How to Avoid Overpaying Tax on Bond Investments

Worried about taxable payouts? Here’s what you should know about taxes and bond investments

For any investor, creating a balanced portfolio can take years of practice and market study – not to mention countless meetings with advisors. While bonds aren’t always the talk of the town, these usually-conservative investments do have their benefits.

Bond investments are often safe and practical. These negotiable promissory notes are often purchased to balance out investors’ portfolios, as bonds bring a steady, predictable income for a set period of time at a set interest rate. Bonds are fixed-income securities because if you keep the bond until its maturity, you will know exactly how much you’ll receive if the issuer can pay its debts.

When you purchase a government bond, you’re essentially lending money to the government that has to eventually be returned to you. As with any loan, interest accrues, and that’s how you make money.

There are ways to avoid paying high taxes on the bond interest you’ll accrue. In some cases, you can avoid paying taxes on your bond investment all together.

Municipal vs. U.S. Treasury bonds

Treasury bonds are purchased from the U.S. Treasury and are considered the most liquid type of bond, since they’re easy to buy and sell.

Series EE bonds are the most common type of bonds that the U.S. Treasury guarantees will double by the time it reaches maturity, which is often twenty years after purchase. Series I bonds earn combined fixed interest rates and variable inflation rates that are adjusted twice a year.

On these types of bonds, you can either pay taxes on interest annually or defer the interest until the bond matures or until you redeem it. But you have to choose an option and stick to it; waffling year to year is not allowed.

Only federal taxes apply to treasury bond interest, so you can avoid state and local taxes (in states where those taxes apply). So, if you live in a state that has high local tax rates, this can be a big plus.

Municipal bonds (or “munis” as they’re commonly known) are exempt from federal tax and in many cases state and local taxes as well, particularly when the bond was issued in the state where the purchaser lives. Puerto Rico municipal bonds are actually tax free in any state.

Municipal bonds are still issued by government units, but not at the federal level. Municipal bonds are a bit riskier than treasury bonds, making them perform better. And interest income from these bonds isn’t part of an individual’s adjusted gross income (AGI), which is good news for those who have exemptions, deductions, and credits phased out because of a high AGI.

All that being said, know that municipal bond proceeds could still be taxable. If bonds are bought at a discount in the secondary market, meaning that investors paid a different amount than face value for the bond, and then that bond is sold or reaches maturity, capital gains may accrue. These capital gains would be subject to federal and state taxes.

Additionally, these two types of bond income could be taxable: bonds sold after August 1, 1987 that were considered “private activity bonds,” which mean that private funds were secured for public-benefiting projects; or bond interest that is considered provisional income, which is related to Social Security benefits. Both may still be subject to minimum tax rates.

Roth IRA bonds

When you redeem bonds that you purchased through a Roth IRA that is managed by a custodian or trustee, you likely won’t have to pay taxes on those funds. These funds are often purchased from the U.S. Treasury, which registers the bonds under the trustee institution’s name. When bonds are kept in the Roth IRA for at least five years and they aren’t redeemed until you reach 59 ½, you’ll be able to avoid taxes.

Using proceeds for education costs

The IRS doesn’t tax Series EE and Series I bond interest that is used for higher education costs. There are limits to the amount you can use, however, and there are rules for how they’re distributed for your children or dependents’ education.

The person who purchased the bonds originally must be at least 24 years old, but if they’re using the money for a child’s education, the child doesn’t have to meet that age requirement. (In short: you can pay for your kid’s college tuition with bond proceeds without worrying about tax.) For this benefit to apply, education costs must be paid in the same year that the bonds are redeemed.

Are you ready to make smarter investments and grow your individual or business wealth? At Provident CPA & Business Advisors, we help our clients set and meet achievable goals that positively impact their communities.

We ensure that you do not overpay on taxes. We’ll also help you ensure your assets are protected and that both your business and wealth continue to grow. Get in touch with us today to learn more.

How to Avoid Overpaying Tax on Cash Investments

While investment planning requires much more than IRS considerations, make sure you’re not paying too much in tax

Cash investments are another way that investors can balance out their portfolios with safe, predictable options. These offer stability in returns, as they don’t fluctuate with the stock or bond markets. However, because there is low risk, returns are fairly low as well. And managing cash investments efficiently means deferring or reducing taxes when possible – but many people don’t realize the money they could be saving just by altering their investment strategy.

When coming up with tax-efficient strategies for your cash investments, there are several things to consider. First, what kind of cash investments are there? What type of cash investments will allow you to pay the least tax? And what are the advantages and disadvantages of each?

Remember, that while tax savings shouldn’t be the only or governing factor of your investment planning, it’s important to understand ways to avoid overpaying taxes on cash investments.

Here’s an overview of which options are best for varying situations and the tax implications of each.

Types of cash investments

First, let’s take a look at traditional savings accounts. Basic bank savings accounts consist of taxable income that earns taxable interest, and usually unlimited withdrawals can be made. But the interest income made can’t be tax-deferred and must be paid now at the current tax rate.

