Tuesday, March 31, 2020

Direct Payments and Charitable Deductions from the Recent CARES Act

Pathways Advisory Group, Inc.
Evon Mendrin, CFP®

To help millions of Americans affected by the novel coronavirus, Congress passed – and the President signed – The CARES Act. Earning a solid 10-out-of-10 on the Catchy Law-Name Scale (our government cares!), the legislation provides over 2 Trillion dollars in aid.

This is Part One of multiple articles on the bill. Let’s dig in and take a look at what individuals and families can expect.

Recovery Rebates - Direct Payments to Individuals and Families

Likely the provision receiving the most interest, the CARES act provides Recovery Rebates – direct payments to the American public.

Married couples filing taxes jointly can receive up to $2,400 and all other tax filers can expect up to $1,200. Families will also receive up to $500 per qualifying child – that is, dependent children under age 17.

The payments come with phaseouts if your Adjusted Gross Income (AGI) is above certain thresholds. Payments will be reduced by 5% for every dollar over the following AGI thresholds:
  • Married Filing Jointly: $150,000
  • Head of Household: $112,500
  • Single/All other filers: $75,000
A few examples:

Jim and Jessica are married with three kids under 17. Their AGI is $160,000. Their potential rebate payment is $3,900 ($2,400 + $500 + $500 + $500). But their AGI is above the threshold by $10,000. So, their actual Rebate payment is $3,400. ($3,900 – ($10,000*5%)).

Jamie is single with one 15-year-old daughter. Her AGI is $50,000. She’s under the $75,000 AGI threshold, so her Rebate payment will be $1,700 ($1,200 + $500).
A single taxpayer with an AGI of $99,000+ ($198,000 for married filing jointly) is phased out and not eligible for the payment. However, if under the thresholds, then you can expect the full payment.

What year’s income is this based on? Here’s where it gets interesting. The payment is technically a refundable tax credit. The credit is for 2020 income but is an advance on that credit.

The 2019 tax return will be used to verify income and family status. If the 2019 tax return is not yet filed, the 2018 tax return will be used. When the 2020 tax return is filed, any extra amount you are eligible to receive will be sorted out in the form of a tax credit.

How will payments be delivered? It depends. Payments will be made electronically directly to bank accounts the IRS has on file for 2019 (or, if not filed, 2018) refund deposits. Those receiving Social Security will receive it in the same account they receive Social Security. It appears all other payments will be sent by check to the last known address on file.

The IRS announced it will create a web-based portal for individuals to provide their banking information to the IRS online, so that individuals can receive payments immediately as opposed to checks in the mail.

When will payments be delivered? The bill requires they be sent as “as rapidly as possible,” and Treasury Secretary Steven Mnuchin mentioned a 3-week goal for those with direct deposit information. The IRS announced on March 30th that distributions will begin within the next three weeks. It is unclear whether those receiving paper checks will fall within this window.

What if I don’t receive my payment? The law requires that a notice is to be mailed to your last known address within 15 days after payment is sent. The notice will indicate how the payment was made, the amount, and a phone number to the IRS to report if you haven’t received it.

There are several points to consider and some uncertainty here. Due to the tax filing deadline being pushed back to July, it’s likely many Americans will not have filed 2019 tax returns. If not, 2018 income will be checked for this payment eligibility. Some odd situations can arise from this.

Because many may have not filed 2019, the payments received now may not reflect the reality of their lives. Many life changes could have happened after 2018. Marriages, divorces, children born, kids turning 17. All of this could change the potential payment received.

For example, someone who got married and had one child after 2018 could potentially have a $1,700 higher payment as a family. If the 2019 return is not filed, these changes aren’t seen by the IRS.

Income may also have dramatically changed between 2018, 2019, and even 2020! It’s possible 2018 income is too high to qualify for the payment. If the 2019 return hasn’t been filed, that higher income is used to verify eligibility.

It’s also likely many people will have dramatically lower income in 2020, even in light of higher income before. You won’t have a chance to benefit from the Rebate until the 2020 tax return is filed and your correct credit is calculated.

This can also work in someone’s favor. If your income is too high in 2019 (and 2020), but you haven’t filed the 2019 tax return, you may be eligible for the payment based on low 2018 income. At least one Senator’s FAQs page says excess amounts will not have to be paid back if the 2020 tax return is filed and it shows you were not eligible based strictly on your 2020 return.

So, what to do? Take a careful look at your 2018 & 2019 tax information and any life changes between those years. Talking with your tax professional makes sense in this situation. It may make sense to file 2019 tax returns so the IRS takes changes into account. It’s not clear when it’s too late to file for payment eligibility - or if it’s already too late.

What if you haven’t been required to file tax returns? In this case, the IRS will provide directions to file a 2019 tax return “with simple, but necessary, information” for the Rebate payments.

Check out the latest IRS information here on the Rebate payments.

New $300 Above-the-Line Deduction for Qualified Charitable Contributions

Congress created a new above-the-line deduction for qualified charitable contributions of up to $300. While it’s not a substantial amount, most taxpayers should be able to benefit. In order to take the deduction, a taxpayer cannot itemize deductions on their Federal return.

The donations must be in cash or check, and they specifically can’t fund either donor advised funds (DAFs) or 509(a)3 “supporting organizations.”

This comes after the Tax Cuts and Jobs Act eliminated some above-the-line deductions and increased the standard deduction. Many taxpayers no longer itemize deductions and don’t take advantage of itemizing charitable contributions.

Interestingly, the text of the law seems to indicate this is an ongoing deduction, stating it “shall apply to taxable years beginning after December 31, 2019.” It’s likely we’ll see additional guidance on the length of time.

AGI Limit for Cash Charitable Contributions Temporarily Repealed

The current limit for cash contributions to charity is 60% of AGI. The CARES Act increases this temporarily to 100% of AGI for “qualified” contributions, which means you can wipe out your 2020 tax liability with proper donations to charity. If total donations exceed the 2020 100% limit, the excess can be carried forward to future tax years for up to 5 years.

The same exclusions to DAFs and 509(a)3 organizations apply.

This should, hopefully, provide some incentive for those with means to donate to charities that might otherwise see large declines in donations.

As always, chat with your tax professional to determine how these provisions affect your tax situation. Stay tuned for our next article, looking at how the law affects your retirement accounts!

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Friday, March 27, 2020

Personal Reflections and Words of Encouragement

 Well 2020.

You’ve been quite the year so far.

At the New Year, life felt very different than it does today. Although the first cases of COVID-19 had already begun sprouting up, they were a world away. Most of us had no idea what life would look like a short three months later.

The economy felt strong. The market was at an all-time high. Housing prices were rising, mortgage rates were low.

Then, in a matter of weeks, everything changed.

Let me take you back to another memorable year...

The year was 2008.

After 2 years as a paraplanner and 4 years at Pathways, I was officially a Certified Financial Planner® practitioner. I had just passed the CFP® test and was beginning to meet with clients on my own.

And I was terrified.

We were in the worst bear market since the Great Depression. I was still “new” to investing and so green, and I had only seen the good times. This was something I had never experienced before. Suddenly, I saw first person how faith in markets could be tested. I held clients’ hands while going through it for the first time myself.

I had a century’s worth of returns at my fingertips and I was forced to really dive in. I had to know for myself how markets worked. I looked back at every bear market. How were they similar? What made them different?

I saw a trend in how the media reported market movement, particularly down markets. I saw multiple headlines, years apart, claiming the death of stocks or that this was a “new normal”. I understood just how much “noise” was out there, and the importance of making sure client’s heard my voice.

On March 9, 2009, I noticed there wasn’t a choir of people shouting “this is the bottom”! In fact, I didn’t hear much of anything other than more doom and gloom. When the market began its dramatic upward climb the next day, it was months before news outlets and “experts” acknowledged that maybe we were on the way up.

That bear market taught me a lot.

Here we are 12 years later and we are wrestling another bear.

In some ways, this bear market is completely different.

While 2008 was founded in subprime mortgages and risky lending, which slowly crumbled our financial structure, this one started with a strong economy blown apart by a world-wide pandemic.

One could say every bear market is “different”. For sure every bear market has its own instigator, as shown below.

Source: Dimensional Fund Advisors. Note Disclosure

 This chart shows how the market has responded to each crisis over the last 30+ years. What returns did the market have after 1 year? After 3 years or 5 years? Although each instigator is different, what’s interesting to me are the similarities. Each time, a mere 5 years later, the cumulative return is quite remarkable.

We have no idea how long our economy will take to recover from our current crisis, but if history is any indicator, it will. And faster than maybe we expect.

This is a scary time. We know this. We worry about our health, the health of those we love, our employment or small business, our medical system, our mental health as we shelter in place and remove ourselves physically from our social networks. And it is natural and normal to worry about our investments as well.

As we have expressed in our correspondence thus far, we reassure you that we are watching this with you. We are looking for ways to maximize the situation to your advantage, whether that be through harvesting capital losses to reduce taxes, rebalancing your Portfolio or simply talking through your concerns.

It’s been quite the journey since 2008. I am grateful for that experience and the 12 subsequent years since then. They have taught me so much, and going through these last few weeks, I understand just how much I have learned. I am grateful for the in-depth discussions we have had together about allocations and risk, the behavior of equities versus bonds and the dangers of market timing. It has prepared all of us for today.

To the new investor, through this time you will gain a rock solid testimony of markets. You will know what it truly feels like to live through the allocation you have chosen. You will get to witness early on the surprise of the recovering market. You will be able to face future bear markets with some confidence of “been there, done that”.

To the long-term client, we have prepared for this. Every discussion, every meeting, has built the foundation needed to withstand shaky ground. We have done it before and we will do it again.

As I sit here in my makeshift “home office”, I acknowledge that we truly are in an unprecedented time. I’m not sure I’ve seen this much fear in the world before, but I have also seen so much community. We are all isolated at home, but in this together.

I wish each of you good health over the coming quarter. Whether in the office or sequestered in our homes, we are here for you. Please never hesitate to reach out.

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Wednesday, March 25, 2020

Tax Day Pushed to July 15th, 2020!

Pathways Advisory Group, Inc.
Evon Mendrin, CFP®

Great news for those who haven’t yet filed 2019 Tax Returns! In response to the economic situation related to the novel coronavirus, the tax filing deadline for 2019 Tax Returns has been pushed back. 

Federal Deadlines Extended

Great news for those of us who haven’t yet filed 2019 Tax Returns! In response to the economic situation related to the novel coronavirus, the tax filing deadline for 2019 Tax Returns has been pushed back.

As part of President Trump’s recent emergency declaration, the Treasury and the IRS announced that the filing deadline has been pushed back to July 15, 2020! This is automatic for all taxpayers, including individuals, trusts and estates, corporations and other non-corporate tax filers, as well as those who pay self-employment tax. The extension doesn’t require any additional forms to be filed.

This also means that any federal tax payments that were due on April 15th are now due July 15th without interest and penalty, regardless of amount owed.

What about estimated payments? The first quarter’s estimated payment (typically due April 15th) is also delayed to July 15th. The IRS also announced the 2nd quarter's estimated payment (typically due June 15th) is also extended to July 15th.

What happens if you’ve already filed and owe taxes? You can still delay paying up until the July 15th deadline without interest and penalty.

Need additional time beyond July 15th to file? Taxpayers can still file an extension beyond the July 15th deadline using Form 4868, making the final extended deadline for 2019 Tax Returns October 15, 2020. Of course, to avoid interest and penalties when filing your tax return after July 15th, you’ll still need to pay the estimated tax due with your extension request.

Contributions to IRAs and HSAs

What does this mean for contribution deadlines to retirement accounts and Health Savings Accounts?

The IRA, Roth IRA, and HSA contribution deadlines have also been extended to July 15th!

Need more info? The IRS has a great Frequently Asked Questions page and will likely be issuing further guidance in the coming days.

California Tax Deadline

Similarly, California’s Franchise Tax Board announced that it will be postponing until July 15th the filing and payment deadlines for all individuals and business entities for:

    2019 tax returns
    2019 tax return payments
    2020 1st and 2nd quarter estimated payments
    2020 LLC taxes and fees
    2020 Non-wage withholding payments
The spread of Covid-19 and the response of federal, state, and local governments have affected millions of Americans. It’s great to see some relief as tax time approaches. Stay tuned for more information on government aid and stimulus in the coming days! 
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Thursday, March 12, 2020

Actions We're Taking During Market Declines

Another week, another rough ride in global stock markets as we all digest unfolding events around the coronavirus and oil prices. 

