By Lori Eason, CFP(R)

As many of you are aware, new cost basis reporting rules were phased in over the past few years. In an attempt to find missing tax revenue, new rules require brokerage firms to include cost basis information on 1099-B's for certain securities. These rules drastically change the way cost basis is reported to the IRS and affect brokers, financial advisors and investors in a major way. We never expected this transition to happen smoothly, and it hasn't so far.

Two very important terms to understand are covered verses uncovered securities. Covered securities are those that brokerage firms are required to track and report cost basis on and uncovered are those they are not. Equities purchased on or after 1/1/11 (Phase 1), mutual funds or ETFs purchased on or after 1/1/12 (Phase 2) and "less complex" bonds and options purchased on or after 1/1/14 (Phase 3 ½?) are considered covered securities. Debt instruments and options were supposed to be considered covered if they were purchased on or after 1/1/13, but in May of 2012, the IRS announced that it would postpone the effective date for these categories until 2014 as the financial services industry was still trying to understand and figure out a way to comply with the new rules from phases I and II.

In 2014, cost basis reporting rules were introduced for "less complex" bonds and most options purchased starting on 1/1/14. These bonds include corporate, treasury and municipal bonds with a fixed interest rate, payment schedule and maturity. We purchase asset backed bonds as well as adjustable rate bonds in many of our client portfolios which without a doubt fall in the "more complex" category. As of now, "more complex" bonds are scheduled to become covered in January of 2016, but we're not sure the cost basis on these will ever be accurately tracked by brokerage firms.

For our clients, part of my job is maintaining our portfolio management software, which among other things, accurately tracks cost basis for every security we purchase, regardless of whether it is considered covered or uncovered by the IRS. For this reason, the Gain/Loss report we provide our clients with at the beginning of each year will always be the most complete and accurate source for calculating your cost basis.

Where's My Social Security Statement?

By Lori Eason, CFP(R)

Have you noticed that you haven’t been receiving Social Security benefits annually? Back in 2011, the Social Security Administration began phasing out mailed annual benefit statements to save money. While people can at any time access the same information by setting up "my Social Security" accounts online, very few people have actually done so (about 6%). In light of this, the administration recently decided that they will begin mailing statements again, but with some stip...ulations. Workers who have created an online account will not receive mailed statements. Workers age 25 and older who aren’t registered online or receiving benefits will receive mailed statements every 5 years and those over 60 will receive annual statements. Here's a link to create an online account to view your benefits if you're interested:  http://www.ssa.gov/myaccount/

April 15th - Just Another Day of the Year?

By:  Lori Eason, CFP(R)

If it seems like every year preparing and filing your taxes has become  more and more difficult, it's because it has. There is probably no better proof of the need for tax reform than what most Americans have to go through now to simply file form 1040. In the past, this was mostly a problem for the ultra-wealthy that had various business interests, tax shelters and an army of accountants to keep up with it all. Not so today. Anyone with even a basic level of financial complexity in his or her life faces a myriad of changing tax rules and strategies to understand and stay current on from one year to the next.

If you're a business, the challenges of complying with the tax code are even worse. This is especially true of financial institutions. Whether they are banks, brokerage firms, or investment companies, any firm that is required to report investors' activity to the IRS is being buried by those obligations. Taxpayers simply have to take a look at the length of their 1099s they receive every year to get a sense of what we're talking about.

Ten years ago, the typical client's 1099 form was roughly 6 pages long. That same client will have seen the number of pages grow to over 50 today. The amount of information that the IRS wants from these financial institutions on you and I has simply exploded. This is clearly an effort by the government to capture any lost tax dollars it thinks may be going unreported. In reality, though, it has created a complex chain in which a series of financial institutions have to file reports to one another so that finally your bank or brokerage firm can provide you with what you need to file your taxes.

Here's a typical scenario: You own a mutual fund in your brokerage account. That fund invests in a variety of securities that include ETF's, partnerships, futures or maybe option contracts. Each of those underlying investments inside the ETF, for example, has to send their financial information to their transfer agent who then passes that along to the shareholder (the ETF manager). The ETF manager then compiles that with all of their other holdings and forwards that to their shareholders (the mutual fund company). The fund company, in turn, compiles that data with all of their other holdings and sends that to your brokerage firm, who then collects similar information for all the activity in your account and prints your 1099.

In the past, the amount of information collected and sent along was pretty much limited to interest, dividend and sales proceeds. There is now far more data that has to be collected and with each new data point comes the likelihood that something will be wrong or missing. Any correction then has to get forwarded up the food chain. This ultimately shows up as a corrected 1099.

The Affordable Care Act created the biggest reporting burden by requiring financial institutions to keep up with the cost basis of most securities held in taxable accounts for the purpose of calculating your trading gains or losses. This is no easy task as the cost basis is subject to tax rules themselves. Factors affecting the cost basis are, just to name a few, the amortization of premiums and discounts, wash sale rules or accounting for multiple tax lots.

Securities subject to these requirements were fully phased in over four years ending last year. Our experience is that we've seen more and later corrected 1099's (some as late as June). Understandably, clients have become increasingly frustrated when this happens. I can't count the number of calls I have received during the past couple of tax seasons with the question "Is this the last 1099?" As badly as I want to answer this, unfortunately, there is no way for neither me nor the brokerage firm, in our clients' case, Charles Schwab & Co., to know.

Through the normal course of business, we often speak to our clients' accountants and what we've heard from them is that filing tax returns by April 15th is becoming a thing of the past. There just isn't enough time by then to accurately compile all of the information the government requires and disseminate it to the end user - tax payers. Literally, every accountant we spoke to last year told us that they are advising their clients to plan on filing an extension from here on out.

Based on what we've experienced, we agree with this advice. If you have been receiving late corrected 1099s, it's probably a good idea to file a tax extension. This will relieve a great deal of stress for both you and your accountant. Filing an extension with the IRS gives you an additional 6 months to file your taxes pushing back the deadline from April 15th to October 15th. It's important to note that this extension of time does not provide additional time to pay and payments made after April 15th are subject to penalties and interest. If you are due a tax refund, this will delay receipt, but filing an extension does not mean you have to wait until October, you can file in late June only delaying your refund slightly. On a side note, if you're receiving a substantial refund each year, you should revisit your tax situation and adjust your tax payments instead of giving the government an interest free loan every year.

Filing an extension is easy and done so by filing Form 4868, which is a very simple and short form. The only somewhat tricky part is that you have to estimate your total tax liability for the year. To do so, you'll need to prepare a mock form 1040. While state tax extension guidelines vary, many states do not require you to file a state extension if you already filed a federal one. Georgia, for example, applies the automatic six-month extension if a federal extension has been accepted and a copy of the federal extension is attached the return when filed. Alabama automatically grants a six-month extension and does not require taxpayers to file an Alabama extension form.

The bottom line is that if you expect to receive late corrected 1099s, filing an extension can make life easier for both you and your accountant. Please let us know if you have any questions about filing an extension or contact your CPA.

Life Just Got A Lot Cheaper

By Charles Webb

As we conclude 2014 and look back over the year, much remains the same as in the previous couple of years. Global politics and strife seem to be in the headlines every day. Political divisions remain in Washington which has led to more legislative gridlock. European debt and lackluster growth are threatening the currency union and questioning the long-term viability of the Euro. And finally, the Federal Reserve looks for ways to exit the capital markets and let interest rates rise to more normal levels.

So as unsettled as the world seems, there was actually little reason for the U.S stock market to get derailed in 2014. It's important to keep in mind that the stock market is always forward looking and as such, it hates uncertainty. Good or bad, uncertainty leads to volatility (up or down). 2014 was a year in which we saw relatively little volatility in the overall stock and bond markets.

This is not to say that there weren't eventful moments during the year. Most notable was the drop in energy prices. Back in June 2014, the price of Brent crude was up around $115 per barrel. As of this month, it had fallen more than half, down below $50 per barrel. This has been a huge story and we think will be the main driver of the fundamental factors effecting stocks in 2015.

Ironically, the initial selloff in oil back in June spooked the markets due to the severity of the decline. Investors worried that this was due to a lack of demand that portended a significant slowdown in global GDP. The stock market actually declined in the third quarter based on these worries.

While these GDP concerns were partially justified, the primary reason for oil's decline was more and more new production making its way into the market. In addition, this new production was coming from non-OPEC sources - primarily the United States. This meant that the traditional oil cartel nations could do little about controlling the supply glut as they typically would in response to a decline in demand. In fact, OPEC has responded just the opposite by announcing at their last November meeting that they would continue current production levels in order to protect their market share and to try and drive out the more expensive sources of production (mainly U.S. hydraulic fracturing).

The oil price crash is a very big deal and is now upending the global economy, with ramifications for every country in the world. Low prices are excellent news for oil consumers in places like Japan or the US, where gasoline is the cheapest it's been in years. But it's a different story for nations reliant on oil sales. Russia's economy is facing a potential meltdown. Venezuela is facing serious unrest. Even better-prepared countries like Saudi Arabia could face heavy pressure if oil prices stay low.

In the U.S., cheaper energy prices are going to have a significant positive impact on our economy. It is estimated that U.S. drivers will spend $550 less per car in 2015 than they did in 2014. That will give consumers more money to spend on other things. Businesses that ship their products will see a huge benefit with lower transportation costs. Transportation companies will obviously see lower operating costs. The travel industry should experience higher volumes of traffic. Oil is also a major input in the production of everything from plastics to fertilizer. Farming will be cheaper and so on.

We believe that sustained lower oil prices will be the biggest factor driving earnings and thus stock prices in 2015. Oil below $60 per barrel should also create a nice counter balance to other negative forces such as the higher value of the Dollar vs. Euro and a possible Fed rate hike later in the year. While we're not expecting a year like 2013, we do believe stocks should do as well as in 2014 - mid to upper single digit returns.

The Land of Opportunity?

By:  Douglas Schwartz

A few weeks ago, I had the privilege of hearing the co-founder of Home Depot, Bernie Marcus, speak.  There was one thing that Mr. Marcus said that I have been unable to get out of my head.  He said that if he were trying to create Home Depot today, he would simply not be able to do so.  He went on to add that in the 1970's, Washington was your friend.  They used to help and encourage free markets, business and entrepreneurship. Today, making money and becoming wealthy is demonized.  Washington is increasingly becoming your foe.

All of the outrageous legislation and regulations are hindering the ability for Americans to start and grow businesses, which obviously has a negative impact on job creation.  For example, let's talk about the Dodd-Frank Act which greatly increases regulation in the financial services industry.  It was passed in July of 2010 yet bureaucrats are still adding regulations to that bill to this day.  As of April 1 of this year, only 52% of the rules mandated by the legislation were completed. Yes, you read that correctly.  All this red tape is making it more difficult to start a business in the so called land of opportunity than other countries. For example, it takes six months to start a bank in England.  It takes three years to start a bank here in America.  It is easier for someone to come out of poverty in China (Jack Ma) and create a thriving business, than it is to here in the USA.   What's wrong with that picture?  I can think of at least one thing.

The problem stems from our citizens, most of us are simply not informed.  As a country, most people vote for the party their parents align with, for selfish reasons, or maybe even for whoever has the best one-liners.  This is another subject Mr. Marcus is outspoken on.  He says it's time for voters to get their emotions under control and look at the facts.  Frankly, most people care about themselves more than their country.  But in their defense, it is hard for people to truly understand the bigger picture.  In terms of economic policy and global economics, just last month, the International Monetary Fund basically admitted that they are out of ideas on how to get the global growth engine running.  More specifically, IMF Chief Economist Olivier Blanchard was quoted in a WSJ article earlier this month saying, "There are two forces at work weighing down prospects: the legacy of high debt and falling growth potential in the future."  All this big government fiscal policy is not working. We have had an accommodative monetary policy (near zero interest rates and quantitative easing) for far too long that has masked the true problems and allowed crushing fiscal policy to take root.

We simply cannot afford to stay on this current trajectory.  Our national debt is out of control.  Mr. Marcus has stated that if we stay on this path of government spending, we'll be in no better shape than Greece, Spain and France, but with no one to bail us out.  We will not see all the consequences of our current government's actions for decades to come.   It is easy for politicians to make promises that feel good, or for them to borrow money now and spend the borrowed dime to push their agenda.  But make no mistake.  We will pay for these crimes one day.  Our leaders are stealing from the next generation.  $17,898,691,021,355.14 and counting in national debt is a big problem.  This number doesn't even come close to including the government's unfunded obligations to Social Security and Medicare.

We have a very important election coming up. Before you go to the polls on November 4th, take the time to educate yourself on the candidates and how each of them stands on important issues.  It is time that we the people take a stand and let our politicians know that this out of control spending and blame game has got to stop.  I want to live in a country where our government encourages entrepreneurs like Bernie Marcus, not hinders them.

A Map Would Be Helpful - Part 2

By Charles Webb

For those who have been paying attention to the stock market the last few weeks, there’s little doubt that it’s been a little nerve racking.  Our clients will have or soon get our latest market commentary in their quarterly reports (see previous post).   In that commentary, we’ve addressed some of the reasons that we feel the market has sold off this month.  However, since then, we’ve seen even more volatility and a further selloff in the global stock market.  We wanted to send out this brief note to address the last few days’ activity.

As of this writing, stocks have had more days of triple digit declines, including an intraday move of -350 points on the Dow Industrial Average.  This has essentially put all the indices in negative territory year-to-date.  While the international concerns mentioned in our commentary are still the primary drivers, other news seems to have amplified this negative sentiment, the Ebola scare being the primary headline. 

Experience tells us that this piling on effect is fairly common.  When stocks top out, such as what we saw this summer, investors get nervous and begin looking for reasons to sell.  Initially, you’ll see the various parts of the market diverge from each other as investors naturally pull away from the more richly valued sectors.  We saw this trading pattern in September as the small and midcap sectors underperformed large caps. 

