Saturday
Oct012016

The Pension Amortization Scam

State law requires conservative investments principles for any investment managed by a government entity. Most interpret this to mean no junk bonds or 'high risk' stocks but it also means to adequately fund accounts for future payments such as bonds and, yes, pension plans. The use of a defned plan and the use of the method outlined by Bill King which is a loophole permitting officials to avoid making unpopular choices circumvent the intent of law mandating conservative investing endangering both the City of Houston and pensioniers.

Fair warning: This post is going to get way off in the weeds of the complex math that defined benefit pension plans entail. So if you are a mathphobe you may want to skip to the next item in your inbox. Unfortunately, because defined benefit pension plans are such complicated financial arrangements, there is no way to fully understand their impact without getting into the weeds, so here goes.

The amount an employer needs to set aside to fully fund a defined benefit pension each year consists of two parts. The first is the estimated cost of the benefits earned by employees that year. This is referred to as the “normal cost” or “service cost.”

Of course that estimate is an educated guess at best. It is fundamentally unknowable how much money needs to be set aside today for an indeterminate benefit to be paid 30 years from now. We know from experience, however, that employers almost always underestimate this cost, which results in the plans becoming underfunded over time. This is equivalent to the employer borrowing money from the pension plan. It is debt, plain and simple.

That brings us to the second part of what the employer should be contributing to its pension plan. In addition to the current cost, the employer should be contributing something toward paying off its debt to the plan. But how much should that be?

To be considered “actuarially sound” the employer should be contributing enough to pay off the unfunded liability in 30 years or less. Most people would assume that if an employer were going to pay off the debt in 30 years, the employer would run an amortization schedule to see how much it would need to contribute to the plan each year to pay off the debt, exactly the same way your bank calculates your mortgage payment. 

But that is not how amortizations are done in the bizarre world of pension accounting. Rather, pension plans normally calculate the amortization schedule to pay off the debt using something called the “level percentage of payroll method.”  It is a complete scam.

This amortization method estimates the total payroll for the employer over the next 30 years and calculates what percentage of that total payroll the employer will have to contribute to pay off the pension debt. When you work through the math, this amortization schedule results in a negative amortization for about the first ten years (i.e. the debt increases for the first ten years) because the payments are dramatically back-end loaded.

I have learned that this is the amortization method the City intends to use in its proposed pension plan. So let’s see what that looks like.

For the purposes of this example, I am assuming that the concessions the pension plans have agreed to really reduce the pension debt by $2.5 billion, something that has yet to be demonstrated. I am also ignoring the debt service on the $1.6 billion of pension bonds that taxpayers will be saddled with if this plan goes through.

Making those assumptions, the City’s remaining pension debt would be $4.1 billion. Assuming the City’s payroll increases by 3% each year and assuming the pension plans earn 7% during the entire 30-year amortization period, the City will need to make an annual contribution of about 19% of payroll. This is what the amortization schedule would be.

 

As you can see, the overall pension debt remains above 2017 levels until 2031. More significantly, the payments begin low and then dramatically ramp up over the 30-year period, more than doubling. So if you are only going to be mayor, say until 2020 or even 2024, you don’t have worry too much about how to pay off the pension debt.

Here is what the numbers look like graphically:

 

Now let me add this caveat. This is a very simplified model of how this amortization method works. Very small changes in the assumptions make enormous differences in the outcome. For example, if the City’s payroll goes up by 5% annually, the payments are even more back-end loaded and the debt balloons to over $5 billion before it starts down. Also, other factors, like the inflation rate, can dramatically affect the future contributions and scheduled pay-down of the pension debt.

Of course, even the presumption that we can project what the City’s payroll will be over the next 30 years is absurd on its face in the first place.

But make no mistake. The only reason to use this squirrelly method to amortize the pension debt is to kick this can down the road to the next City administration.

Thursday
Sep012016

IRS Warns Of 2017 Tax Refund Delays

 

By Ashlea Ebeling  Forbes Staff

 

PERSONAL FINANCE 8/31/2016 @ 2:23PM 34,761 views

It’s better to owe taxes in April than to get a refund, and for the 2017 tax filing season, it’s especially important. The Internal Revenue Service today issued a warning of 2017 tax refund delays for certain taxpayers, urging folks to adjust their tax withholding now. We’re talking about your 2016 taxes that are due April 15, 2017.  There’s good reason to pay attention—at least there’s something you can do about it.

“We don’t want people caught by surprise if they get their refund a few weeks later than previous years,” said IRS Commissioner John Koskinen in the release.

A couple things are to blame. First, a new tax law effective next year requires the IRS to hold refunds a few weeks for some early filers who claim the Earned Income Tax Credit and the Additional Child Tax Credit. The IRS has to hold the entire refund, not just the portion associated with those credits, until at least February 15.

Second, the rise in identity theft is causing the IRS and state tax authorities to spend additional review time to protect against fraud. Additional safeguards will be set in place for the upcoming 2017 filing season. “We want people to be aware we are taking additional steps to protect taxpayers from identity theft, and that sometimes means the real taxpayers face a slight delay in their refunds,” Koskinen said.

Shutterstock

So what’s the solution if you don’t like the idea of a tax refund delay? Adjust your tax withholding for the rest of 2016, so you get more take-home money now and a smaller refund. Check out IRS tips on tax withholding and a withholding calculator.