While we shared some of our general thoughts on the events and our philosophy on how markets work, a common question asked is – what do we do at this time?  What actions are we taking with our portfolios?  What decisions should be made around our investments? 

Here are few opportunities, decisions, and actions we’re considering for client (and our own) portfolios:

1. Rebalancing

This is a key action we’re looking to take.

What is rebalancing? This is selling the categories of investments that are higher than you want to hold, and buying the categories that are lower.

When we build client portfolios, we diversify across different investment categories. There are the main categories – stocks, real estate, and bonds. Within those, there are also subcategories – large and small companies, value vs. growth, US vs. foreign, etc. We target a certain percentage to hold for each category.

However, over time the rise and fall in each investment type drifts away from the intended target percentage. This can be sudden, during dramatic market swings (up or down) as we’re seeing now. Or, it can be gradual.

When we rebalance, we simply sell the category that’s higher than we want to hold (for example, bonds) and use those proceeds to buy the categories that are too low (for example, stocks).

Why do this? This is a systematic way to sell high and buy low. It doesn’t feel intuitive at the time – buying the categories that are experiencing a bear market. However, long-term it can provide a great benefit to your portfolio and keeps it within the risk profile you originally wanted.

2. Tax-Loss Harvesting

Losses never feel good, but there is a silver lining!

What is tax-loss harvesting? Selling positions that are at a loss and buying shares of another fund to replace it (this does not apply to retirement accounts).

When you sell positions for a loss, it’s a tax deduction that can be used to offset other capital gains you’ve triggered this year. Up to $3000 can also be used on your Tax Return to offset ordinary income. And you can roll any unused losses to be used in future tax years. For those with large enough losses, with large capital gains, or at a high enough tax bracket, this can be a great opportunity to take advantage of the decline in prices.

However, the second step here is very important. This is not selling out of the position and staying in cash. It’s immediately buying another similar investment. You want to stay invested.

There are some risks and rules to follow here, so it’s important to do this with caution. First, when harvesting (selling) stock positions, you are out of the market for a day even if you immediately buy another stock investment. It simply takes time to do the transaction.

Secondly, you have to be careful not to buy the same investment you sold within 30 calendar days (or one “substantially identical”). Even in a different account, such as a retirement account. The IRS has “wash-sale” rules that would disallow the loss you created if not followed correctly.

3. Continued Deposits and Contributions

For investors with long-term time horizons, this decline in prices means everything’s on sale. We aim to continue all regular, ongoing deposits and contributions and invest accordingly. What a great buying opportunity!

4. Process for Portfolio Withdrawals

For those that are withdrawing from their portfolios, we use the following process to manage the portfolio and create cash for withdrawals:

• Have a cash buffer: We aim to have 3 months-worth of withdrawals in a cash buffer for very short-term needs. This is in addition to cash savings account clients may have at the bank.

• Selling from categories that are high and allowing the others to recover: We aim to not sell the investments that have gone down in value during a market decline. In this case, that’s stocks. In fact, selling stock positions converts a temporary decline into a permanent loss.

We are able to rely on the bond portion of the portfolio to sell if needed. Bonds are historically a great diversifier and an important anchor of stability. While stocks have tumbled during this decline, high-quality bonds have largely been positive (as of writing).

So, we trim bonds to send funds to clients, allowing stocks to recover.

• Take advantage of portfolio income. As your portfolio distributes interest income or dividends, those chunks of income are either reinvesting (at more favorable, lower prices) or creating cash as needed.

• Not making material changes to our portfolios or process. We don’t know what’s next for stock prices or for the economy. But, as Evon mentioned in his recent post, this is a normal part of stock/business ownership. As earnings are expected to decline and uncertainty increases, the prices of stocks to decline. These short-term declines are the price we pay for higher long-term expected returns. We expect this as a part of our long-term investment philosophy and process.

So, barring major life changes, we aren’t planning any major changes to our investment allocations. We take advantage of opportunities mentioned above, and stay the course. Our long-term outlook is one of positivity – this too shall pass!

PS: Our preferred Mutual Fund provider – Dimensional Fund Advisors – is offering a webinar tomorrow (Friday the 13th) entitled Perspective on Recent Market Volatility. Watch your email for instructions to attend.

The Pathways Team

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