Increasing Your Return on Life.®

Frank Talk - 4th Quarter Newsletter (2015)

Published: 08/01/2015

Table of Contents


Written by: Frank Fantozzi

Happy Autumn! As an avid gardener and landscaper, I always find autumn to be somewhat bittersweet. While I welcome the cool, crisp days and turning leaves, they’re a constant reminder that it’s a time for harvesting, pruning, and preparing for the months ahead if I want my yard to yield a healthy and beautiful landscape in the spring. This requires patience as we all know we have to go into “hibernation” to wait for the results.

There are many parallels that can be drawn in managing your financial portfolio. That’s why the PFS team takes a patient but proactive approach to your portfolio management and seeks to make adjustments in preparing your portfolio for the markets ahead. Throughout autumn, we are reviewing portfolios with a focus on year-end tax and investment planning ideas, including tax harvesting where appropriate, repositioning portfolios as needed, and adjusting strategies to help take advantage of opportunities we see while taking preventive measures to help limit exposure to volatility.

Welcome to our newest PFS Retirement Plan Advisor

We were very pleased to welcome our newest member, Chris Waters, this summer. Chris brings a strong background in business and financial services to his role as a PFS Retirement Plan Advisor, helping to ensure plan sponsor objectives are addressed and plan participants receive the level of education, communication, and personalized service that can help pursue desired retirement outcomes.

Prior to pursuing a career in the financial services industry six year ago, Chris enjoyed owning and managing a privately-owned business in the retail sector for nearly 20 years. As a former business owner, he brings firsthand knowledge and understanding to company leaders seeking to provide their employees with the most effective retirement programs customized to their specific needs and goals. Chris attended The University of Akron where he majored in Business Management. He holds his Series 6, 7, 63, and 65 securities registrations with LPL Financial, and his Ohio Life and Health Insurance license.

Positive Feedback from Beachwood Office Renovation

We appreciate the great feedback those of you who have visited out Beachwood office in recent months have shared with us. In April, we completed our Beachwood office renovations, providing our clients and team members with a more tech savvy and aesthetically pleasing environment that is both comfortable and conducive to meeting with clients and serving your wealth management needs. If you haven’t had a chance to visit the Beachwood office yet, give us a call and set up a time to stop by.

Making a Difference in the Lives of Young People throughout Northeast Ohio

We hear too many heartbreaking stories on the news concerning young people who didn’t have access to the help they needed and tragically chose to end their own lives—sometimes taking others with them. PFS has been involved for several years with LifeAct, a not-for-profit organization that’s helping to not only shed light on the growing problem of teen suicide, but is making a difference in thousands of young lives throughout Northeast Ohio.

LifeAct’s mission is to prevent suicide by teaching young people to recognize the warning signs of suicide and to seek professional help for themselves and others. Each week, LifeAct delivers its proven program in a classroom setting. As a LifeAct Trustee, I’m happy to say that this year alone we will reach more than 20,000 students in 132 Northeast Ohio schools, thanks to generous support from individuals, business owners and corporations like you. Last year, 1,008 students came forward during our program to seek help. For more information on LifeAct, contact me directly or visit

Market & Economic Update

The Institute for Supply Management’s (ISM) September 2015 Non-Manufacturing Report on Business showed that the service sector remains robust, with the non-manufacturing ISM hitting 56.9, which over time, is consistent with real gross domestic product (GDP) of 3.5%. However, the report, as usual, was largely ignored by market participants, even though non-manufacturing activity (mainly the service sector) represents 70% of the U.S. economy.

Financial markets, however, correctly focus more closely on ISM’s Manufacturing Report on Business, as S&P earnings—which over time, drive stock prices—are much more closely correlated to the manufacturing portion of the economy than to the service side. But for those concerned about a U.S. recession, the recent data on both the non-manufacturing and manufacturing ISMs are comforting. As noted above, the non-manufacturing ISM readings of 56.7 in September and 57.3 so far in 2015 indicate fairly robust economic activity continues in 70% of the U.S. economy.

