January 10, 2008

Dear Client:

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Market Summary

2007 ended with a whoosh, as the air continued to rush out of the equity markets. The last quarter of 2007 was very volatile, mostly in a downward direction. For the year, the mortgage bond crisis resulted in losses in financial stocks (down 21%) and consumer discretionary stocks (down 14%). Most other equity sectors had gains for the year, despite fourth quarter losses.

What's New in Taxes for 2008

• Health Savings Account limits increase to $2,900 for individuals and $5,800 for families. Participants born before 1954 can contribute an additional $900 as a "catch-up" contribution.
• The limit on deductions for long-term care insurance premiums increased to:

• The deduction amount is subject to the 7.5% of AGI medical deduction, thus the allowable long-term care deduction for your age is added to other medical expenses, and deductible to the extent that your total medical expenses exceed 7.5% of your AGI.

• IRA CONTRIBUTIONS
  • The limit on contributions to IRAs and ROTHs increased to $5,000, with an additional $1,000 "catch-up" contribution allowed for people born before 1959.
  • The 401(k) contribution limit is unchanged from 2007, at $15,500 plus an additional $5,000 allowed for people born before 1959. The SIMPLE IRA contribution limit is unchanged, at $10,500, plus $2,500 for catch-up contributions.
  • Defined contribution plan limits increased to $46,000, based on up to $230,000 of income.
  • The benefit limit for pension plans increased to $185,000.
  • The credit for retirement plan contributions (up to $2,000) is available to filers with AGI below $53,000 (joint) and $26,500 (single).
  • The phaseout for deductible IRA contributions increased, as follows:
    • If both spouses are participants in a company plan, you may take the full deduction for AGI up to $85,000; the deduction is phased out from AGI of $85,000 to $105,000; and there is no deduction for AGI above $105,000.
    • If one spouse is a participant in a company plan, you may take the full deduction for AGI up to $159,000; the deduction is phased out from AGI of $159,000 to $169,000; and there is no deduction for AGI above $169,000.
    • For singles who are participants in a company plan, the phaseout applies from AGI of $53,000 to $63,000.
  • For Roth IRA contributions, full contribution is allowed at AGI up to $159,000 (joint) and $101,000 (single); the allowable contribution is phased out from $159,000 to $169,000 (joint) and $101,000 to $116,000 (single); and the contribution is not allowed for AGI above $169,000 (joint) and $101,000 (single).
• SOCIAL SECURITY AND MEDICARE
  • The Social Security wage base increased to $102,000, raising the maximum FICA withholding by $279, to $6,324.
  • Social Security benefits will increase 2.3% over 2007.
  • Medicare Part B premiums rise to $96.40 per month, plus another $16 to $67 more per month depending on your AGI. For example, single filers with AGI of $102,000 to $153,000 in 2007 will pay $161 per month. Details are on the US Department of Health & Human Services Medicare website.
• EDUCATION
  • The AGI at which the deduction for student loan interest is phased out increased to $115,000.
  • The maximum HOPE credit increased to $1,800.
  • The phaseout for education credits increased to start at $96,000 (joint) and $48,000 (single); credits are not allowed for AGI above $116,000 (joint) and $58,000 (single).

Registered Domestic Partners

Tax Returns

For 2007, Registered Domestic Partners who are registered with the California Secretary of State will be required to file a joint state tax return. Although the state has attempted to give RDPs the same rights as married people, they have in fact imposed a significant burden on RDP taxpayers. Since federal law does not recognize RDPs, they will have to file federal returns as Single or Head of Household status, and California returns as Joint/RDP.

The California tax calculation begins with Federal adjusted gross income (AGI). Since federal returns will be separate, nearly every income item and deduction will have to be adjusted to create the joint California return: capital asset sales (home and investment) mortgage interest, property taxes, depreciation, rental property losses, IRA contributions, alimony, etc.

In some cases, the adjustment will be more complicated than simply adding the two individual amounts. For example, if each partner has capital losses of $3,000 on their federal return, they have a total of $6,000 capital loss, but only $3,000 will be allowed in 2007 on the CA return. Thus the adjusted Federal amount, for CA purposes, will be $3,000.

In addition to the calculation, the taxpayers may have differing cost basis and loss carryovers for federal and CA, which will have to be tracked each year going forward.

We analyzed the 2006 tax returns of two domestic partners and determined that their combined income taxes would have increased by $1,150 if filed as RDPs rather than single filers.

For a look at the complexity of this legislation, read the FTB's "Questions and Responses" memo (in PDF format) about tax return filing questions for RDPs.

Property Taxes

Another part of the legislation corrects a terrible result of the previous RDP law. Before 2006, transfers between RDPs triggered a property tax reassessment. If an RDP added his/her partner's name to the deed, the property was reassessed to current market value for property tax purposes.

Since January 1, 2006, RDPs whose properties were reassessed may file a claim for reversal of such a reassessment. Going forward, the RDPs will pay property tax based on the old (pre-reassessment) values. However, no refunds will be made for prior assessment years, and counties may charge a fee to recoup costs related to processing the claim.

Estate Planning

From the perspective of income tax and property tax, the Registered Domestic Partner legislation poses some disadvantages over non-RDP status. The taxation of property transfers under federal legislation is another area in which there is a potential for huge financial damage as a result of RDP status.

Thus far, the legislation raises more questions than it answers. Since the federal government does not recognize RDP status, does the placement of an RDP on a deed amount to a gift of 50% of the value of the property? Since only $12,000 of gifts are allowable in a given year, is the excess a taxable event? If an RD Partnership is terminated, will the federal government treat the property transfers as gifts, or worse yet, as sales between partners?

Going Forward

We look forward to working with our clients who are unmarried domestic partners to plan for the impact of this legislation.

California legislators' intentions were admirable (in my opinion), but they have created tremendous complexity (translation: cost and potential for errors) and uncertainty (translation: potentially enormous cost; potential for unintended outcomes). Most of the benefits available to RDPs can be achieved through estate planning and contracts; thus we recommend strongly to partners who are considering becoming RDPs to consult with us before registering.

A Gesture to RDPs

We expect that it will take three or four times the effort to prepare RDP returns as it will for comparable married couples or single filers. We also expect the tax software providers and the FTB to have problems and delays processing these returns. As a small gesture in support of the idea of providing the same benefits to RDPs as to married people, Grubman Financial will prepare tax returns for RDPs for the same cost as for single or married filers. Thus, for clients with managed assets under $1 million we will charge $600 to prepare both domestic partners' tax returns (RDP or non-RDP). For clients with assets of $1M or more, we will not charge anything for the RDP returns (although we normally would charge for this as it involves a second tax return and greater than normal complexity).

All of us at Grubman Financial are very excited about working closely with you in 2008. We are rolling out a host of new features and services. We look forward to continuing to provide you with a valuable and unique suite of financial services in this new year.

Regards,

Audrey Grubman, CFP^®
Portfolio Manager and President
GRUBMAN FINANCIAL