Volume 11 Number 1

From The Corner Office By Mitchell Freedman, CPA/PFS

They keep on coming: the Northridge temblor; Hurricane Andrew; Oakland Hills fire; 9/11; ad infinitum. Now we have had a new tragic natural event to add to the list of disasters: Hurricane Katrina. Such occurrences usually happen when we least expect them. However, as Katrina has shown, humongous tragic disasters can occur even when they are expected.

How prepared should we be? We in California, have been told for decades, that we must be prepared to be totally self-sufficient for a minimum of 72 hours. Are we? Were they in New Orleans? Even under the best of circumstances it takes a significant amount of time to mobilize and implement Federal disaster plans. New Orleans was an accident waiting to happen. The blame game seems to be pointing for the most part at the Federal government and FEMA. However, it is clear to any informed observer that the blame goes much deeper, wider, and further.

According to recent reports, even here in California, there are likely scenarios in the Sacramento River Valley which could match and even exceed the flood losses on the Gulf Coast. The Sacramento river levees were built of soil and mud nearly 150 years ago. The number of people who might be affected and the damage to property that could occur is nearly beyond comprehension. And, yet, California is truly not prepared for such an event.

Earthquakes, forest and brush fires, localized flooding and mud slides are all on our radar screens. Yet, are we truly prepared to be able to deal with such a tragic event in our communities? Do we have personal disaster plans? Do we have work or business disaster plans? Can we be self sufficient until aid arrives? If not, I urge you to take action now. Develop a disaster plan. It is also very important that you periodically monitor the plan to make sure that all elements of it are current. If your business has not established and tested a disaster plan, start one. If your employer doesn't have one urge them to develop one.

The American Institute of Certified Public Accountants (AICPA) and the California Society of Certified Public Accountants (CalCPA) have resources available to you to help you plan for, and recover from, a disaster. I am privileged to have been one of a small handful of CPA Personal Financial Specialists (CPA/PFS) to have edited two publications offered by the American Red Cross and published by the AICPA and National Endowment for Financial Education, Disaster Recovery: A Guide to Financial Issues and Financial Planning: A Guide for Disaster Preparedness. They are available for viewing and downloading at: www.redcross.org/services/disaster/0,1082,0_605_,00.htm. Additional information can be obtained from CalCPA at: www.calcpa.org/californiacpa/newstrends/2003/11.29.htm.

Tax Notes When in Doubt Salary it Out By Brian J. Switaj

In recent years S-corporations have become an increasingly popular business entity choice. One of the reasons is simplicity: As a “pass-thorough entity,” the S-corporation generally has only one level of Federal taxation. The income or loss is passed through to the individual shareholders, who report their share of the income or deduct the loss on their respective personal income tax returns. There’s another reason for their popularity: In a traditional C-corporation, any income remaining in the business at year end is taxed. If that income is then distributed to the shareholders, it is subject to tax once again at the shareholder level, albeit at the favorable tax rate on dividends. However, an S-corporation distribution of previously taxed income isn’t again taxed at the shareholder level. Therefore, there has typically been no significant downside to paying out these distributions. The income has already been taxed, in the year earned, and the distribution just completes the transition of corporate earnings to the shareholders. At least, that’s how many taxpayers (and often their advisors) have looked at it.

The Internal Revenue Service (IRS) sees it differently. Usually the shareholders are also the officers of the corporation. As such, they are, by law, employees. To the IRS, by not paying a reasonable salary, the corporation may make an end-run around the payroll taxes it and the shareholder/employee should have paid: The tax courts have agreed on this matter. What’s the cost of this tax dodge? According to a May 2005 study, it cost $5.7 billion for tax year 2000 alone! Now the IRS is taking an active role in doing something about it. Recently, they announced that they will be randomly auditing some 5,000 tax returns that fit the profile.

The moral of the story: When in doubt, salary it out!

REITs: A Solution For The Rest Of Us By Tad Jakes

Feeling like you've missed out on the real estate boom because you can't afford to buy a home? Or, perhaps you already own a home but can't afford to purchase a second one or an investment property. Well, for those of you out there who want to take part in the appreciation of the real estate market but can't due to high prices, there is a solution - Real Estate Investment Trusts (REITs) and Real Estate Exchange Traded Funds (ETFs).

REITs are sector-specific mutual funds where a portfolio manager buys and sells shares of real estate related companies. REITs invest in all areas of real estate including commercial properties, residential housing, lodging and resorts, industrial projects, malls, shopping centers, mortgage companies, health care facilities, title companies, insurance companies and warehouses, just to name a few. However, some REITs can be very specific and concentrate on just one area of the real estate market.

REITs were created by Congress in 1960 in an effort to allow everyone the opportunity to invest in real estate enterprises when they would otherwise be unable to do so. Buying into real estate, especially for large-scale projects like commercial buildings, can be an expensive and intimidating process for an inexperienced investor, but with the advent of the REIT, taking part in real estate appreciation and income is as easy as buying a mutual fund. Everybody has the opportunity to take part in a diverse array of real estate investments and can do so with great ease.

