Hidden Tax Opportunity For Tax-Deferred Investments

As IRA and other retirement plan account balances continue to grow larger, often into very significant amounts, the need to understand tax characteristics becomes more critical.

These types of accounts offer the tremendous benefit of tax deferral, as everyone is well aware, but a “taxing” problem may remain upon the death of the participant. This quandary is known as income in respect of a decedent. Income in respect of a decedent is income to which the decedent was entitled, but due to his or her death was not includable in his or her taxable income. In other words, IRD assets do not receive a step-up in cost basis at death like capital assets. Therefore, they are taxable to the estate or the heir who receives them.

Another unique characteristic of IRD assets is potential dual taxation. They are included in the gross estate of the decedent, so they are subject to estate taxes. Further, the IRD asset, when distributed, is subject to income tax upon receipt. If a beneficiary receives the IRD, it is included in his or her ordinary income for that tax year and he or she is taxed on it. However, there is a hidden tax opportunity just waiting to be utilized: a 691(c) deduction.

691(c ) is an income tax deduction designed to offset the double whammy on inherited assets that incur both federal estate and income taxes.

But income tax forms don’t flag this important tax break, popular tax-preparation software barely mentions it, and many accountants and attorneys are unaware of its importance. This deduction is likely to be most useful for people who have inherited IRAs or other such retirement plans. But the deduction also applies to things such as lottery winnings and interest on unredeemed U.S. savings bonds.

A growing number of individuals who qualify for this deduction are throwing it away every year because they have no idea it even exists.

To determine if the deduction can be claimed, it is necessary to examine the decedent’s federal estate tax return. If there is no federal estate tax, then the income tax deduction is not allowed because double taxation has not occurred. But if there is a federal estate tax, an income tax deduction is permitted based upon the estate tax directly attributable to the net value of the IRD.

The deduction can be claimed as distributions from the IRD asset becomes subject to income tax. Therefore, it is important for beneficiaries to keep track of how much of the deduction they have used.

To claim the deduction, individuals must itemize. Unlike other miscellaneous itemized deductions, which can be written off only to the extent they exceed 2% of an individual’s adjusted gross income, the deduction for income in respect of a decedent can be claimed in full. Individuals who missed the IRD deduction when they first inherited the asset may have an opportunity to amend their returns.

Of course, this brief article is no substitute for a careful review of your unique personal circumstances. Before implementing any significant income tax strategy, please contact a tax professional and Financial Advisor.

Ken Morris
Fearing the American worker is being left in the dark, Mr. Morris, a fee based Investment Advisor Representative with Raymond James Financial Services, Inc., helps 401k participants get the most out of their retirement plan.
raymondjames.com

Wyoming’s Uranium Mining Frenzy

“Staking activity is up significantly,” said Lynne Boomgaarden, Wyoming’s Director for the Office of State Lands and Investments, referring to the number of claims filed for uranium development in her state. “We have really seen a significant increase since about June 2004. We took one lease application to the board in April 2004. In June 2004, we had 30 or so applications. That’s when we really saw the increase.” In June 2004, David Miller of Strathmore Minerals (TSX: STM; Other OTC: STHJF) quickly filed 10 minerals claims for uranium. On his heels, William Sheriff began filing claims as well. Since then, pages and pages of claims covering tens of thousands of acreage have been filed by Miller, Sheriff, their associates and their respective companies.

Subsequently, others jumped into the rush for Wyoming’s state uranium claims. From Crook, Campbell and Converse counties to Carbon, Sweetwater and Fremont, most of the available state trust lands, where uranium rollfront deposits had been previously identified by drilling during the previous two uranium booms, were snapped up. From Wyoming’s Powder River Basin, where most of America’s uranium and coal is produced, to the Great Divide Basin, which has seen uranium mining, any serious players, who wanted to quickly establish an in situ leach (ISL) mining operation in Wyoming, marked their territory.

“Most of the activity we’ve seen in leasing has been speculative activity,” explained Boomgaarden. “We don’t have new mines and new operations right now.” As noted in Part 2 of this series, permitting a property to put into place an ISL uranium operation may take two or more years. She added, “When I first came here in the spring of 2003, there was nothing.” A few changes have taken place, which Boomgaarden and many others have noticed. Through the first half of 2003, spot uranium prices stagnated around the $11/pound level. On March 3rd, spot uranium traded at $39.25/pound, according to TradeTech LLC, which keeps track of weekly and monthly spot uranium sales.

Holding costs on Wyoming’s state trust lands are affordable to speculators, when the underlying commodity in question has had a 500 percent increase in the past 62 months. Applicants file a lease application and pay an annual lease fee of $1/acre for each of the first five years of the lease. The application is presented to the Wyoming Board of Land Commissioners, which meets every other month. “Our royalty revenues from uranium have been pretty flat,” said Boomgaarden. “We can only hope as fiduciaries that we will enjoy operations on these leases that result in royalty returns.” And it appears her wish may soon be granted.

