Ask the tax adviser
Tax-exempt money market accounts, and taxes
on gifts from foreigners
When tax-exempt money market
accounts are the right investment
Dear Tax Talk:
I have seen references to tax-exempt money market accounts by a
couple of Bankrate advice gurus. One says that if you're in a high
tax bracket or in a state with high taxes, a tax-exempt money market
account is a possibility. That's me on both counts. How does this
If you've got enough taxable income from salaries and investments,
then you definitely should consider moving into investments that
produce tax-free income, such as a tax-exempt money market account.
Of course, if you are facing this problem, then you definitely should
consult a financial planner who can properly design an overall financial
plan considering your family, age and objectives. For example, although
a tax-exempt money market account produces tax-free income, so does
a low- or no-yield stock with long-term appreciation potential at
preferential capital gains rates. This investment decision depends
on your time horizon, asset allocation and risk tolerance, which
are properly evaluated as part of an overall financial plan.
On your specific question, a high marginal tax
rate makes a tax-free investment more profitable than some taxable
investments, after taxes are considered. Suppose your marginal rate
for federal income tax purposes is 39.6 percent and you live in
California, where the top rate is 9 percent. Since the California
taxes are deductible for federal income taxes, your effective California
rate is about 5.4 percent, for a combined rate of 45 percent. If
you have the option of investing in a tax-exempt money market account
that yields 5 percent, you have to figure how much a taxable investment
would have to yield in order to make it better after taxes. To do
this, divide the tax-exempt yield by 1 minus your marginal tax rate
of 45 percent. Another way of looking at it is 1 minus your marginal
rate is the amount of income you get to keep, 55 percent vs.
the amount the government keeps, 45 percent. So the 5 percent tax-exempt
yield divided by 0.55 results in a taxable yield equivalent of just
over 9 percent. So if a 5 percent yield tax-exempt investment were
available, you would have to earn more than 9 percent in a taxable
investment to be better off, after taxes in the taxable investment.
An investment is tax-free because the federal
government gives state and local governments the ability to issue
federally tax-exempt interest bonds. This makes the cost of borrowing
lower for the state and local governments. Unfortunately, most states
tax their residents on tax-exempt interest earned on obligations
of other states. Therefore, when researching a tax-exempt investment,
you may want to consider a money market account that invests only
in obligations of your state.
Taxes on monetary gifts from
Dear Tax Talk:
I received a monetary gift from my dad, who is a British citizen.
Do I have to report this sum of money to the Internal Revenue Service?
You must be a very good son. A U.S. resident or citizen does not
pay tax on the receipt of a gift or bequest either from a U.S. person
or a foreigner. However, a few years back, IRS through an act of
Congress started requiring that certain large gifts from foreigners
be reported for information purposes. The motivation here is that
certain U.S. persons with foreign connections were claiming that
everything they received from abroad was a gift when in fact it
was a disguised payment for services or from a trust fund. Since
no reporting was required it was hard for IRS to pick up the fact
that an individual may be underreporting income. Now that gift reporting
is required, I speculate that IRS is scrutinizing tax returns that
report little income and big gifts.
If the gift of money was from your dad individually,
then report the gift if it exceeded $100,000. If you received the
payment from a foreign corporation or partnership, then you must
report the gift if it exceeds approximately $11,000. This threshold
is adjusted annually for inflation and was $10,735 in 1999. The
year 2000 amount hasn't been announced yet, so that is why I gave
an approximate figure. The implication here is that businesses don't
make gifts and therefore the chances that it is taxable are greater,
which warrants greater IRS scrutiny. Form
3520, Part 4, is used to report the foreign gifts.
-- Posted Nov. 14,