December 2008

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MONTH YEAR: Lead Article: 1 ¾ pages [2nd page about 45 lines]
Lead Article Title: Thoughts on a Rough YearSummary: It’s been a very rough year for everyone. The purpose of this article is not to trivialize the pain that many have suffered and continue to suffer. Nor to any manner imply that recent economic events could have been anticipated or planned around. Recognizing this, and that hindsight is always 20-20, lessons can be learned from the carnage. Although the observations following are not profound, and many are quite simplistic, they are drawn from problems others have experienced, and can hopefully provide some relevant ideas.■ Time Horizons.Too many investors forgot the concept of time and accepted asset allocations that were out of sync with the time frame that was appropriate for them. Yes, asset allocation can reduce risk and increase return, but it’s was never intended as a two dimensional decision. The almost mechanistic application of what some advisers passed off as investment planning too often ignored the investor’s time horizon. This same essential lesson is now being ignored by investors again. Some investors have abandoned equities because of the risk they now associate with them. That decision should consider the investment time horizon. Just as many investors were hurt by assuming too long a time horizon, many will be hurt in future years from now ignoring the lengthy time horizon they have.

■ It’s Not One Investment Pot.

One lesson from the carnage of the 2008 meltdown seems to be that too many investors, or their advisers, viewed the entirety of their investment assets as a single pot for asset allocation purposes. It was not uncommon for many investors to have a financial planner run a fairly boilerplate financial analysis and come up with an allocation that would then be applied to the investors overall portfolio. This was always too simplistic an approach. Assume that your overall allocation was 60% stock: 40% bonds. If you have a college fund for your children, and have a child in college and one two years from college, an allocation to cash and near cash investments, such as laddered CDs and money market funds, might be appropriate. Your rainy day money to get you through a job layoff, health emergency, and so forth could be pure cash. Saving for the purchase of a vacation home five years out, would warrant a less aggressive allocation because of the limited time duration, but certainly not the allocation to cash of the college or rainy day funds. If your remaining portfolio is $10 million and you’re spending about $350,000/year. $8 million of this portion of your portfolio might be used to support your expenses assuming a withdrawal rate of a bit over 4%/year. The remainder of your portfolio may in fact be funds almost assuredly being held to bequeath and have a much longer time horizon. Thus, breaking up your overall portfolio into separate pots for different purposes might not only yield a much more appropriate asset allocation for each major objective, but will better reflect the time horizon and risk each “pot” should bear [pun intended]. Does the hammering your portfolio took in 2008 undermine the integrity of asset allocation theory? No. But maybe the application of the theory deserves a more carefully crafted approach then many had used.

■ Budget is not a Four Letter Word.

You’re rich, you don’t need to budget! Wrong. Sorry, budgets are for everyone, even the wealthiest. The following scenario has been replayed too many times. A successful entrepreneur sales the family business for far more than imagined. The family is on easy street. Money is no object. Or is it. The family adjusts its lifestyle accordingly, and its’ spending grows to $750,000/year. While the $10 million net of tax you pocketed on the business might feel substantial, if you’re spending 7.5% on you investment assets (even forgetting the recent market meltdown) unless you quite old or infirm, you’ll long outlive your money. Do some simple math. Put together a balance sheet. Subtract off all the “B’s” bungalow, boat, and bling. What’s left is your investment assets. Multiply by 5%. If you’re spending more, you have a definite problem. If you want real assurance you won’t outlive your money, your spending probably should be closer to 3.5%. Its not that wealth cannot enable you to avoid the unpleasantness of budgeting, it can, but only if your spending is within reason of your asset base. Market meltdown or not, too many wealthy investors simply don’t control the relationship of their spending to their investable wealth. Read The Millionaire Next Door (Stanley and Danko). The surest way to become a millionaire is to live below your means. The surest way to fall from the ranks of the wealthy to the middle class (other than having invested with Madoff) is to spend well beyond your means. Wealth, and the status it supposedly brings, are seductive. It is as easy, as it is dangerous to your financial health, to be lured into excessive spending. The next few suggestions will help.