Uranium ISL’s May First Start inWyoming’s Powder River Basin

Of the six companies we interviewed, five expressed their initial ISL operation would be established in Wyoming’s Powder River Basin. The most prolific coal- and uranium-producing areas in the United States, the tri-state Powder River Basin lies between Wyoming’s Laramie Mountains, the Big Horn Mountains of Montana and Wyoming, and the Black Hills of South Dakota. According to the U.S. Geological Survey published in 2002, the Powder River Basin was estimated to have a mean of 16.5 trillion cubic feet of undiscovered natural gas, 1.5 billion barrels of undiscovered oil and 86.5 million barrels of undiscovered natural gas liquids. It has been geologically prolific for uranium because the host formation is the Eocene age Wasatch Formation, which occurs under the entire area.

At the southern part of the Power River Basin, Cameco’s (NYSE: CCJ) wholly owned subsidiary, Power Resources, has been steadily producing uranium oxide (U3O8) at their Smith-Highland Ranch. In 2005, Cameco reported production of 1.3 million pounds. The property has published proven and probable reserves of 16.1 million pounds of U3O8. (In Part Five of the Wyoming Series, StockInterview.com will discuss the tour of the ISL operation at Smith Ranch and feature an interview with Pat Drummond, superintendent of the mining operation. During our interview, Mr. Drummond announced the expansion of uranium production on the PRI properties and the additional hiring of personnel.) Capacity could run up to 2 million pounds annually at each of their two processing facilities.

Three of the six uranium development companies we interviewed also stated they intended to fast-track their ISL operation by creating a “satellite facility.” Such a facility would eliminate the need for a Nuclear Regulatory Commission (NRC) license. The uranium development company plans to “attach” its mining operation to an established producer. Under such a circumstance, the company would solution mine (also known as in situ leach mining) uranium on its property. The uranium would then be shipped to an established producer for processing. Because the spot uranium price is rising, and may hold around these levels (or soar higher), a profit-sharing arrangement negotiated by the newly producing uranium company and the more established company would probably make sense.

You Can Not Eat Average Returns!

It seems almost once a week I hear some buffoon stating that “the average return for stocks over the last (fill in the blank) years has been 10%.”Listen, I don’t care about “average returns.”

And neither should you. I’ll explain why through a simple math problem. Add up these positive and negative numbers: -25, +30, +10. I get +15 as my total answer.

The average of the three numbers is +5. Suppose you’re looking at your investments and you learn that these three numbers are what the stock market returned the past three years (it didn’t). You calculate that the total return should have been 15% for the last three years and +5% is the average annual return the past three years.

Or was it?

Now, let’s apply these numbers to your account. Say you started with $100,000 three years ago. Let’s do the math:Year One you lose 25%, you’re down to $75,000.Year Two you make back 30%, now you’re at $97,500.

Still underwater!

Year Three you make another 10%, now you stand at $107,250. You made $7250 in three years. This actually works out to be an “average” of $2416 per year, or 2.4%...not the 5% advertised.

Maybe the order you earned these returns will matter, you say?

OK, try this:Year One, you make 30%, and $100,000 has grown to $130,000. Great!Year Two you lose 25% and now $130,000 drops to $97500.

Uh-oh.Year three you make back 10% and you are back at $107250.

Wait, let’s mix the numbers again for one more time!Year one you make 30% and your $100,000 grows to $130,000.

Year Two you make another 10% and now the account is up to $143,000. Cool.

Year three you give back 25%. The account is now worth $107,250. Bad.

Beware the man touting average returns!Repeat after me: you can’t eat “average returns.”

Average returns do NOT translate into actual dollars in your pocket! Don’t believe average numbers!

This is important: you’re going to NEED this money someday to pay for college expenses, pay for retirement, pay for medical costs, pay for living expenses and on and on. “Average” returns will be of no use to you when you really NEED the money.We need to do everything in our power to avoid losses. As you can see from the examples above, negative numbers (losses) will destroy more portfolios than most other mistakes investors can make (and they can make some whoppers!). That one year loss of 25% above is a killer, no matter what year it appears in! You can beat the market simply by avoiding the big down years, or minimizing losses in bad years.

That’s EXACTLY why we use a tactical approach of measuring supply and demand when examining your investments. It’s not just important, it is CRITICAL that we’re aware (in real time) what sectors of the market are in demand (where their prices rise) and which areas of the market are experiencing greater supply (where prices fall). Simply staying far away from weak sectors can drastically improve the outlook of your portfolio.

Buy a Photo Album!

We’re also not helping ourselves at all when we make mistakes like hanging onto losing investments (only because someday it MAY come back). Keeping certain stocks for sentimental reasons is another bad idea. Photo albums are for sentimental keepsakes!Suppose, instead, that the -25% return (loss) for one year was actually a flat year? Where there was no gain or loss at all. How do the numbers shape up now? Pretty well! But let’s be realistic, suppose the year that the market lost 25% ...you only lost 10%. The account would look much better than most others in the market at that time!Minimizing losses will improve the overall picture each month on your statements. Simply waiting for an investment to recover is a bad strategy. Eliminating losing investments from your account will make your statements look better. And you’ll free up cash for other areas of the market that are working. Or when times get rough and we need to be defensive, eliminating a loser is a great way to raise cash.

Thomas Mullooly, President of Mullooly Asset Management, works one on one with individuals so they can regain control of their investments. Tom's popular email alerts help folks to reduce the risks in their portfolios. To learn how to stop making simple investing mistakes and to sign up for Tom's email alerts, visit www.mullooly.net, today!