News concerning fundamental factors such as GDP and earnings drive most of this initial selling, but from there things tend to get irrational.  Once again, the Ebola news would fall into this category.  This is what you’d call “headline risk”.  There’s no reasonable explanation at this point to link stock market performance to something like a few people in the U.S. contracting a virus.  What it does, though, is create a catalyst for those looking for a reason to sell.  The trading jargon for this is “capitulation” and the financial news loves to report on it.

Whenever stocks reach historic highs, it’s necessary to have a periodic retreat to consolidate those gains.  Investors are never comfortable when things go straight up.  They always expect there to be a selloff.  Once that occurs, the feeling is that it’s now behind us and it’s safe to get back in.  You’ll hear a lot of talk of “10% corrections” and technical terms such as “200 day moving averages” being thrown around.  This is all just an effort to figure out when the sellers are done.

We never felt that 2014 was going to be a particularly good year, but we do believe it will finish positive for the year.  The good news is that bonds continue to rally.  For those who like to frequently look at their account balances, that will help. 

A Map Would Be Helpful

By Charles Webb

The title of this quarter’s commentary is derived from what seems like a complete lack of direction in both the stock and bond markets.  There certainly has been no shortage of news for the financial markets to respond to, but much of it has been conflicting and of questionable importance.  Weeding through the headlines of the last quarter, the larger drivers of the U.S. market performance have been shifting Fed policies, U.S. dollar valuation and foreign growth trends.   

After years of unprecedented market intervention, the Federal Reserve appears to be ready to end its bond buying program, known as quantitative easing, and eventually raise interest rates.  We’ve just started to see the technical details of how they plan on accomplishing this, but there’s still little consensus among board members of when these policy changes should take place.  The primary task at hand is to raise short-term rates from essentially zero to a preferred 2% without adversely impacting the economy.

The Fed has announced that it will end its six year experiment in long-term rate manipulation this month.  Through QE 1-3 and Operation Twist, the Fed has successfully propped up asset values, such as the housing market, by buying Treasury and mortgage-backed bonds in the open market.  The Fed now holds roughly four and a half trillion dollars of these bonds in its portfolio.  We’ve seen relatively little volatility over the last number of years and that has been largely attributed to the Fed’s market interventions. Now the principal question is how the markets will respond to the various economic uncertainties in the world without the Fed’s safety net. 

The answer to that question, we may need to look no further than the last few weeks of market volatility.  The past two weeks in particular have seen a reemergence of back to back days of the Dow Jones Industrial Average whipsawing hundreds of points in either direction.  Driving these swings are economic concerns abroad.  While slow growth in Europe is nothing new, what is new is the absence of a response from our central bank – the Fed.

The European Central Bank cut interest rates in June and September, when it also announced a bond-purchase program. These measures are designed to combat anemic growth and low inflation in their economies. Meanwhile, the Bank of Japan, too, is considering whether to enhance its bond-buying program to raise consumer prices and boost growth.

These moves and others have led to a reduction in the value of the foreign currencies relative to the U.S. dollar.  The stronger dollar in turn has put pressure on corporate earnings as our exports become less price competitive.  In previous years, these moves would have been offset by the monetary expansion that comes with quantitative easing.  Absent that, the markets are unsure as to where the dollar will stabilize and what the ultimate impact on corporate earnings will be.

As of now, the recent selloff has erased this year’s modest gains and actually pushed most indices into the red.  Large cap stocks have fared the best from a total return standpoint at near or just above breakeven.  The small cap sector, on the other hand, performed the worst, losing around 7% thus far.

The bright spot has been in the bond market.  The benchmark 10 year Treasury bond has rallied considerably since the spring.  We’ve seen the yield drop from as high as 3% at the end of last year to its current level of 2.2%.  While this has been good for bond prices, it hasn’t been good for those seeking income. 

We view all of this as temporary, as the markets attempt to find the right trading levels in a world without the Federal Reserve market interventions.  We’ve been stating since last year that we felt this was going to be a mediocre year for stocks.  For most of the year that has been true.  We still hold out hope that this recent selloff will be temporary and that we’ll see values pick back up by the end of the fourth quarter. 

Income is still king in our book.  Our total return focus has taken our portfolios into more diverse areas of the market.  These include the addition of convertible bonds, expanded use of Master Limited Partnerships (MLPs) and preferred stocks. 

Generating cash flow continues to be a challenge for investors and we look forward to higher interest rates in the near future.  Investors need a break from the Fed’s easy money policies.  We’ve been concerned for years about the credit risk average investors have to expose themselves to in order to meet their income needs.  Although higher rates typically put pressure on the stock market, we feel this is necessary in the long run to achieve a more balanced and risk appropriate investment strategy.