■ Annual Meetings are Vital.

To assure the success of your financial, estate, insurance and other planning you need to meet with your advisers at least annually. Meeting with your wealth manager quarterly is a prudent step. Meeting with your accountant to review and sign your tax return is also advisable. But an annual meeting of all your advisers and key family members is crucial and the above don’t substitute for it. Your annual review can range from a large board meeting spanning an entire day, or a mere hour long consultation with your estate planner who sequential calls your other advisers, depending on your budget and the complexity of your situation. The annual meeting will assure, if properly done (see below), that the expertise of each of your advisers is marshaled for your best interest. An annual review assures that no one looses site of the “big picture” of your planning. This is especially important during tumultuous times.

■ Coordinate your Adviser Team.

Too many people are realizing that investment, business, spending and other decisions were not made optimally. But many of those people did not have all of their key advisers: accountant, estate planner, business attorney, insurance consultant, wealth manager, trust officer, etc. coordinated and fully informed. A team approach can help identify gaps in planning, an adviser who is not following through, miscommunications between advisers that can result in duplication of efforts on your dime, or worse, dropped balls. To succeed, your advisers should work in consort. Backstabbing or one-upmanship don’t help you. Foster an atmosphere that welcomes identification of opportunities for improvement, and even mistakes. If the first thing that happens when a mistake is identified is one adviser blaming another (rightfully or wrongly), you loose. Be certain each adviser has the opportunity to be heard and voice their concerns. Don’t let your longest, or loudest, adviser dominate. Typically one of your advisers assumes the quarterback role. Be certain it is clear to everyone who it is, and then be sure to give the quarterback the authority to do what he or she believes needs to be done to protect you. Calling your estate planner your quarterback and not providing her with the annual meetings to keep current of your affairs, or leaving her off key memorandum from your other advisers, will never work.

■ Your Accountant is more than a Bean Counter.

Use your accountant as more than a bookkeeper and tax return preparer. Without intent to second guess the many shrewd investors taken in by histories biggest Ponzi scheme, your accountant might well have identified some concerns if you brought a proposed investment with Madoff to your annual advisory meeting. Your accountant might of raised concerns over the funds use of a small accounting firm, in a small town (New City, New York), operating from a 13 x 18 foot storefront office between a pediatrician’s office and another medical office. Your accountant might have determined that the auditor had not had a peer review since 1993. While this is all past history, using each of your advisers’ abilities to the fullest, in the context of a pro-active and collegial team, might help you avoid the next Madoff, or other pitfalls.

■ The Key Planning Question Too Many Forgot.

“What if”. Simple, obvious, almost trite, but that is the key to all planning. “What if”. Too many people just stopped asking enough “what if” questions in their planning. Let’s leave aside the market meltdown. “What if” you were disabled tomorrow and couldn’t work again. “What if” you were diagnosed with a debilitating, but not terminal disease, that would prevent you from working and increase your costs of daily living substantially? These are not farfetched or unreasonable questions. Millions of people face just such tough news every year. What if you were hit by a major lawsuit, one that had nothing to do with your work, perhaps a colleague stabbed you in the back by filing an incorrect document and setting it up to look as if you had done it. Your savings and career could be jeopardized. If you had asked these unpleasant but not implausible “what if” questions would you have fared differently through the economic turmoil?

■ Count Your Blessings.

“…Count your many blessings Money cannot buy…” (Johnson Oatman, Jr.). Focus on what is really important. Keep your perspective. It will help you get through the current economic problems with less pain. It will help you make better decisions going forward.
Checklist: Second Article 2 lines less than One Page [about 54 lines]:
Checklist Article Title: Art and Collectibles Part I

Summary: Art and collectibles raise a host of unique issues and considerations affecting income tax, insurance, estate and charitable planning. The subject matter is so broad that this brief checklist can at most highlight the breadth and complexity if the topic, not provide a comprehensive guide.

