ETF Trading and Your Tax Planning

The tax efficiency benefit of ETFs (exchange-traded funds) quite often goes unnoticed when considering the other advantages like flexibility, low operating cost, and transparency. Looking towards the end of the year, we need to take stock of how an investor can reduce their tax liability by changing some of their portfolio instruments to ETFs. We will also look at other strategies in ETF trading that can lighten the tax burden. It would be wise to discuss your proposed action with your tax consultant first.

Taxes can have a negative impact on fund performance depending on the quality and timing of management. Even well managed mutual funds have lower tax efficiency than ETFs. Mutual fund managers, to fence in capital gains have been known to sell rather late in the year. The gains to current shareholders would be distributed pro-rata.

The indices tracked by ETFs generally sell and buy securities a lot less often than do mutual funds. There is therefore no need for most ETFs to distribute any year end capital gains to go into the 1099 form for your tax file. The largest suite of ETFs, iShares has never distributed capital gains to its investors. Lucky or astute investors, would you not say!

Another point is that shareholders of mutual funds redeem and purchase shares from the fund which could result in the distribution of gains to the other fund shareholders. An investor could find themselves falling afoul of capital gains commonly called "imbedded capital gains", whereby the sale of an investment made years ago affects a shareholder who was not in the fund then. The ETFs on the other hand sell and but ETFs on an exchange basis without affecting other shareholders. The ETF investor therefore has a better transparency and control on the liability.

These tax advantages that are clear to the eye can also be used as a toll in reducing your tax load.

Instead of keeping stocks that are held at a loss, an investor could turn to ETFs. An investor with, let us say, a loss on healthcare stocks in their portfolio, could sell them off and buy into an ETF sector like iShares DOW Jones U.S. Healthcare Sector ETF.

There are double tax benefits when switching to an EFT from a position of loss on a mutual fund that is actively managed. The first benefit is that of losing on capital without losing the value of the exposure. The second is a more efficient tax position and the added benefit of a limit chance of a distribution of capital gains.

Does Class Warfare Prevent Barack Obama and Hillary Clinton From Understanding Taxes?

During the April 16th debate between Barack Obama and Hillary Clinton, the young senator said repeatedly that he would not raise taxes on middle class earners, those he described as earning between $200,000 and $250,000 per year.

He said the following: "I not only have pledged not to raise their taxes, I've been the first candidate in this race to specifically say I would cut their taxes."

Later, he said he's open to raising the current capital gains tax rate from 15% to 28%.
This alone would nearly double that rate and raise taxes on all 100 million workers who own stock, mostly through owning 401 K'S.

Moderator Charlie Gibson asked Senator Obama why he wants to "increase the capital gains tax when history shows that a higher rate brings in less revenue."

Senator Obama responded by citing rich hedge-fund managers. He then declared that "raising the capital gains tax is "necessary to make sure . . . that our tax system is fair and that we are able to finance health care for Americans who currently don't have it and that we're able to invest in our infrastructure and invest in our schools. And you can't do that for free."

No senator, you can't do that for free. In fact it would cost a fortune. So why propose something that gets you further away from it?

In 2005, 47% of all tax returns reporting capital gains were from households with incomes below $50,000, and 79% came from households with incomes below $100,000.

When Mr. Gibson pressed further about the self-defeating nature of this idea, Senator Obama deflected it to John McCain and how Senator McCain's proposals would in effect drive us further into the terrible, ruinous, tragic and hopeless economy which according to at least one Democratic spokesman, obviously unconcerned with childlike exaggeration, declared that the Bush economy "has made us the most hopeless Americans in US history."

Senator Clinton Also Receptive To Raising Capital Gains Tax Rate

Hillary Clinton said that she "was open to hiking the capital gains tax rate."
However, she too had earlier stated emphatically during Wednesday's debate she would not "raise a single tax on middle-class Americans, people making less than $250,000 a year."

Senator Obama Causes Further Confusion

Senator Obama also wants to lift the cap on wages subject to the payroll tax. That cap was $97,500 in 2007 and is $102,000 this year.

That would raise the maximum payment to $7800 on a tax that had a maximum payment of $60 a year, in its initial year.

It became law in 1935, the argument in favor was that it would always be just a small affordable amount that everyone could afford in order to have a safety net upon retirement.

Opponents in 1935 argued that it would become just another way to fund more programs, and like all government programs would grow incessantly. It has done exactly that.

Congress has already stolen just under $2 trillion dollars from that fund and spent it on old and new programs. It has replaced that $2 trillion dollars with worthless paper IOU'S and put that collection of worthless paper in the TRUST FUND.

Democratic congressmen constantly deceive taxpayers by essentially describing those IOU'S as cash. This allows them to say that social security is solvent till 2041, instead of admitting that it goes from a yearly surplus to a yearly deficit in 2017.

That deficit will soar without drastic reductions in government spending.

Naturally those who contribute little or nothing to FICA are all in favor of raising FICA taxes on hard working Americans. Yes they'll cheer Barack on, hoping that some of the higher payments from others, will come their way.

Barack supposedly represents sweeping change!

What that change is all about is a change to a much higher rate of redistribution than that which presently exists.

The Role of Qualified Intermediary In A 1031 Like Kind Exchange

Exchanging is a creative method for marketing property. Section 1031 of the Internal Revenue Code (IRC) offers a golden opportunity to motivated real estate buyers to defer the capital gains tax liability associated with the sale of a business or investment asset. 1031 exchanges ensure maximum return on investments to people of all financial backgrounds. However, to qualify for 1031 like kind property exchange the transaction has to be done in accordance to the detailed rules, regulations and compliance issues set forth in the tax code.

Also known as a facilitator or exchange accommodator the Qualified Intermediary serves a critical function under the Internal Revenue Code. Choosing an Intermediary to facilitate the 1031 exchange is the first and most important step. The Qualified Intermediary should be a corporation that is in the full-time business of facilitating 1031 exchanges. The Internal Revenue Code requires that the person or entity serving as QI cannot be someone with whom the exchanger has had a business or family relationship prior to the transaction. It has to be an independent organization whose only contact with the exchanger is to serve him as a QI.

A Qualified Intermediary must be used to facilitate the 1031 Exchange Transaction. By definition a 1031 Qualified Intermediary is an independent and professional facilitator who receives the funds from the original sale and holds the funds until they are needed to purchase the new exchange property. The Qualified Intermediary then directly delivers the money to the closing agent who delivers the deed directly to the real estate investor.

The QI is responsible for performing the following activities in a 1031 Property Exchange:

· Acquiring the Relinquished Property from the taxpayer

· Transferring the Relinquished Property to the buyer

· Acquiring the Replacement Property from the seller and

· Transferring the Replacement Property to the taxpayer

The QI can perform all these without ever actually taking title to either of the properties. The QI is responsible for properly filling out the appropriate tax forms for the client. A QI typically provides three different documents: the exchange agreement, an assignment, and a notice. The exchange agreement is a contract between the client and the QI that sets out the rules, which must be followed in order to complete the 1031 exchange. The assignment of the sales contract to the QI must also be in place. This is because, theoretically, the QI steps into the client's shoes and sells the property. The third document the QI provides is a notice to the party on the other side of the transaction advising that the transaction is a 1031 exchange. The purpose of notification to the other party is to prove that the exchange was in place at the closing.

An exchanger must be particularly aware of selecting a qualified intermediary before going into the transaction. There are hundreds of qualified intermediaries providing like-kind exchange services today, but most of them don't have the necessary insurance, bonding, financial backing, transactional structure, and internal controls that should be required of them. Exchange funds are often grossly under-insured, under-protected, and at risk. In today's volatile economic climate, choosing a financially solid, time-tested 1031 qualified intermediary with the necessary financial strength, resources and backing are crucial for the safe completion of a 1031 like-kind exchange transaction.

Private Equity Professionals and Carried Interest - Tax Treatment Now and in the Future

Carried interest is the profit earned on private equity investments by a deal-maker in a private equity house. Often known as carry, it allows these professionals to receive up to 20% of the profit from a company they sell. The carry can be a significant portion of a private equity professional's total compensation.

Private equity firms are typically structured as investment partnerships where the general partners manage the firm's fund on behalf of the limited partners (the investors). The firm then uses the fund to purchase an equity position in a number of companies. When these equity investments are sold, the investors typically receive 80% of the profits and the managers collect the remaining 20% (known as the carried interest).

Current Treatment - Carried interest profit is eligible for capital gains taper relief, which is why it is currently taxed as a capital gain at 15% for both investors and managers. Investment partnerships have long maintained this lower rate.

Debate and Uncertain Future Outcome - In recent years, lawmakers have been pushing to tax carried interest as ordinary income, which would set a much higher rate than 15%. Supporters of higher taxing of this interest, such as the Coalition for Tax Justice, have argued the issue is tax fairness. A bill proposing a change would require fund managers to treat carried interest as ordinary income received in exchange for the performance of services to the extent that the interest does not reflect a reasonable return on invested capital. The bill would continue to tax carried interest at capital gain tax rates to the extent that the interest reflects a reasonable return on invested capital. President Obama's 2010 released budget proposes to raise taxes on carried interest to more than 39%, effective 2011.

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Capital Gains Tax in Cyprus

Capital gains tax is payable by both residents and non-residents at a rate of 20% on the gains made from the disposal / sale of immovable property in Cyprus in relation to the cost acquisition. If the property was acquired prior to 1.1.1980 the property's value is adopted as at 1.1.1980 and this value is so recorded on the title deed. If after 1.1.1980 the actual cost of acquisition is adopted. In both cases the acquisiton cost is upgraded / inflated, based on the cost of living index, so published on a monthly basis by the Cyprus Government. So, if a property is acquired at a cost of say CP100.000 2 years ago and the index is, say, now +7%, the indexed cost [the cost which will be taken into account by the tax authorities is CP100.000 x 107%] = CP107.000.

There are several allowances to the tax which is worth mentioning:
If the property is the sellers' primary residence, with land extent upto 1.500 sq.mts., there is a lifetime [i.e. once only] exception of CP50.000. If it is in the names of both spouses then again the sum of CP50.000 [i.e. CP25.000 each] is in total. This is so, provided that one lives in the residence for the past five years prior to sale and there are no other previous claims [for the CP10.000 mentioned below in paragraph 3]. If a previous allowance has been made, this previous allowance is deducted from the CP50.000 allowance. This allowance of 50.000 holds good provided one claims it, within 12 months after the house is sold or within 12 months from not living in the residence.
If one has a house which was sold and has claimed the exception, which did not warrant the full allowance of CP50.000 then the balance can be claimed from the new permanent residence, purchased. He can claim the difference provided he lives in the new residence for a period of 10 years, prior to the sale. It is repeated here that the CP50.000 is for life in total of any number of residences.
For any other kind of property (e.g. a holiday home, plots, land), only CY10,000 is exempt, and this exemption is for each registered owner, [once only] not per property, so if a gain is made by two co-owners each one is allowed the CP10,000 exception. For agricultural land sold by a bona fide farmer, the exception increases to CP15.000. [One cannot claim both [1] and [3] of these esceptions. The total amount that can be claimed for both allowances must amount to CP50.000 maximum.
Exchange of property. Capital gains tax is paid on the difference between the value of the property given and the value of the property obtained.

So, if for example, one exchanges a 500.000 property with another property of 300.000, then the capital gains tax is applied on the difference of 200.000. If the exchange is equal in value, then no Capital Gains Tax is paid.
Part - exchange [antiparochi]. This refers to cases where a property is "given" to say, a developer, who undertakes development on the same property and part of the new development is given to the original registered property owner, in part exchange against the value of the plot of land. If a property is given for the development, the sales price is calculated based on the land value in analogy. So if you "give" a part exchange, a plot to the extent of say 70%, to a developer and the total land value under the exchange is say CP300.000, then the tax authorities will assume a sale of the land at [CP300.000 x 70%] =

CP210.000 [less the relevant allowance].

All the calculations are made as follows:

Sales price: 70% of the value

Allowances: 70% of all allowances.
6.1.1. Exception from capital gains tax include the following:
Transfers due to death and compulsory acquisition are not considered as disposal.
Gifts to close relatives such as spouses or children;
Gift to the Government or a charity;
Exchanges or sale in accordance with Agricultural Land Laws [Land consolidation]6.1.2. Added allowances

If one undertakes any improvements or additions to the property, from the acquisition date / or from 1.1.80, this will be added to the cost of the property [the indexation factor covers also the additions] and deducted from the assumed profit made from the sale, thereby reducing the liability. This is so provided there is written proof of the improvements [including a planing permit] and in case where V.A.T. is applicable, V.A.T. must have been paid, indexed accordingly.

6.1.3.Also the following can be deducted:
Land transfer fees - * Not indexed.
Legal estate agents commission + Vat on sale
Interest on loan made for acquisition purposes of the said property, provided it is not for rent. 
Caution. Please note that the allowance of CP50,000 or CP10,000 is not deducted from the final tax amount calculated, but from the gains made from the sale. e.g. sale of a property:Sale of a property 100.000

Total indexed cost of the property 60.000

Gain from the sale 40.000

Less allowance say 10.000

Taxable gain 30.000

Capital gains tax, 20% x 30.000 6.000

Please refer to your accountant for further information and details of any particular transaction.