Reuters Money

There will be tax breaks: Investing in oil and gas drilling

Seated in the conference room of his wealth management firm in San Ramon, Calif., Rich Arzaga breaks out a few tools to explain the investment advantages of oil and gas drilling programs. He’s got a fine-point pen and a sketch pad — but alas, no milkshake a la Daniel Day-Lewis in “There Will Be Blood.”

“This is not wildcatting,” says Arzaga, founder and CEO of Cornerstone Wealth Management and an adjunct professor in personal finance at the University of California at Berkeley. Lewis’ anti-hero in “Blood” swindles and snakes for oil wherever he can find it, whereas Arzaga (pictured) wants to discuss something much more civilized: qualified drilling programs that yield big tax savings for investors and, if you’re lucky, 10 or more years of financial returns.

Still, if that sounds a little bit Hollywood, Arzaga understands. “Insurance companies, wire houses and banks don’t offer this type of alternative investment,” he says. “It’s not their thing. You have to hang out with the independent advisers who do this.” You also need at least $25,000 to start, which explains why over the last five years, Arzaga has been limited to roughly a dozen clients in this realm.

Yet at a time when Wall Street sports the stability of a rickety roller coaster, and European turmoil dogs investors on North American shores, oil and gas drilling represents a niche so far outside the norm that it’s in many respects immune to common economic doldrums. And when oil prices soar, the prospects for this commodity look downright appealing— that is, up to a point. To be sure, once you give your cash over to the program, it stays there until the wells pan out, or don’t — making it much unlike a liquid mutual fund, for example. This explains in part why the program works best for those trying to avoid a major tax hit on an appreciated asset, where the burden might be 40 percent.

What’s more, “The number one risk is that there’s a certain amount of fraud out there,” says Grant Rawdin, president of Wescott Financial in Philadelphia. Yet once you find a drilling company with a solid reputation — Arzaga, like many in the game, uses Atlas Energy — you don’t just sit back and wait for the black gold to pour in.

“Then you have to do your homework,” Rawdin says. “You need to look at geological surveys, how other wells have done, what the drilling costs are going to be. And once that oil well goes dry, you’re done, so you have to amortize your investment over the life of the well.”

In the typical program, an investor immediately yields tax breaks as sanctioned by IRS codes, which are now more than three decades old. With a highly appreciated asset, you can put the money into oil and gas drilling and shelter it almost entirely from capital gains tax. If you invest $1 million and are in a 40 percent tax bracket, you will save about $350,000 right off the bat, Arzaga says. (The sheltering comes from how the program is structured; federal laws allow typically for 89-91 percent of the investment to be allocated to intangible drilling costs that can be written off entirely in year one.)

Charitable remainder trusts: How the wealthy give it away and get it back

Though he first attended the Hollywood Bowl more than 30 years ago, Ron Moormeister remembers well those Los Angeles Philharmonic concerts. His voice waxes rhapsodic as he recalls the lineup: Mandy Patinkin, Julie Andrews, a Tchaikovsky Spectacular complete with the bombastic 1812 Overture.

So when he hit it big in 1995 — selling his insurance brokerage firm at age 49 — he decided to help the orchestra and to get a tax benefit too. He used a  charitable remainder trust, or CRT, a creative strategy that allowed him to give away his money, yet still derive funds from it based on a mix of tax deductions and investment.

He started the trust with about $350,000. “I had to get used to the idea a little bit,” says Moormeister, 64. “I thought, ‘Gosh, do I want to give away this money?’ But I wasn’t just giving it away. It was going to work well for me, for others and for my family.” He also wanted to protect his assets from the claims of creditors or lawsuits, equally important factors in his decision to implement a CRT.

So far, all has worked out well. Moormeister set up his CRT with the help of Simon Singer, principal and founder of TheAdvisor Consulting Group in Encino, California (pictured). Under the trust guidelines, Ron guarantees that 25 percent of funds go to the Los Angeles Philharmonic. Yet in setting up the trust, Ron estimates that he’s saved at least $250,000 in tax deductions over time. His initial investment was sheltered from federal and state taxes, and trust money that’s invested grows tax free, much as it does in a retirement account.

This means Moormeister can make money off the CRT without expensive tax consequences. “I could use an investment counselor, but I control the investments myself,” he says, “and I can invest in virtually anything.”

Simply defined, a charitable remainder trust allows you to transfer cash or assets to the trust — from which you may receive income for life or, if you prefer, a fixed term not to exceed 20 years. The income can be paid over your life, your spouse’s life and even the lives of your children and grandchildren. (The guidelines are outlined in IRS code section 664.) In essence, the trust takes advantage of the tax-exempt status of the nonprofit it benefits.