■ Recordkeeping for Art and Collectibles: Maintaining proper documentation of your collection is vital, and the first step to most other aspects of planning. You cannot insure, appraise, plan or sell a collection without information. Here’s some of the info you should keep:

♦♦ What type of collectible (e.g., painting, sculpture) ♦♦ Name or title of the work. ♦♦ Artist or other creator ♦♦ Dimensions (with and without frames, bases, etc.) ♦♦ Signature (is it signed? How? Where?) ♦♦ When made ♦♦ Composition (what is it made of) ♦♦ Ownership history (Provenance) ♦♦ When did you acquire it? ♦♦ How did you acquire it? (self created, purchase, gift, inheritance, auction) ♦♦ How much did you pay and how did you pay (save proof: receipts, bill of sale, cancelled check, certificate of authenticity, etc.) ♦♦ Location (where do you keep it? If multiple locations provide details as to when it is moved and how) ♦♦ Photographs (take good quality photographs, or better yet rely on the ones from a professional appraiser; include inventory number or other description in the photograph) ♦♦ Inventory details (if you have an inventory explain the numbering, where each item is tagged, bar codes, etc.) ♦♦

■ Income Tax Considerations: There are a host of income tax considerations to holding art and collectibles. The following is a smattering of them:

♦♦ Are you a dealer in art or collectibles? There are substantial tax implications. A dealer will realize ordinary income on sale, not capital gain, but will be able to deduct expenses a non-dealer cannot. If there is any gray in how this determination applies to you, you should carefully plan and document support for the conclusion that is optimal for you. ♦♦ If you sell collectibles at a loss, your tax deduction is limited to (1) losses incurred in a trade or business, which means your being a dealer; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business, if you can demonstrate this; and (3) , losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. IRC Sec. 165. ♦♦ You might be able to engage in a tax deferred exchange of some of your collectibles for others, but only if you can demonstrate that they were held for investment. IRC Sec. 1031. ♦♦ If your holding artwork or collection activities are not engaged in for profit, no deduction attributable to that activity will generally be allowed. IRC Sec. 183. If the gross income derived from your collecting for 3 or more years in the preceding 5 years exceeds the deductions attributable to your collection activity, then, unless the IRS establishes to the contrary, your activity will be presumed to be engaged in for profit. ♦♦ The top capital gain rate for sale of assets held for at least one year is usually 20%, but a 28% top rate applies to gains from the disposition of collectibles held for more than one year. “Collectibles” means art, rugs, antiques, metals, gems, stamps, coins, and alcoholic beverages. IRC Sec. 1(h)(6)(A) , 408(m). ♦♦ Interest expense incurred to carry investments is generally limited to net investment income. Net investment income excludes dividends and net capital gains unless you elect to include all or part of these in your investment income. IRC Sec. 163(d)(4)(B). Whether or not its advantageous for you to make this election may depend on the capital gains tax rate you’ll pay. Consider whether the election will cause gain on collectibles subject to the 28% rate to be treated as ordinary income. ♦♦ Depreciation generally cannot be claimed on collectibles. This is because depreciation is not permitted on assets which are not adversely affected by the passage of time, or by your use. The most commonly ecluded assets are art, antiques, and collectibles. Rev. Rul. 68-232, 1968-1 CB 79. There are a few limited exceptions. Inexpensive paintings used as furniture might qualify for depreciation if you can demonstrate a limited life for them. Some courts have held that depreciation is permitted if the collectible sustains wear and tear in its use. An antique violin bow or bass viol as examples. Liddle v. Commr., 103 TC 285 (1994), aff’d, 65 F3d 329 (3d Cir. 1995).