The same goes for CDs, which are also issued by banks. These savings accounts typically have higher interest rates than standard savings accounts, but there’s usually a set date of maturity and a fixed interest rate, and the funds aren’t as accessible.

Frankly, these types of bank savings accounts are not tax-efficient investments. Even if you don’t cash out the interest income earned and it is added to the account’s principal instead, those earnings are still taxable when they are accrued.

Next: money market funds. Interest income received from these accounts is also taxable when it’s earned, similar to bank savings accounts. However, where these differ is that if you invest in treasury money market funds from U.S. Treasury securities, income received is not taxable at the state and local level. Municipal money market funds are also free from taxes, both at the federal level and (usually) the state and local level as well.

Treasury bills are short-term investments, with less than one year of maturity, and are not taxable at the state and local level. These bills are bought at a discount from face value, and the longer the maturity date, the higher the interest rate the investor receives.

While federal taxes do apply to these, you can actually defer tax at year end with the right strategy. For example, if you purchase the bill in the fourth quarter and the maturity date is in the first quarter of the next year, you can avoid paying taxes until the year of maturity.

Tax-deferred accounts

Tax-deferred accounts offer investors the option to defer taxes as long as the funds stay in the accounts. Examples include standard 401(k) and 403(b) accounts and traditional IRAs. These are beneficial for tax reasons because income tax rates are usually lower during retirement, when you will be withdrawing the funds from these accounts. So, you’re avoiding the higher income tax rate that you’d be paying on this income right now.

Annuities and variable life insurance accounts are also tax-deferred. Tax-deferred annuities actually have no contribution or distribution requirements from the IRS, as some tax-advantaged accounts do.

With whole life insurance policies, common in retirement planning, cash grows tax-deferred, and you only pay tax on dividends received that exceed the total premiums you’ve paid. And you don’t have to pay tax until you surrender your policy

Key takeaways

Putting a significant amount of cash into standard bank savings accounts is not the most tax-efficient option, though many people do it. Especially if you spend the interest as it accrues on your cash, consider investing it in a money market fund – either treasury or municipal. And if you’re saving funds to be used down the road, a tax-deferred account can be a great way to go.

When you’re ready to take a look at your overall investment portfolio, our experienced team is here to help you make the right decisions that will allow you to avoid overpaying on taxes. At Provident CPA & Business Advisors, we ensure that you are making tax-efficient decisions and can help you earn as much as possible on your investments.

Contact us today to learn about long-term tax strategies and how to take advantage of different cash investment options available to you.

Getting the Right People in the Right Seat, Part 2: Evaluating, Counseling, and Firing Employees

What to do when an employee won’t play ball

In our previous article, we talked about getting the right people into the right seat. This methodology is especially useful when it’s used to evaluate current employees and ensure that they are the correct person for the job. But the scrutiny doesn’t end there, of course.

Let’s say, for example, that a company’s core value is respect, and there is a weekly meeting every morning at 9:00. “Julie” continues to be late to that 9:00 meeting. You’ve cautioned her that “early is on time and on time is late” but she’s consistently tardy. Given the core value of respect, she should be able to extrapolate that this includes respecting other people’s time – and perhaps she’s been explicitly told the connection. Thus, the organization now has an issue with a person not following its core values.

You could plot this on your people analyzer chart and see how it acts within the context of your other values to determine how it affects Julie and her aptitude for the seat. If this is the only value where she is lagging and her performance might be improved, it may not be such a big deal. If it continues, however, it could be a larger problem.

From there, it becomes a person-to-person issue. Someone within the organization – usually, her direct manager – has to explain to Julie why she needs to get on track and how to do so. One of the best ways to approach this is with a three-strike system. A person might not hit it out of the ballpark after one or even two strikes, but failing to make contact with the ball on a third try is serious. In general, three strikes means you’re out.

The best thing to do is explain to Julie how she can improve this behavior, and what is at stake if she does not. This involves counseling.

Counseling an employee

Counseling is the process of trying to improve the attitude or aptitude of an employee who has been negatively evaluated in one or more respects. This can be due to an issue they have following the core values or one that involves failing to meet the accountabilities of the seat they are in. Make sure to bring in specific examples to any coaching sessions. What they did, when they did it, and how it affected the organization and their fellow employees.

If Julie is counseled, her manager might advise her to change certain behaviors to ensure she makes it to her meetings on time. Maybe she needs to go get that coffee five minutes earlier. Maybe she needs to buy a watch. Or maybe … it’s simply that, at her core, she doesn’t respect the meetings or the people who depend on her to make them on time.

Thirty days later, if there’s no improvement, it’s time for another meeting. Same discussion, strike two. Another thirty days. No improvement, another meeting. This time, it’s a different and far more serious discussion, as it’s strike three.

Julie must be held accountable for her repeated tardiness and disrespect, and it is time to consider that she is the wrong person in the wrong seat.

