNBC writes: Big tax changes this year will force many top earners to pay closer attention to the tax treatment of their investments, including retirement accounts.

New Jersey attorney Doug Bramley usually gets a tax refund each spring, but he won't this year—or in the future—at least he's stopped counting on it.

"That's no longer going to happen. As my tax burden increases, I'm paying more and more in taxes and I'm not getting tax refunds and we have to plan financially for that," said Bramley, 40, who is married with two children.

Top earners like Bramley will take a big tax hit this year on earned and investment income. For couples with incomes of more than $450,000—or $400,000 if you're single—increases in federal income tax and Medicare surtax will result in a total tax hit of nearly 42 percent on earned income in 2013—a more than 5 percent increase over last year.

Add to that taxes on dividends and long-term capital gains now at nearly 24 percent for top earners—an almost 9 percent increase compared to 2012, and tax on interest income in 2013, which is now at a whopping 43 percent. Facing a potential tax hit like this is forcing households like Bramley's to make some changes.

Payroll tax changes have also reduced take-home pay for millions of Americans. "We have already done a lot of planning as a family in anticipation of the fact that my income will be a little lower because of these tax bites. We've made the decision not to move," said Bramley, who had been planning to relocate his family to a larger home until he reviewed his tax situation.

Big changes are ahead for portfolio planning, too. Financial advisors say recent tax increases give new urgency to the need for diversification, and they recommend new strategies for investing.

First, buy some stocks for growth "that aren't paying dividends that maybe give you the same result in the end, but have a little less tax implications," said Doug Lockwood, a certified financial planner and principal of the Harbor Lights Financial Group in Manasquan, N.J. Then, "make sure that after you look at your nonqualified money you go to your tax-deductible money—your 401(k)s, 403bs, your IRAs—and make sure that you're absolutely maximizing those opportunities."

So where should you put your retirement dollars to avoid a big tax hit? Lockwood and other financial advisors suggest:

• Contribute the maximum amount to a 401(k) or employer-sponsored plan—up to $17,500 this year or $23,000 if you're 50 or older— to reduce your taxable income. 
• Convert a regular IRA to a Roth IRA. You'll be taxed on the money you convert, but you can generally take the money out tax free in retirement, after age 59½ as long as you've held the account for five years. 
• You can still keep a taxable account in the mix. Although putting more dollars there may be less attractive now. 

"We're going to get back to really managing investments (thinking of) what the tax liabilities might be," Lockwood said. "And those folks who manage it the best will get to the finish line first."

For many, a varied investment strategy for an uncertain tax landscape is an imperative.

Key Employees Show Concern, Yet Optimism, About Retirement Future ... And Employers Can Help

Steve Parrish for Forbes writes: I’ve been catching up on my reading recently and trying to connect the dots on retirement planning for a special group of employees. It started with my review of a survey of key employees’ attitudes about retirement.

Key employees in small- and medium-sized businesses want to feel good about their plans for retirement — and they’re doing something about it. The survey of these highly compensated employees (HCEs) reveals that while these employees identify some threats to their retirement security, they also have a willingness to take charge of their own financial situation. In the survey, key employees identified the top three threats to their retirement as market volatility (51%), reduction in Social Security benefits (47%) and reduction in Medicare benefits (45%). In response to how market volatility affected their financial well-being, almost half indicated they have moved to a more conservative investment approach. And, they are using a variety of ways to save for retirement, including Individual Retirement Accounts, savings accounts, brokerage accounts and real estate.

When asked to select the main issues key employees are most concerned about when it comes to retirement, the top answers included: 1) being able to enjoy the same quality of life in retirement, 2) outliving personal savings and 3) rising cost of inflation reducing purchasing power. Nonetheless, they don’t appear to be passively accepting these challenges as the status quo. Eighty two percent of key employees are aware of the amount of money they will need in order to be comfortable in retirement; and, 62% of them believe they are saving enough money in order to live comfortably in retirement.

Financial goals are not out of reach

The research also stated that key employees are much more satisfied with their current situation and progress towards future financial goals than other employees. The report showed a significantly higher percentage of key employees (62%) agree they are extremely happy about their current financial well-being compared to all other employees (27%). More than half of them rate themselves as financially healthy (66%), compared to other employees (43%).  And, key employees are more likely to completely agree that they are taking steps to improve their financial health (37%).

So … what does this mean for you and your business? That’s where the connection with a second research study comes in; a study offering a way for employers to leverage key employees’ retirement attitudes with benefits that can support broader organizational goals.

A solution

A couple months ago I reviewed some trends in tax planning from the new tax law.  I suggested then that, especially in the current tax environment when income taxes are on the rise, nonqualified deferred compensation plans (NQDC) are particularly compelling. Such plans allow for an employee to defer compensation, and therefore income taxes, into the future. Likewise, it allows employers to use discretionary contributions as an incentive and so-called “golden handcuff.” The second research I referenced appears to support this point of view. It suggests employers truly care about their key employees’ ability to retire. Nearly three in five employers expressed some level of concern about their organization’s top talent having sufficient income during retirement.

Why deferred compensation as a solution? The paper reveals the employers’ top three reasons to offer a NQDC plan are to (they could choose multiple reasons):

• Allow key employees a means for retirement savings in excess of qualified plan limits (93%)
• Provide a competitive benefits package when recruiting key employees (91%)
• Help retain key employees (86%)

In addition to sponsoring NQDC plans where the employee is deferring income, employers have also made increasing use of discretionary contributions. Over six in 10 plan sponsors reported using discretionary contributions in 2012, and this trend has increased steadily since the Great Recession began. This may not only be because of increased employer cash availability, but also because these plans are an alternative to nonqualified stock options and restricted stock grants.

This research demonstrates a classic alignment of needs between key employees and their employers. The top talent wants a way to save more for retirement, and the employer wants to attract, retain and reward these employees. A supplemental retirement plan, such as nonqualified deferred compensation plan, may well fit the bill.