8 crucial tips for last-minute tax filers

There’s just two weeks to go till tax time, and Bill Fleming, managing director in the personal financial services division of PricewaterhouseCoopers, has been cranking hard on his clients’ returns, but has yet to start the one he’ll file for himself and his wife. “I know all about procrastination,” he laughs.

If you haven’t finished your taxes — and fear waiting in line at the post office on April 18th — you’re not alone. In fact, this year tax season may be moving a bit slower than usual because the last-minute, year-end tax agreement delayed the usual timetable for the Internal Revenue Service to get its forms and systems ready. “We are probably a week behind last year,” Fleming says. “Everything has been pushed back a week or so.”

The mad dash to the finish could cause extra problems this year because of the feds’ push for electronic filing; e-filing is now mandatory for accounting firms that do at least 100 returns a year, and there’s no precedent for how the government’s e-filing system will do under pressure.

If you’re among those who are just now struggling through your taxes, here’s a quick guide to the things you need to know now:

IRA contributions. Making a contribution to your IRA is a necessity for a secure retirement, and if you fit the rules for a tax-deductible contribution, it will also lower your tax bill. The deadline for making your 2010 contribution (even if you get a tax extension) is April 18th. You’re allowed to contribute up to $5,000 ($6,000 if you’re 50 or older). The $5,000 contribution limit can go to either a traditional IRA or a Roth IRA, or be split between the two. If you want more in a Roth than you’re allowed by income limitations, you could set up a non-deductible IRA and immediately convert it, as there are no income limitations on conversions.

HSA contributions. If you were covered by a high-deductible health insurance plan in 2010, you have until tax day to make a tax-deductible contribution to a Health Savings Account. You can deduct that contribution even if you don’t itemize, and the money in your account will grow tax-free — and you can withdraw it tax-free, too, if you use it to pay uninsured medical expenses. Maximum contributions are $3,050 for singles and $6,150 for families (with an extra $1,000 if you’re over 55).

Roth conversions. If you converted an IRA to a Roth last year, as many people did to take advantage of the new rules that removed income limitations on conversions, you’ll owe taxes on that move starting this year. You get the option to pay the taxes, on 2010 conversions only, over two years; unless you expect to be in a higher tax bracket next year, that’s likely a better deal. Also, note: Your 1099 form won’t necessarily say that it’s for a conversion, so you need to be sure that your accountant knows.

Wrapping up 2010 estates

For those whose loved ones died in 2010, this is the time to wrap up their estates.  Last year was an unusual year — the estate tax disappeared altogether to the benefit of some and the detriment of others. But in its absence, a different capital gains tax emerged. That means anyone sorting out a 2010 estate now gets to choose which tax to pay.

The choices are to pay the estate tax under its new rules, which allows for a $5 million exemption and a maximum tax rate of 35 percent, or to opt out of the estate tax and elect what’s known as “carryover basis.”  The answer you might think — to opt out of the estate tax — is likely the poor choice for the vast majority of people.

To understand why, step back for a minute. When the estate tax disappeared last year, so too did the so-called “step-up in basis.” This rule allows the “basis” — essentially the adjusted purchase price on which any capital gains would be calculated — to be reset at death. This could be a fabulous deal for the ultra-wealthy who passed away in 2010 (George Steinbrenner, perhaps?), but if your estate isn’t in the multi-millions it’s likely to bring lots of headaches and the potential for paying more tax.

In fact, one of the many reasons that estate tax attorneys and financial advisers were up in arms last year, desite the lack of an estate tax, was that the alternative could have caused many wealthy, but not super-rich families, to owe more tax. Perhaps worse, the 2010 carryover basis rules, which allowed the executor to assign $1.3 million in “step-up” basis (above that allocated to a spouse), also had the potential to spur family squabbling since the executor would have to choose how to divide that benefit if there was more than one heir. (Yes, it’s complicated.)

Thus the fix in the year-end tax agreement: Executors can choose whether to pay the estate tax or not, for 2010 estates only. Those who choose to pay the estate tax will get the exemption and the step-up in basis; those who don’t will owe capital gains based on the carryover basis.

There’s still time to figure it out. Estates typically have nine months after death to file their federal estate tax returns, but the deadline was extended because of last year’s tax uncertainty. The earliest anyone would need to file an estate tax return for a death in 2010 is September 19, 2011, nine months (plus two days to account for the weekend) from the date the tax legislation was enacted.

