The May newsletter concluded with "Have a great summer!" Well, my summer turned out to be unusual, gardening wise. It was so cool for so long that the usual rush of tomatoes and beans and eggplants did not start until October.

The Stock Market has also been unusual if judged by recent standards. Positive moves have been followed by declines and there has not been much net gain in the broad market. Maybe the stock market is running out of steam.

At times like this, it is natural to consider moving your investments from stocks to money market funds in the hope of avoiding a decline. The greater risk is that you might be out of the market when stocks move upward.

Concern about market declines could reflect your apprehension about whether you will be able to finance near term needs. "What will I live on if the market tanks? How will I finance my children’s education?" You might sleep better if you kept the money for your near term needs outside of the stock market.

Suppose that you needed $50,000 a year to supplement other income. Since, historically, there has been only a 10% risk of the market being down for more than five years, a $250,000 rainy day fund in CDs or in a bond ladder should let you wait out most market declines.

Keep your eyes on the longer time horizon if volatility is making you seasick. Create an adequate rainy day fund and keep the rest of your money in a stock portfolio where it should appreciate significantly faster than inflation.

TIPS. I continue to be impressed by the US Treasury Inflation Protected Securities. These pay 4% interest and, in addition, your principal is adjusted for inflation. Inflation hit 12 –13% during the 1970s. If this situation reoccurs, TIPS holders would receive 4% interest plus a 12-13% adjustment to principal.

Four percent plus inflation is twice the historical return of long term US Treasury securities. Furthermore, the price of these bonds is less sensitive to interest rate changes than is the price of other long term securities because the federal government has assumed the inflation risk. Give me a call to discuss further or check out my analysis at www.lingane.com/tax/tips.pdf.

An Examiner arrived unannounced on my doorstep recently. She gave me a clean bill of health other than a quibble about one phrase in my engagement letter. Since the oversight of registered advisors is meant to be self supporting, California billed me $ 287 for her time and expenses.

You are entitled to a summary of the information which I have filed with the California Department of Corporations, (916) 445-7205, File 925-2760. The most recent revision is dated 1/19/99 and can be downloaded from my web site at www.lingane.com/tax/adv.htm. I would be pleased to mail you a copy.

National Tax Practice Institute. One item not yet included in the information filed with the state regulators is my completion of a three year program in Representation and Practice before the Internal Revenue Service. This training is sponsored by the National Association of Enrolled Agents and is only open to Enrolled Agents, CPAs and attorneys. Only one out of ten EAs is also a Fellow of the National Tax Practice Institute.

This training will enable me to better champion your interests in the inevitable questions and disputes that arise with the tax authorities.

Tax Simplification. The National Association of Enrolled Agents has created a "tax simplification" task force. I was invited to participate and I suggested that reform efforts will continue to flounder until advocates begin to distinguish between tax simplification and tax redistribution. To illustrate, the high income taxpayer currently pays about 25% of their income in federal taxes whereas many lower income taxpayer pay no federal tax at all. It would certainly be simpler if everyone paid a 17% tax on all of their income but such a plan would redistribute the tax burden to lower income taxpayers.

The challenge is to simplify the tax system without redistributing the tax burden. One suggestion as to how this might be achieved is posted on my web site at www.lingane.com/tax/complex.pdf.

Social Security. Those of you receiving Social Security benefits are probably already aware that your monthly check will increase by 2.4% in January.

The Social Security wage base increases each year in proportion to the increase in the national average wage index. Tax will be assessed on the first $76,200 of wages or self employment income next year, up from $72,600 in 1999.

The Social Security Administration has undertaken an ambitious program to better inform us about our potential benefits. They have begun an annual mailing to those twenty five and older who are not yet receiving Social Security benefits and for whom the IRS has a current mailing address. Statements are timed to arrive three months before your birthday. The mailing will summarize the Social Security earnings with which you have been credited and will encourage you to bring errors to their attention.

This mailing will include a forecast of your personal Social Security disability, retirement and death benefits. You may be pleasantly surprised.

Social Security benefits are based on your average lifetime earnings. The average is calculated using your best 35 years and is adjusted for annual changes in the national average wage index.

The benefit formula favors lower earners. For example, someone retiring next year at age sixty five might receive $1,000 a month if their lifetime earnings have been average. (The average wage is about $29,000.) Someone who has earned 1.5 times the average receives $1,300 and the maximum is $1,461.

Benefits also depend on the age at which you begin receipt. If you delay benefits, you get more each month because you are likely to receive benefits for fewer months. Neglecting changes to average lifetime earnings, someone aged fifty today, who is entitled to full benefits from age sixty six, increases their Social Security check by a third if they delay benefits to age seventy. They reduce their check by a quarter if they accelerate benefits to age sixty two.

The benefit formula for workers age sixty and younger increases each year by the increase in the national average wage index. Wages have been increasing 5% a year recently. Benefits after age sixty are adjusted for inflation but they are no longer affected by changes in the average wage, even if you are still working. The 2.4% increase in January adjusts for inflation only.

A married individual is entitled to a benefit based on their earnings or to a benefit based on one half of their spouse’s earnings. This rule applies to divorced persons who were married for at least ten years and who are not now married. Social Security also pays benefits if you become disabled or if you die. For example, a surviving spouse (or unmarried ex-spouse) may be entitled to a benefit equal to what the decedent would have received if they were still living.

Spousal benefits are reduced if claimed before the spouse’s full retirement age.

If you continue to work after beginning Social Security benefits, your monthly checks will be reduced if you are less than age 65 and earn more than $10,080 or if you are between ages 65 and 69 and earn more than $17,000. After age seventy, you can earn whatever you like without losing Social Security benefits.

Check out the Social Security site to learn more or to download software so you can do your own calculations. Simply follow the links from the introductory page at www.ssa.gov/OACT/COLA/Intro.html. The most recent trustees’ report (published April 1999) is at www.ssa.gov/OACT/TR/TR99/index.html.

The Social Security benefit forecasts should be reasonably accurate for someone about to retire or whose income has always exceeded the maximum subject to tax. The forecast may understate future benefits if you expect your earnings to increase faster than the increase in average wages. Give me a call if you need help understanding your benefit statement or if you would like me to confirm your benefit calculation.

The IRS has extended a Roth deadline. Announcement 99-104 says that the deadline for reversing a conversion that you made in 1998 has been extended to December 31, 1999. Apparently, the IRS has identified thousands of cases in which traditional IRAs were converted to Roth even though the taxpayer’s income exceeded the $100,000 conversion ceiling. The extra time is to encourage taxpayers to reverse such conversions. Otherwise, the Roth IRA is not valid, future growth will be taxed and there may be penalties.

You might also want to reverse a 1998 conversion if your investments have declined in value.

You must have already filed your income tax return in order to be eligible for the extra time. You will have to file amended federal and state income tax returns to receive a refund of tax paid.

Mutual Fund Distributions. The fourth quarter is not the best time to invest in mutual funds.

Many funds distribute their trading profits in December. These distributions are taxable and every shareholder receives the same distribution even if he or she has only owned the fund for a few days. So you, the new shareholder, get to pay income tax on gains that the fund realized months before you purchased shares. Vanguard uses this analogy. "Investing in a fund right before it pays a sizable taxable capital gains distribution is a lot like joining a party as it's winding down, then getting saddled with clean-up duty—you do get to enjoy yourself a bit, but you're really paying for everyone else's fun."

Since distributions reduce the per share value, buying a fund immediately before a distribution tends to accelerate tax rather than to increase tax. There may be some tax rate arbitrage. For example, if you were to buy a fund shortly before a capital gains distribution, you would be liable for 27 - 28% combined federal and California tax on the distribution. If you sell the fund shortly after the distribution, you would create a short term capital loss equal to the decline in per share value when the distribution is paid. This loss could provide a 35 - 45% tax benefit in some circumstances. Paying 27 - 28% tax and shortly thereafter gaining a 35 - 45% benefit is a good deal.

If you are intending to sell a mutual fund which you purchased some time ago, it’s probably worthwhile to estimate whether your tax liability would be smaller if you sell before or after the distribution.

These comments do not apply to purchases and realignments within IRAs.

If you are gifting shares in a mutual fund, consider whether to make the transfer before or after the distribution. Suppose that you had purchased a fund for $8/share, that it is now worth $10/share and that the fund is forecasting a $1/share year–end distribution. If you gift one thousand shares before the distribution, the donee will own 1,111 shares worth $9 each after the distribution and will have to pay the tax on the distribution.

If you transfer $10,000 worth after the distribution, the donee receives 1,111 shares worth $9 each and you have to pay the tax liability. Transferring the shares before the distribution means that you are gifting $10,000 less the tax whereas a transfer after the distribution lets you gift $10,000 plus the tax.

Contact your fund for estimated year end distributions and timing. Vanguard and other fund companies often post distribution estimates on their web sites.

Year End Planning. The next couple of months is a good time to review your tax situation. Many people delay the bulk of their charitable contributions until late in the year. This lets them make their contributions in December or in January, depending on which timing provides the larger tax benefit. Individuals without mortgage payments might benefit by doubling up contributions in one year and making no contributions in the following year.

High income individuals should review their situation with respect to the alternate minimum tax so as to decide whether to make their fourth quarter estimated tax payment in December or in January. This is important if you exercised incentive stock options this year or have an AMT credit or if most of your income is from long term capital gains.

When selling to rebalance a taxable portfolio, consider whether there is a tax benefit if you sell your losers in December and your winners in January.

If your birth month is July through December and if you celebrated or will celebrate your seventy first birthday this year, you have the option of taking an IRA distribution in 1999 and another distribution next year. Alternatively, you could take both distributions next year. Consider the tax implications.

Self employed individuals and owners of rental real estate may benefit by paying bills and scheduling capital investment in December, or in January.

You don’t have to fund a Keogh plan before you file your income tax return but the plan must exist on December 31 if you intend a 1999 contribution. Incidentally, don’t make your entire contribution before you have a good estimate of your income since an over contribution will be penalized even if you withdraw the excess early next year. (Over contributions to IRAs and 401k plans can be withdrawn early next year without penalty.)

It’s wise to make year-end gifts in December rather than in January since this gives you the option to made additional tax-free $10,000 gifts next year. Gifts by check only qualify in 1999 if your check clears your bank by December 31.

Gift Tax Returns. Each of us can give $10,000 a year in cash to a child or grandchild, or indeed to anyone at all, without gift tax consequences and without the need to file a gift tax return. On the other hand, if you give a $10,000 non cash asset, or if the gift is to a trust for the benefit or potential benefit of a grandchild, you are probably going to want to file a gift tax return even though there were won’t be any tax.

You should file a gift tax return when the value of the gift is uncertain because this forces the IRS to accept your valuation or challenge it within three years.

It is pretty easy to determine the value of a hundred shares of IBM but the value of shares in a privately held company or limited partnership or the value of a family heirloom is less clear cut. If you do not file a gift tax return, the IRS can challenge your valuation when your estate tax return is filed, even if the gift was made a dozen years earlier. Since it may be impossible to validate valuations of old gifts, it could be necessary to compromise with the IRS and to pay additional tax.

I prepared a gift tax return a few weeks ago for someone who had funded a trust with a half million dollars of stock in their privately held Silicon Valley firm. The trust benefited the more than fifty children, nephews, nieces and grandchildren in their extended family. Since this works out to less than $10,000 per beneficiary, there was no gift tax liability. We filed a gift tax return anyway in order to start the statue with respect to the valuation of the stock.

You also want to consider filing a return when you make a gift to a trust, even a cash gift, if one of the beneficiaries is or could be a grandchild. The government’s view is that they want half of everything that you leave to your children plus half of what your children leave to your grandchildren. If you try to frustrate this sequential taxation by giving money directly to grandchildren, the government’s view is that you have skipped a generation and that they are therefore entitled to a 55% "generation skipping tax" (GST.)

GST does not apply to annual gifts of $10,000 or less if made directly to a grandchild but GST applies when you gift indirectly via trusts. For example, the $10,000 gift to a life insurance or education trust for the benefit of your children and of their heirs is subject to GST rules.

In addition to the $10,000 annual GST exemption for direct gifts, there is a million dollar lifetime GST exclusion. You have to file a gift tax return in order to take advantage of the lifetime exclusion since this is the mechanism whereby you allocate the exclusion to specific gifts.

Failing to allocate the lifetime GST exclusion can be very expensive. For example, the half million dollars of stock gifted to fifty plus family members in the prior example might grow to fifty million dollars if the firm goes public. Some of this money will be distributed to grandchildren and would have been taxed at 55% of the value at the time of distribution had we not filed a gift tax return and allocated part of this individual’s lifetime exclusion.

My recommendation is that you make it a habit to discuss gifts as part of your annual review with your tax advisor. It is also good practice to extend the time for filing a gift tax return whenever you extend the time for the filing of your personal return since the gift tax return is due on the same schedule.

Check out www.financialengines.com. Some advisors seem worried by competition from on-line advisory services such as this. My view is that your needs come first. I aspire to be your trusted advisor rather than to be your only advisor.