Firing is never easy – but it can be handled in an easier way

In some cases, firing an employee is the solution. Unless this person is your rock-star employee – the very best – and everything would indeed fall apart without them, this might be the only remaining option. That said, we often find that many rock-star employees aren’t quite as essential as you may assume they are; and some actually create as many or more significant problems than the ones they tend to solve.

As before, it is essential to be specific and clear during the firing process. Share examples of what the individual did wrong, when they did it, and how it affected others. Then remind them of all the chances they had to make a change, and that they either ignored their warnings or failed to adapt. Hopefully, this will show this person that they were hurting the organization more than they were helping it. And if they were to continue ignoring the company’s core values, they run the risk of eroding a healthy culture created by these values. In essence, make it clear that they are being fired for cause.

In Julie’s case, she certainly wouldn’t be fired for being late to a single meeting. But consistent tardiness and disrespect will start to affect others. Maybe other employees begin to think that the meetings are not worth attending; that timelines are flexible; or that they can blow off memos or miss work without calling in. And if Julie was otherwise a rock-star employee but consistently displayed this disrespect, perhaps other employees will come to view inconsistently-applied rules as a double-standard.

Of course, this is just a simple example. Whether an employee consistently fails on a core value, several of them, or the five to seven accountabilities associated with their position, the same standards and processes apply. Evaluate performance. Set standards, such as a three-strike rule, and provide counseling that provides opportunities for improvement. If the employee fails to adapt, it’s usually far better for your organization if it doesn’t adapt to their behavior.

To learn more about getting your business strategy on point, as well as how we can help you save significantly come tax time, call Provident CPA & Business Advisors at 1-855-693-7829 or get in touch through our contact form.

Getting the Right People in the Right Seat, Part 1: The People Analyzer

How to evaluate the right person for the job

The hardest thing to manage in business is people. The Entrepreneurial Operating System (EOS®) defines that businesses are comprised of vision, people, data, issues, process, and traction – but in practice, managing people represents probably sixty-percent of the effort. This is one of the reasons it’s essential to get the “right person, in the right seat” and use effective procedures to evaluate and enable this maxim.

Figuring out who is the right person requires you to examine your vision/traction organizer (VTO), specifically the section outlining your business’s core values. You must assess whether a person in your organization embodies each of these values:

  • Do they follow them most of the time? (+)
  • Some of the time? (+/-)
  • Or hardly ever? (-)

Look at each value and assign one of these three assessments. As shown above, these are quantified as a plus, plus-minus, or a minus.

Let’s say you have five core values. You examine a person and they get, say, a plus, plus, plus, plus, and a plus-minus. From there you see that they share most of your core values most of the time – even if they can be a little fickle on that fifth one. In contrast, an individual with a couple of (or more) minuses may not be a fit.

The right seat

The right seat part of the equation dives deeper into exact positions and their accountabilities. Specifically, it involves creating an accountability chart, which is like an organizational chart on steroids. This document has the hierarchy and the boxes connected with lines in a traditional org chart, but its most important component is the inclusion of five to seven accountabilities associated with each seat.

When someone is sitting in a certain seat (or may sit in it), you must ask the essential GWC questions: Do they get it? Do they want it? Do they have the capacity to do it? In other words:

  • Do they understand what it takes to sit in that seat?
  • Do they want to be responsible for these five-to-seven accountabilities?
  • Do they have the ability to do this job effectively? Breaking this down even further: Do they have the time? Can they actually do the work? Or are they sitting in multiple seats and are too busy with their other accountabilities?

The people analyzer

These components are rolled up into a “people analyzer.” It is basically just a sheet of paper split into columns: one for each of the core values, then one for each of the GWC questions.

The test from there is pretty simple:

  1. Does the person share each core value most of the time, some of the time, or hardly ever? Enter plusses and minuses all the way down.
  2. Then you look at the GWC questions: Do they get it? Do they truly understand? Do they want it? For the last question, you must ask the person if they want to sit in that seat. The other two are assessed based on what you know about them and what you’ve seen; do they have the capacity, the innate ability, and the bandwidth?

Once you’ve finished filling in the people analyzer, you should have a few rows of plusses and minuses. Hopefully the plusses outnumber the minuses, but that may not always be the case. This is why you must set a benchmark. How low will you go for any of these numbers? What is the bare minimum you are willing to accept? What is the expectation for people in your organization?

This test, on a more limited basis, can also be used for the hiring process. But work experience makes it especially valuable for evaluating current employees and making decisions about promotions, lateral moves, coaching, and, unfortunately, letting someone go.

This tool provides a methodical yet straightforward way to evaluate employees, giving you a snapshot that enables smarter decisions. If your core values are on point, and key accountabilities are well-defined, using it to get the right person in the right will simplify managing people.

To learn more about getting your business strategy on point, as well as how we can help you save significantly come tax time, call Provident at 1-855-693-7829 or get in touch through our contact form.