Sunday, November 11, 2012

Tax Planning Considerations After the Election

With the elections now behind us, we have a little more clarity regarding what lies ahead from an economic policy perspective.  Some initiatives, such as Proposition 30 (Temporary Taxes to Fund Education) are certain to raise taxes for California residents immediately.  In fact, the terms of Proposition 30 go into effect retroactively to January 1, 2012.  Prop 30’s provisions include creating a series of high income tax bracket rate increases (see the table below) beginning at $250,000 taxable income for single taxpayers and $500,000 for joint taxpayers.  Also the sales tax rate for California will increase from 7.25% to 7.5%.  Estimated revenues expected to be generated from Prop 30 range from approximately $7 billion to $9 billion with most of the funds allocated to K-12 grade levels with the balance going to community colleges.

Other issues affecting how much we pay in taxes, often referred to as the “Fiscal Cliff”, are not quite as clear in terms of the final outcome at this point.  The “Fiscal Cliff” reference includes tax increases that will go into effect January 1, 2013 such as the reversal of last year’s payroll tax cuts, expiration of income tax rate cuts put into effect  by President Bush and his team in the early 2000’s, the start of taxes related to President Obama’s healthcare law, cuts in defense and non-defense spending (approximately equally), etc.

President Obama has been clear that he wants to let the Bush tax cuts expire on December 31, 2012 for those earning over $250,000 annually.  Although it is possible President Obama and the Democrat controlled Senate may compromise and extend those tax breaks for a year or so, there’s still a strong chance those cuts will be allowed to expire and higher Federal income tax rates will accompany higher State income tax rates for many California business owners.


Generally the rule of thumb is to defer income and accelerate deductions as permissible using a variety of strategies.  With the prospect of income tax rates rising January 1, 2013, it may be wise to abandon the general rule and bring income, at least in a measured way, into 2012.  With federal tax rates set to increase as much as approximately 5 points (from 35% Federal to 39.6%), it seems quite appealing to take income now rather than paying almost 5 points higher in federal taxes next year.  In this environment, it is difficult to get much return on investment so why not consider taking the several point benefit in 2012?  Of course President Obama and Congress may extend the Bush-era tax cuts for all, including the high income earners, but in my view playing roulette with those prospects isn’t worth earning only a deferral (remember, it’s only timing we’re talking about).  If you gamble and win, you pay taxes next year (a nice benefit and supplement to cash flow to be sure) instead of this year at the same rates as 2012.  If you gamble on this issue and lose, you pay taxes next year anyway, just at higher federal rates.

Another issue that has to come back into the conversation is whether S Corporation status is as attractive as it’s been these past many years for small business owners.  See my article on S Corporations wherein I discuss this issue in January 2009 in my final paragraph of that posting.  The average corporate federal tax rate is 34% (there are lower tax rates for corporations with taxable income less than $75,000 which get phased out at higher income levels).  The California State Corporate tax rate is 8.84% and the personal tax rates (see schedule below) will fall somewhere between 10.3% and 13.3% for many business owners who are structured as S Corporations.  Given the higher personal income tax rates versus corporate tax rates, it makes sense to consult with your advisors as to whether S Corporation status still makes sense.  In many cases the answer will still be yes as avoiding the double taxation of corporations, especially in a liquidation event, will still win the day for S Corporations.

California Personal Income Tax Rate Structure Under Prop 30

Single Filer's Taxable Income
Joint Filer's Taxable Income
HOH Taxable Income
Current Tax Rate
Additional Tax Rate
Total Tax Rate
500,000 - 600,000
Over 500,000
Over 1,000,000
Over 680,000

Tuesday, October 23, 2012

Unlimited FDIC Insurance Set to Expire

If you are responsible for treasury management at your company then a scheduled change in the FDIC insurance coverage may impact how you manage your cash assets.  For many years we were accustomed to a cap on the amount of deposits the FDIC would insure per institution.  During the financial crisis of 2008 the FDIC changed its rules to provide unlimited insurance on non-interest bearing bank deposits in an effort to help prevent outflows from banks.  This unlimited guarantee is set to expire December 31, 2012.