With property values as high as they are, there are some significant benefits to purchasing REITs over individual properties. One of the most significant advantages is diversification. If you are fortunate enough to own a home, or possibly two, you are virtually putting all of your eggs in one basket with your investment performance dependent on one or two variables. With REITs, not only are you diversifying your overall investment portfolio, but the REIT itself is diversified among different real estate investments and different geographic regions. Your investment performance is not dependent on just one sub-sector of the real estate market or just one property or just one city or state. You are literally invested in hundreds, if not thousands, of real estate investments. Attempting to duplicate this diversification by purchasing individual properties would be impossible for the average investor.

The diversification of a REIT also allows for appreciation and current income because of it's various holdings. It has similarities to that of an equity security and a fixed income security. Certain holdings will rely on appreciation for investment return and, as the holdings appreciate in value, the share price will increase. Other holdings depend on income in the form of rent received or mortgages owned and the income is distributed as a dividend. So it allows the investor to take part in the hybrid aspect of real estate investing by enjoying appreciation in market value and a regular income stream.

Of course, real estate is not a liquid investment due to the time it takes to research properties, negotiate a deal, acquire financing, and deal with title, insurance, inspections and escrow. REITs have a tremendous advantage over real property because they are highly liquid. Buying or selling shares in a REIT or real estate ETF simply requires a buy or sell order with your broker or a telephone call to the management company.

In contrast, if you own a property and want to sell to lock in a gain, you may see prices drop considerably before you are able to find a buyer. If you own a REIT and see a downturn in the market, you put in a sell order and one to two days later the money is in your account. When it comes to liquidity there is no comparison.

So now that you know how REITs work and what some of the benefits are, just how well have they performed over the years? According to the National Association of Real Estate Investment Trusts and Standard and Poor's, the average dividend yield for REITs in 2003 was 5.5% compared to 2.0% for the S&P 500. In addition, the average return for REITs from 1971 to 2003 was 12.91% compared to 11.45% for the S&P 500. REITs have consistently been able to provide a means of current income with long-term appreciation and all while providing investors with a more diversified portfolio and reduced risk.

There are always going to be up and down cycles in the real estate markets, and this is to be expected, but due to their liquidity REITs have some advantages over the purchase of real property which can limit the downside and provide great potential for the upside. They are diversified, provide dividend income, have the potential for long-term appreciation and are liquid. And for people who can't afford to buy a property outright, it is a great way to participate in the real estate market without the hassle or financial burden of buying property. It only requires minimal research, a small investment and a little patience. At MFAC Financial Advisors, REITs and real estate ETFs are generally included in our clients asset allocations.

Heard in the Hall

Congratulations to Niko D'Oyen and her husband, Marlon, on the birth of their daughter, Kaelyn, on June 8, 2005.

Mitch Freedman spent a great deal of time in airports this past Springtime. He attended the Jump$tart Coalition for Financial Literacy State Leaders Forum, 10th Anniversary Dinner, and General Meeting April 6th and 7th, 2005 in Washington, D.C. On April 19th he presided, as Chair, over the California Jump$tart Coalition (CAJ$) Financial Fair on the steps of the State Capitol in Sacramento in recognition of April 2005 being Financial Literacy Month. As Chair of the Executive Committee of CPAs Reforming our Profession (CROP), on April 22nd Mitch and another CROP Executive Committee member met with the current and incoming Chairs of the American Institute of CPAs (AICPA) in New York City regarding issues critical to the CPA profession and the AICPA. He also presided over the CAJ$ Board of Directors meeting on April 27th. On May 9th and 10th Mitch attended the AICPA PrimePlus/ElderCare Task Force Meeting in Montreal. He also attended the CalCPA Personal Financial Planning Committee Meeting May 19th and 20th in Newport Beach. On May 22nd to 24th he attended the AICPA Semi-Annual Council Meeting representing concerned CPAs throughout the country. As Chair of the Consumer Outreach Committee, Mitch attended a Board of Directors Meeting of the Association of CPA Financial Planners on June 5th in Las Vegas. He also presided over his last meeting as Chair of the CalCPA Communications Advisory Committee on June 8th in Burbank. Mitch attended the semi-annual meeting of The All-Star Financial Group in New York City on June 10th and 11th.

In the AICPA publication Disasters and Financial Planning; a Guide to Preparedness, Mitch was acknowledged for his participation. On May 5th Mitch was interviewed on wsRadio.com regarding investing, financial literacy, and financial elder abuse. To listen to the two segments go to http://www.wsradio.com/everydaywealth/may2005.htm In early June Mitch was featured, as an entertainment industry financial expert, on a one hour BBC television program wherein he discussed the financial issues to be faced by Michael Jackson after his trial and acquittal. During this past Springtime Mitch was featured in three issues of Accounting Today. The issues and titles of the articles are: May 1st - "Disaster Recovery is a Numbers Game"; May 15th - "Tax Me Out to the Ball Game"; and June 5th - "Legislation Spurs Knowledge ‘Upgrade' for Client's Advisors."