Forbes’  Kelly Phillips Erb explains how to complete your W-4 here, finding the right balance between holding too little (you’ll owe Uncle Sam at tax time) and holding too much (you’ll be due a refund, which you might have to wait for).

The IRS gives an extra warning to taxpayers who work in the gig economy. If you have income outside of wages and salary– Schedule C self-employment income, capital gains, interest and dividends–you need to pay estimated taxes in quarterly installments. (You don’t have to make estimated payments if your tax due—after subtracting withholding and credits–is less than $1,000).

Typically taxpayers who pay estimates use what’s known as the “prior year safe harbor.” That means they pay in 100% of the prior year’s tax as estimates (or 110% if their adjusted gross income was above $150,000). Using the 100%/110% prior year safe harbor is easy but in some case it means you’re overpaying. The alternative rule–to avoid penalties for underpaying estimated tax payments—is to pay in 90% of your current year estimated tax.

Already in 2016, the IRS has issued more than 102 million tax refunds (out of 140 million individual returns), and the average refund is over $2,700. Most refunds will still be issued within 21 days or less, the IRS says.

Wednesday
Aug172016

Scammers Target Tax Pros with Fake Software Update Email

The IRS is warning tax pros that scammers are now using fake emails that pretend to be from tax software providers and tries to trick recipients into clicking on a bogus software update link.

The email scheme is the latest in a series of attempts by fraudsters to use the IRS or other tax issues as a cover to trick people into giving up sensitive information such as passwords, Social Security numbers or credit card numbers or to make unnecessary payments.

In the new scheme identified as part of the IRS Security Summit process, tax professionals are receiving emails pretending to be from tax software companies. The email scheme requests the recipient to download and install an important software update via a link included in the e-mail. 

Once recipients click on the embedded link, they are directed to a website prompting them to download a file appearing to be an update of their software package.  The file has a naming convention that uses the actual name of their software followed by an “.exe extension.”

Upon completion, tax professionals believe they have downloaded a software update when in fact they have loaded a program designed to track the tax professional’s key strokes, which is a common tactic used by cyber thieves to steal login information, passwords and other sensitive data. 

Although the IRS knows of only a handful of cases to date, tax professionals are encouraged to be on the lookout for these scams and never to click on unexpected links in emails. Similar email schemes using tax software names have targeted individual taxpayers.

The IRS recently launched a new campaign to raise awareness among tax professionals about security threats posed by identity theft issues targeting their industry. The Protect Your Clients; Protect Yourselfcampaign features an ongoing effort to urge tax professionals to step up their security protections and be aware they increasingly are targets of cybercriminals.

The IRS urges all tax preparers to take the following steps:

  • Be alert for phishing scams: do not click on links or open attachments contained in e-mails and always utilize a software provider’s main webpage for connecting to them.
  • Run a security “deep scan” to search for viruses and malware;
  • Strengthen passwords for both computer access and software access; make sure your password is a minimum of 8 digits long (more is better) with a mix of numbers, letters and special characters;
  • Educate all staff members about the dangers of phishing scams in the form of emails, texts and calls;
  • Review any software that your employees use to remotely access your network and/or your IT support vendor uses to remotely troubleshoot technical problems and support your systems. Remote access software is a potential target for bad actors to gain entry and take control of a machine.

Tax professionals should review Publication 4557, Safeguarding Taxpayer Data, A Guide for Your Business, which provides a checklist to help safeguard taxpayer information and enhance office security.

Wednesday
Aug032016

IRS Acquiescence Gives Unmarried Couples a Double Deduction

Mortgage interest deduction limit applies on per taxpayer basis

WASHINGTON, D.C. (AUGUST 2, 2016)
 

A year ago, a divided Ninth Circuit reversed the Tax Court in Voss v. Commissioner, allowing two unmarried co-owners of real property to each claim a home mortgage interest deduction. Now, the IRS has acquiesced in the decision, giving a bonus to unmarried individuals who buy property together.

Bruce Voss and Charles Sophy, unmarried co-owners of the property, each claimed a home mortgage interest deduction under Tax Code section 163(h)(3). The Code section allows taxpayers to deduct interest on up to $1,000,000 of home acquisition debt and $100,000 of home equity debt. The IRS said Voss and Sophy were jointly subject to section 163(h)(3)’s debt limits, and therefore disallowed a substantial portion of their claimed deductions.

Voss and Sophy claimed the provision applies on a per-taxpayer basis, so they were each entitled to deduct interest on up to $1.1 million. While the Ninth Circuit conceded the language of the Code is “anything but plain,” it agreed with the taxpayers. 

The decision of the IRS to acquiesce opens the door for unmarried couples outside the Ninth Circuit to claim the deductions subject to the increased limit, and adds an additional element to the marriage penalty under the Code.

Friday
Jul222016

From the Wall Street Journal News of Over 100 Countries Agree to Share Tax and Bank Information.

A Shrinking World Spurs Calls to Rewrite the Tax Guidebook 

 

Jul 21, 2016 1:46 pm ET

  • Arguments to tax Capital Gains at rates close to or equal to rates for wages.
  • Agreement to share citizan's tax and bank details.
  • Expressed desire to shift tax burden to higher income individuals by taxing capital gains.