The Wall Street Journal published a good article today written by Emily Chasan. It raises many good points as well as shares the perspectives of many tasked with treasury management.  Her article follows below…

The $1 Trillion Balancing Act

Companies Weigh Banking Risks Against Alternatives as Insurance Change Nears

A looming change in federal insurance on bank deposits is forcing corporate cash managers to reassess the safety of their banks and has them poring over their investment policies to determine how much money they can keep in any one institution.
The task is gaining urgency as the Federal Deposit Insurance Corp.'s unlimited guarantee on noninterest-bearing bank deposits nears its Dec. 31 expiration.
The FDIC introduced the blanket guarantee in 2008 to keep corporate deposits from fleeing banks during the financial crisis. It has provided a haven for corporate cash for the past four years. Banks are holding more than $1 trillion in assets under the program. After it expires, only the first $250,000 of each deposit will remain insured.
With few good options in sight, company treasurers are scrambling. At the annual conference of the Association for Financial Professionals last week in Miami, two panels promising ideas on safe places to park corporate cash drew standing-room-only crowds, and some people had to be turned away.
Many treasurers follow policies that require them to assign risk weightings to bank deposits and limit balances in any single bank. But when their deposits were fully insured by the U.S. government, they only had to consider the strength of the federal guarantee.
"We'll have to go back to evaluating credit risk, rather than sovereign risk," Winston Cummins, assistant treasurer at apparel retailer Lululemon Athletica Inc., LULU -0.45% said at the conference.
Measuring credit risk has gotten more complicated, however, because many banks have lower credit ratings than they did before the financial crisis. In June, Moody's Investors Service cut its ratings on 15 banks, including J.P. Morgan Chase & Co. and Bank of America Corp. BAC -1.53%
In addition, many traditional cash alternatives, such as auction-rate securities, are no longer an appealing choice. Those securities once were viewed as the equivalent of cash, but the market for them froze during the financial crisis, tarnishing their reputation for liquidity.
Money-market funds also pose potential problems: Corporate treasurers have spent much of the past year limiting their holdings of money funds with exposure to the euro-zone crisis.
"As a treasurer our No. 1 goal is to preserve corporate assets, not to chase yield," said Jeff Cappelletti, treasurer at security company G4S GFS.LN -0.98% Secure Solutions, a unit of G4S PLC. "But there were a lot more options a few years ago, and the problem now is that everyone has cash and there is nowhere to put it."
Banks and money-market funds are stepping up their efforts to figure out how much money might move once the FDIC guarantee expires. A survey of nearly 1,000 AFP members at last week's conference found 49% expect to hold less in bank deposits six months from now, while 48% expect to keep deposits steady. Just 3% said they expected to increase deposits.
Treasurers like Mr. Cappelletti, who keeps most of his company's deposits at Bank of America, say they are generally comfortable leaving cash in the largest U.S. banks without insurance. But smaller banks are worried about losing deposits, and big banks are concerned companies might spread their cash across more institutions.
Lawmakers have been quiet about any extension of the unlimited guarantee ahead of next month's elections. But former FDIC Chairman Sheila Bair said the guarantee's abrupt end could create instability in the banking system. In an interview, she said it should be phased out instead. "My fear is that once the guarantees go away, the small-enough-to-fail banks are going to lose deposits," she said.
An FDIC spokesman declined to comment
Large banks, including J.P. Morgan and Citigroup Inc.'s C -1.48% Citibank unit, say their bankers are talking with treasurers about handling credit risk. Some banks also have hired consultants to gain a better understanding of treasurers' intentions. "I haven't heard treasurers definitively say they are going to do X or Y," said Andrew Gelb, Citibank's head of North America treasury services.
While J.P. Morgan fully expects to hold on to most deposits, "we're helping corporate clients understand what their counterparty risk is," said Diane Quinn, managing director at J.P. Morgan Treasury Services.
Money-market funds and other investments, whose own options are limited by factors such as low interest rates and the European debt crisis, are checking that they can handle corporate inflows without compromising returns for their current investors.
"The longer a corporation waits to make a decision, the fewer the options will be," said Richard Saperstein, managing director at corporate adviser Treasury Partners. "If $1 trillion is trying to find its way into money-market funds in the past few weeks of December, it's going to be a challenge."