If you’re trying to figure this out for someone you love who died in 2010, here’s how to think about that decision:

Pay less to the IRS with tax-managed mutual funds

Werner Renberg is a writer and author based in Chappaqua, N.Y. He is the author of four books, including All About Bond Funds: A Complete Guide for Today’s Investors. The opinions expressed are his own.

If you own equity or mixed-asset mutual funds in taxable accounts, one thing is certain: Whatever the top income tax rate on capital gains that President Barack Obama and Congress will agree on for 2013 and beyond, it will continue to hit you in two ways — and possibly even a third:

1. You, of course, will owe income tax when you sell mutual funds’ shares out of taxable accounts if your capital gains exceed your capital losses.

2. You also will owe income tax when funds sell securities and have net capital gains at year’s end, requiring them to credit you with your portions of the taxable distributions even if you didn’t sell one share — and even if your funds values dropped.

3. You would suffer a third strike if all your net capital gains and capital gains distributions lift your adjusted gross income (IRS Form 1040’s Line 37) enough to put you into a higher tax bracket.

Can you do anything to have more of your taxable retirement portfolio continue to work for you and pay less to the IRS? Perhaps. You could move money into one or more tax-managed equity or mixed-asset funds. Such funds tend to have two goals:

•  Maximizing after-tax returns by (a) offsetting capital gains with capital losses to reduce, if not to avoid, long-term capital gains distributions and (b) using other tactics, such as keeping stocks targeted for sale for a year until they become long-term holdings to avoid highly taxed short-term capital gains distributions. For income, these funds prefer stocks that pay lower-taxed qualified dividends and may also invest in federally tax-free municipal bonds.

Catapult the U.S. tax code from the Middle Ages

The new tax bill just passed by Congress added a few more turrets to a hopelessly medieval fortress.

Each tax break still supports thousands of economic fiefdoms: $6 billion for the ethanol industry, $235 million for Puerto Rican rum makers, $40 million for NASCAR stock car track owners .

Then there are the write-offs that largely benefit the affluent: $498 billion for interest paid, $470 billion for home-mortgage interest, $467 billion for charitable contributions.

True, Congress will help millions by extending unemployment benefits, blunting the impact of the pox-like Alternative Minimum Tax and retaining the Bush-era tax cuts for the middle class in a time when the U.S. is still reeling from the 2008 banker’s bacchanal.

As it stands now, though, the income and estate tax rates reinforce the clout of what is becoming an ancient regime, a class of landed gentry who disproportionately benefit from an archaic tax code.

GOP leaders, for example, insisted that the 35-percent estate tax rate with an exemption for estates under $5 million ($10 million for couples) be part of the package.

While the rallying cry from conservatives was that the estate levy needed to be lowered to shield family farms and small businesses, the nonpartisan Tax Policy Center estimated that only about 100 family farms and businesses paid the tax in 2009, when a $3.5 million exemption was on the books.

With tax deal in sight, it’s time for year-end planning

The tax flux appears to be over.

On Monday evening, President Obama announced the outlines of the deal that had been reached between Republicans, who wanted to see the Bush tax cuts extended for all taxpayers — including the wealthiest — and Democrats, who wanted those tax breaks to expire for couples who make more than $250,000 a year and singles who earn over $200,000 a year.

The agreement taking shape would keep the Bush tax cuts in place for all taxpayers for two years, bringing the discussion back in time for the next Presidential election; extend unemployment insurance for 13 months; cut payroll taxes for all workers for one year; extend a slew of tax credits for middle-class Americans; and reinstate the estate tax at a higher exemption and a lower rate.

“Make no mistake: Allowing taxes to go up on all Americans would have raised taxes by $3,000 for a typical American family. And that could cost our economy well over a million jobs,” Obama said in announcing the compromise. The package would cost about $900 billion over the next two years.

Whether you agree or disagree with the compromise — and there are things in it for both Republicans and Democrats to love and to hate — the nearing resolution means that if you’ve been putting off year-end tax planning because of the flux in Washington, you can now get down to business.

“The bottom line is that everybody has to put brakes on all their thinking and change their mindset, and there’s not much time,” says Andrew Katzenstein, a partner in Proskauer’s personal planning department in Los Angeles. With just over three weeks to go in 2010, here are three key things to think about:

Timing of deductions and income. For those who thought their tax rates were going to go up, it was simple math: Deductions for expenses are worth more when taxes are higher, so the smart thinking was to defer some of them till after January 1st. Similarly, it would have made sense to accelerate income, when possible, into 2010, if rates were going to go up.