The manufacturing ISM data, however, are more concerning. The manufacturing ISM for September 2015 came in at 50.2, below the consensus of economists as polled by Bloomberg News (50.6) and the August 2015 reading of 51.1. In fact, the September 2015 reading on the ISM was the lowest since May 2013, and indicates that the manufacturing economy, which accounts for just 30% of the U.S. economy, is teetering on the edge of contraction. But what about the broader economy?

The ISM noted in the press release accompanying the data that “a reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.” The manufacturing ISM has averaged 52.2 over the first nine months of 2015, which, if sustained, would be the lowest average reading on the ISM since 2012, when it averaged 51.7. But the Institute for Supply Management press release notes that an average reading of 52.2 on the manufacturing ISM is consistent with growth in real GDP of 2.9%, which is just shade below our long-held forecast of 3.0%+ for 2015.

The last time the manufacturing ISM averaged below 50 was in the recession years of 2008 (45.5) and 2009 (46.4). As a reminder, the ISM would have to dip to the low 40s to indicate that the overall economy was in recession. As the manufacturing ISM nears 50 in the current business cycle—close to indicating a contraction in the manufacturing sector but still a long way from signaling an economy-wide recession—we note that the manufacturing ISM has dipped to 50 (or below) in each of the last three expansions without a recession actually occurring. Similar to today, a substantial drop in oil prices played a part in all three of these episodes.

S&P vs GDP

It’s all too easy for people to jump to conclusions about the markets or economy based on a single indicator, such as the most recent GDP or job growth reports, or the daily rise and fall of the DOW or S&P 500. However, it would be highly unusual for any one indicator to definitively predict either a period of expansion or recession. It takes many indicators measured over time to create a trend. To gain a true understanding of what’s really taking place in the markets or economy at any given time, it’s important for investors to understand the difference between the various economic and financial market indicators and how they work.

For example, S&P 500 companies have different drivers for earnings than the components that drive GDP. There are several key factors that differentiate the economic data from the earning power of corporate America that we think are important for investors to keep in mind:

  • Corporate profits are more manufacturing driven. Two-thirds of S&P 500 profits are from manufacturing, while two-thirds of U.S. consumption in GDP is services.
  • Corporate profits are less consumer driven. While 70% of GDP is consumer spending, only one-third of it is from discretionary categories, while an even lower 15% of S&P 500 profits come from consumer discretionary spending.
  • Corporate profits are more international trade driven. International trade only accounts for about 10% of GDP, and it acts as a drag on growth for most quarters because the U.S. imports more than it exports.
  • Corporate profits are hurt much less by higher commodity prices than GDP. In fact, higher commodity prices generally benefit S&P 500 companies because most of them either produce commodities (energy and materials); supply commodity producers with equipment (largely industrials); or are not heavy commodity users, and therefore, are not impacted much by higher commodity prices (technology, healthcare, financials, and telecommunications).

As year-end approaches, we look forward to assisting you with year-end strategies and 2016 investment and tax planning. Don’t hesitate to contact us at any time with any questions or concerns you may have. We are always honored to also help your friends and business associates pursue their Return on Life®. We welcome and are sincerely grateful for the many introductions our clients and professional partners continue to provide and thank you for the confidence you place in our team to help you live your life, your way.

Continued health, happiness and prosperity,    

Frank Fantozzi, President

Three Benefits of Donor-Advised Fund Giving

Written by: Sarah Horrigan

Charitable giving through donor-advised funds (DAFs) has grown in popularity in recent years. A DAF comprises contributions made separately and independently by individual donors. The fund maintains legal control of the contributions, and donors retain advisory privileges regarding investments and fund distributions.

DAFs provide several advantages, particularly for high-income individuals. For example, they can help you:

Separate tax planning from charitable planning. When you make a contribution to a DAF, you receive an immediate tax deduction up to 50% of adjusted gross income (AGI) for gifts of cash and up to 30% of AGI for gifts of appreciated assets (with a five-year carryforward on gifts that exceed the limits). And you can make contributions even before you’ve decided which charity will ultimately receive the funds or when that contribution will be made.

Make larger gifts. When an individual contributes appreciated stock to a DAF, he or she receives the full charitable deduction while avoiding the capital gains tax as long as the stock has been held for at least one year before the contribution. Donors can effectively make more generous charitable gifts because the charity receives the amount that would otherwise go to taxes.

Pursue growth opportunities. DAFs typically offer a variety of investment options. Therefore, contributions have the potential to grow while you determine how best to earmark the funds.

Contributing to a DAF could help you achieve both charitable- and tax-planning goals — all in one fell swoop. However, as with any financial strategy, making gifts using a DAF comes with potential drawbacks. Contact your financial advisor for further guidance.

© 2015

Taking the Right Steps When Using an FLP or LLC

Written by: Elisabeth Plax

If you wish to transfer large amounts of wealth to your family at discounted values for gift tax purposes, you might consider forming a family limited partnership (FLP) or a limited liability company (LLC). But a pitfall to be aware of when using an FLP or LLC is the step transaction doctrine. Let’s take a closer look at how FLPs and LLCs work and how to avoid the step transaction doctrine.

Using an FLP or LLC

There are standard procedures for establishing an FLP or LLC:

  1. Set up the vehicle, initially retaining all of the partnership or membership units. 
  2. Contribute assets to the entity, such as cash, real estate, marketable securities and/or business interests. 
  3. Give (or sell) minority interests in the entity to family members or to trusts for their benefit.

This process allows you to retain control over assets while shifting most of the ownership interests to your family at a minimal tax cost. For gift tax purposes, minority FLP and LLC interests generally are entitled to substantial valuation discounts (often in the neighborhood of 40% to 50%) for lack of marketability and control.

Avoiding missteps

To ensure the desired tax treatment, the FLP or LLC should have at least one legitimate nontax business purpose, such as maintaining control over a family business, consolidating management of an investment portfolio or protecting family assets from creditors. Also, you must treat the entity as a legitimate, independent business, observing all business formalities and documentation requirements.

Even with legitimate nontax reasons for forming an FLP or LLC, families frequently get themselves into trouble because they’re lax about business formalities or they commingle personal and business assets. Failing to adhere to these formalities may cause the IRS to conclude that the entity is a sham, disregard it for gift and estate tax purposes, and assess gift or estate tax on the full value of the assets, rather than the discounted amount.

Another common mistake is to complete all of the transfers at around the same time. People often set up an FLP or LLC, transfer assets to the entity, and transfer FLP or LLC interests to family members all in the same meeting. If the IRS determines that the transactions were simultaneous — or, worse, that FLP or LLC interests were transferred before the entity was funded — it will likely apply the step transaction doctrine and treat the arrangement as an indirect gift of the underlying assets, taxable at full value. Even if the transactions are completed in the right sequence, the IRS may challenge the arrangement as an indirect gift under the step transaction doctrine.

Defining the doctrine

The IRS sometimes invokes the step transaction doctrine to collapse a series of transactions into a single transaction for gift tax purposes. This dramatically alters the tax outcome.

Under the step transaction doctrine, separate steps may be collapsed into a single transaction if the parties, at the time of the first step, had a binding commitment to undertake the later steps. In addition, the IRS may invoke the step doctrine if the steps were prearranged parts of a single transaction designed to produce a particular end result, or are mutually interdependent — that is, so closely intertwined that they’re meaningless on their own.

Binding commitments are uncommon, but it’s fairly common for the IRS or a court to invoke “end result” or “mutual interdependence” tests. Under these tests, a key to avoiding step transaction treatment is to establish that the intermediate steps have tax-independent significance. Among other things, this means that enough time should pass between funding an FLP or LLC and transferring minority interests so the assets are subject to “real economic risk” during the interim.

Unfortunately, there’s no magic number for determining how long you should wait; it depends on the nature of the assets, economic factors and other circumstances. Generally, funding an FLP or LLC and transferring interests later the same day won’t be enough.

But the U.S. Tax Court has held that a six-day delay was sufficient. In that case, parents funded an FLP with heavily traded, highly volatile stock and assumed the risk during the six-day period that the stock’s value would fluctuate before they transferred limited partnership interests to their children. More stable assets, such as cash, less-volatile securities or real estate, may require a longer waiting period to establish economic risk.

Getting the timing right

Using an FLP or LLC is a smart strategy for transferring a large sum of assets to loved ones at a discounted value for gift tax purposes. But before taking action, work with your qualified tax or legal advisors to set up the ideal structure and determine the appropriate waiting period between funding an FLP or LLC and transferring interests to your family. Doing so can help you avoid having the IRS invoke the step transaction doctrine on your FLP or LLC.


Currency Movements and Your Portfolio

Written by: Frank Fantozzi

The opportunities – and  pitfalls – of a fluctuating dollar

As of this writing, the U.S. dollar is coming off sharp gains relative to its currency counterparts around the world. Such a situation — or its reverse, a falling dollar — is likely to have profound effects on the global economy and financial markets, not to mention on individual businesses, consumers and investors.

In other words, shifts in the value of any currency create financial winners and losers. Understanding why can give you insight into your portfolio’s past performance, as well as ideas about how you might position it appropriately for the future.

Foreign exporters benefit

When the dollar is strong, it’s a boon for foreign companies that sell products to Americans. Why? Because the profits they receive in dollars are worth more after those dollars are converted back to their local currency.

Simultaneously, when the dollar is gaining in value compared to, say, the euro or Japanese yen, foreign travel or imported goods become more appealing to anyone with dollars to spend. In other words, Americans suddenly find themselves with increased buying power overseas.

In this environment, a Japanese automaker will be at a relative advantage in the U.S. market compared with an American competitor, as the company abroad can either price its cars lower and increase sales, or boost earnings by keeping prices steady. Foreign tourism companies also benefit, as more Americans find travel abroad affordable.

Local exporters don’t

Some businesses, of course, will be less enthusiastic about a stronger dollar. For example, it hits U.S.-based exporters especially hard, given that these companies receive foreign profits in the now less-valuable local currency.

Also, consumers abroad who want to buy U.S. products encounter higher costs. That means lost sales for the producers, or, if they choose to hold down prices, lower profits. Thus, American automakers become less competitive abroad, as do U.S. travel and leisure companies, such as hotels or tour operators, if their businesses depend on a steady stream of foreign tourists.

Effects on commodities

A rising U.S. dollar tends to push down the cost of oil and other commodities priced in dollars. Lower oil prices are a boon not only for consumers but also many businesses (outside the energy sector, of course, where some companies directly benefit from high oil prices).

When oil is cheaper, the price of gasoline tends to follow. Whatever money consumers save at the pump is money they can spend elsewhere. In fact, according to AAA, lower gas prices provided the equivalent of a $14 billion tax cut to consumers in 2014.

Thus, a dollar that maintains its strength and oil prices that remain relatively low — neither of which can be assured — could provide a relatively favorable backdrop for U.S.-focused consumer-oriented companies, given the increased disposable income available.

Impact on stocks

A company’s share price tends to follow its earnings over time. Accordingly, you’d expect stocks of companies helped by a strong dollar to encounter a tailwind, while the shares of firms penalized by a robust currency face an added headwind.

Certain sectors are more likely to be exposed to foreign currencies. According to Zacks Investment Research, for example, information technology and energy companies, on average, derive more than half of their revenues from overseas, thus making them more vulnerable than many other industries to the effects of a strong dollar.

Utilities and telecommunications companies represent the other extreme, remaining mostly domestically focused.

Also, small-cap stocks tend to be less exposed to foreign markets (even though many smaller companies reside in the technology sector).

Multiple factors to consider

Bear in mind that these rules of thumb come with many exceptions. What’s more, the dollar is always fluctuating in value. Nobody knows if the strengthening trends will continue, although current market sentiment appears to reflect a consensus in favor of a strong dollar for some time.

In the end, lots of factors drive stock prices, and the effects of currency movements represent just one. Moreover, markets are forward-looking, meaning that your portfolio needs to reflect not what’s happened already, but what’s next for the markets. Your financial advisor can help you tailor your investment portfolio to economic and market conditions.

Sidebar: What drives currency movements?

When the dollar is strengthening against, say, the euro, it means that each dollar you own can be exchanged for more euros than before. It also means that foreign money in your drawer from your last trip to Italy will be less valuable than before. In fact, every currency in the world sees its value constantly fluctuating, influenced by various factors. These include expectations for economic growth, central bank monetary policy, inflation projections and geopolitical worries. The dollar’s significant strengthening that began in 2014 was the culmination of many factors. But, at its core, it stemmed from a U.S. economy in much better shape than its counterparts around the world.

© 2015

Are You at Risk for AMT Liability?

Written by: Jeremy Bok

Do you know if you’re likely to be subject to the alternative minimum tax (AMT) — and what actions can trigger it? If not, you need to find out so that you can consider taking steps to address potential AMT liability.

AMT defined

The AMT was established to ensure that high-net-worth individuals pay at least a minimum tax, even if they have many deductions that reduce their “regular” income tax. If your AMT liability is greater than your regular income tax liability, you must pay the difference as AMT, in addition to the regular tax.

AMT rates begin at 26% and rise to 28% at higher income levels. The maximum rate is lower than the maximum income tax rate of 39.6%, but far fewer deductions are allowed, so the AMT could end up taking a bigger tax bite.

For example, you can’t deduct state and local taxes, property taxes, or home equity loan interest on loans not used for home improvements. You also can’t claim the standard deduction or take personal exemptions for yourself or your dependents.

Vulnerable taxpayers

Those with high incomes are more susceptible to the AMT than others, but AMT liability may also be triggered by:

  • A large family (meaning you take many exemptions),
  • Substantial itemized deductions for state and local taxes, home equity loan interest, medical expenses, or similar expenditures,
  • Exercising and holding incentive stock options,
  • Large capital gains,
  • Adjustments to passive income or losses, or
  • Interest income from private activity municipal bonds.

Knowing some of the risk factors can make it easier to reduce or avoid AMT liability.

Strategies to minimize liability

Fortunately, you may be able to take steps to minimize your AMT liability, including:

Timing capital gains. The AMT exemption (the amount you can deduct before calculating AMT liability) phases out based on income, so realizing capital gains could cause you to lose part or all of the exemption. Moreover, the AMT has fewer deductions to offset a large gain. You may want to delay sales of highly appreciated assets until the next year (when you won’t be subject to the AMT) or use an installment sale to spread the gains (and potential AMT liability) over multiple years.

Timing deductible expenses. Try to time the payment of state and local taxes and other miscellaneous itemized deductions for years that you don’t expect the AMT to apply. Otherwise, those deductions will go unused. If you’re on the threshold of AMT liability this year, you may want to consider delaying state tax payments if the late penalty doesn’t exceed the tax savings from staying under the AMT threshold.

Investing in the “right” bonds. Interest on tax-exempt bonds issued for public activities (for example, schools and roads) is exempt from the AMT. You may want to convert bonds issued for private activities (for example, sports stadiums), which don’t enjoy the interest exemption. Or, if you’re subject to the top income tax rate of 39.6%, invest in taxable bonds that will nonetheless result in a higher rate of after-tax return, taking into account the lower AMT rate.

Don’t put your head in the sand

Failing to pay the AMT can lead to penalties and interest, so it’s best to determine ahead of time whether it will apply. Your financial advisor can help you assess your risk and implement appropriate strategies to reduce the odds of liability and the liability itself.

© 2015

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