■ Insurance: ♦♦ Determine what coverage is available. ♦♦ Obtain a replacement value appraisal for insurance purposes. ♦♦

Recent Developments Article 1/3 Page [about 18 lines]:

■ S Corporation Compensation Games. Mr. Big only gets paid $500/week, but gets a distribution of $1 million/year form his S corporation. Why? Might it have something to do with minimizing payroll taxes? Mr. B, the IRS wasn’t born yesterday! Distributions and other payments by an S corporation to an officer must be treated as wages to the extent the amounts are reasonable compensation for services. Factors considered by the courts include: • Training and experience • Duties and responsibilities • Time and effort devoted to the business • Dividend history • Payments to non-shareholder employees • Timing and manner of paying bonuses to key people • What comparable businesses pay for similar services • Compensation agreements • The use of a formula to determine compensation. FS-2008-25; IRC Sec. 1362. Corroborate the basis for your salary, and most importantly do what Dr. Phil, CPA says “Get Real”!
■ Continuous Representation. A law firm’s former client’s claims concerning offshore trusts the firm helped the client form to avoiding taxes were not barred by the three-year statute of limitations. The court held that the firm continued to represent the client after the trusts were formed. The continuous representation theory is to protect clients, not help attorneys. De May v. Moore & Bruce LLP, D.D.C., No. 08-845 (ESH), 11/06/08.
■ Taking an IRS Audit too Hard. You thought that the 1993 movie Falling Down with the character William “Bill” Foster (played by Michael Douglas) was a movie. But the script sounds like a documentary about Randy Nowak. Randy, the owner of a construction company, took a recent IRS audit in Bill Foster style. Randy hired a hit man to bump off the IRS agent and burn down the local IRS office. Well, who needs a tax attorney! Unlike Bill, however, Randy will have lots of time to contemplate his misdeeds during his long prison term. US v. Nowak, M.D. Fla. No 8:08MJ1362TBM, 12/18/08).

Potpourri ½ Page:
■House Closings. Perhaps for the first time in memory banks have reneged on funding mortgage commitments they have approved. Buyers should protect themselves by having real estate counsel address this risk in the mortgage contingency clause in purchase contracts. Thanks to Kenneth J. Gould, Esq. White Plains, NY.
■ Legal Fees for Docs. There’s a website where docs can go to see what legal fees should cost for such “standard” legal work as reviewing an employment agreement. Yeah, that makes a lot of sense. Someone should set up a website telling you what surgery should cost. How about doing it the good old fashion way. Get references to find a lawyer who is reputable and skilled in the expertise you need. Then pay them hourly for the amount of work that is necessary to help you accomplish your goals. If you want to control costs there are real ways to do that (and looking at numbers on a website is not on the list!). Try these steps: 1) Vet the attorney before you hire; 2) Ask what can be done to control costs and do it; 3) Review detailed bills to monitor the process; 4) Cooperate and stay focused to minimize meeting and other controllable time; and 5) Do your homework. Inform your attorney of the business aspects of the deals, your goals, etc. Make concise lists. No attorney can know the intricacies of a particular practice, or the dynamics of the deal until informed. The real measure of the “cost” of obtaining legal help is not just the upfront cost, it’s the results over the course of the deal. A cheap price up front can easily be outweighed by the costs of litigation on a sloppy deal later. Didn’t mom warn you about being “penny wise and pound foolish”? While all this may be obvious, remember that millions of patients run to their physicians asking for the “purple pill”. People love simple answers. If life were only so simple…..
■ Care Taker Contracts. The home health aide hired to take care of gramps also took care of herself by becoming a primary heir. While this might sound like a TV script, its really for a reality show, and its no uncommon. Gramps may well become attached to his caregiver. Once the caretaker is in gramps house it’s tough to manage the situation. Your efforts to protect gramps from a manipulative caretaker might be viewed by him as a lack of caring. Have an elder law or family law specialist address the issues head on in the initial employment agreement before the caretaker starts. Thanks to Pravin J. Philip of www.biz4nj.com.

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