Tax cuts: You could be a “millionaire”

Werner Renberg is a writer and author based in Chappaqua, N.Y. He is the author of four books, including All About Bond Funds: A Complete Guide for Today’s Investors. The opinions expressed are his own.

When President  Obama says that his proposed Fiscal 2011 budget would “give tax cuts to…98 to 97 percent of Americans” by permanently extending the expiring Bush tax cuts for them—but not for “the wealthiest 2 percent”—how does he split taxpayers into two classes? By drawing a line at “families earning more than $250,000 a year.”

In election campaign language, that becomes “folks who are already millionaires” and “folks” who are not. In the precise language of a tax return, it would mean:

1) Married individuals filing joint returns and surviving spouses face hikes in their marginal income tax rates—as well as in the rates on taxable dividends, long-term capital gains, and mutual fund capital gains distributions—if their adjusted gross income (AGI) tops $250,000. Single taxpayers’ rates go up if their AGI tops $200,000.

2) Other taxpayers continue to enjoy current rates until their AGI crosses the lines.  Congress is currently weighing the budget as well as bills to extend the tax cuts for everybody. It is also grappling with current law which would let everybody’s tax rates go up in 2011 if it does nothing.  Are all possible results of the president’s proposals clear to you?

One possibility may not be. For once in your life, maybe twice, you could be a “millionaire” as that word is understood in the election campaign—and be taxed as one—even though you don’t expect to earn enough to have filet mignon every night.

How?

3 ways to play higher taxes

Nothing is certain except death and taxes, so the saying goes. But today, with tax rates in flux after yearend, and daily pronouncements from lawmakers — now back from summer recess — about what should happen, uncertainty reigns.

Will the Obama Administration win its battle to extend the Bush-era tax cuts for the middle class (read: couples who make $250,000 or less, and singles who earn $200,000 or less), while allowing them to expire for the wealthy? Will the Republicans win in their efforts to have all of those tax cuts extended for everyone, including the well-heeled? Will gridlock mean that the tax cuts simply expire?

Or will some other compromise emerge, perhaps one that differentiates between the merely well off and the really rich?

At issue are the tax cuts put into place by President Bush in 2001 and 2003, which lowered marginal tax rates, decreased the long-term capital gains rate to 15 percent, and offered qualified dividends the same preferential tax treatment as cap gains. Without legislative action, all of those tax cuts expire in 2011. Under the Administration’s plan, the rate on long-term capital gains and qualified dividends would rise to 20 percent for high earners, while the top marginal income tax rate would revert to 39.6 percent. (The estate tax and gift taxes are also in flux, but that’s for another post.)

Forget fast resolution, especially with Congressional elections in November. “This is very much an ongoing argument, and it may not resolve until after the election,” says Clint Stretch, managing principal for tax policy at Deloitte Tax in Washington, D.C. “There’s a lot of political advantage to the various players in the system not to have this resolved.”

So how should you deal with the uncertainty? In tax planning, you’re always playing the odds, so first you need to differentiate between what’s really contentious and what’s likely to be resolved — and between the things you can control and those you cannot. If you’re a couple making $200,000, say, or an individual bringing home $150,000, be especially wary of making any sudden moves: While anything is possible when it comes to tax, this tax battle isn’t about you.

If you do expect to be hit by higher rates next year, there are some tax-planning moves to consider:

How to plan for higher taxes

Now that Congress is back from the summer recess, hopes for a compromise on the much-politicized topic of taxes are fading fast.

For those who need a recap: Tax breaks put into place by former President W. George Bush in 2001 and 2003 are scheduled to expire in 2011. President Barack Obama wants to let the tax cuts for wealthier Americans expire while freezing rates for families making $250,000 or less a year to bolster the economy. Republicans say wealthier Americans are drivers of economic growth and that tax cuts for them help the whole country.

If the current tax law “sunsets” and disappears, Americans are certain to face higher income and estate taxes. They’ll pay higher taxes from the sale of investments like stocks, bonds and mutual funds. Dividend income will be taxed at a higher rate, too. If you are married, the marriage penalty will be more harsh.

No one knows what will happen — that’s usually the case with tax legislation. Here’s a detailed look at what expected tax changes could mean for your finances if the current law sunsets and how to plan for higher taxes:

New and higher tax brackets

Tax brackets are expected to change, but, contrary to popular sentiment, rates will automatically go up for everyone who pays taxes — not just the individuals in the top federal income brackets, commonly referred to as “the rich.”

Specifically: