Author: Leon Clinton

The Fed is finally taking aggressive action to fight inflation, but will it work?

Where’s the stock market headed?

Who knows?
Real estate might be a good inflation hedge, but it’s a non-liquid asset and no sure thing.

Clearly, this is not a great environment for investors or retirement savers.

If you are thinking of investing conservatively but in a way that also offers some inflation protection, here’s an option to consider.

Treasury Inflation-Protected Securities

U.S. Treasury Inflation-Protected Securities (TIPS) are a special variety of Treasury bonds that are adjusted for inflation.

Specifically, in times of inflation, TIPS principal balances are adjusted upward twice a year, based on changes in the Consumer Price Index.

In contrast, significant inflation can punish the conservative investment strategy.

Okay, sounds interesting. How do TIPS work?

TIPS Basics

TIPS are sold at original issuance with terms to maturity of five, 10, and 30 years. They pay cash interest twice a year at a fixed rate that’s set at issuance.

Also, as we mentioned above, during times of inflation, TIPS principal balances are adjusted upward twice a year.

You receive the following if you hold a TIPS bond:

1. Cash interest payments twice a year at the stated fixed rate. Each semiannual payment equals half the stated rate times the inflation-adjusted principal balance at the time of the payment. So, cash interest payments go up with inflation because they are based on the increasing inflation-adjusted principal balance.
2. At the date of maturity, you receive the inflation-adjusted principal balance.

The Deflation Scenario

While deflation might seem highly unlikely at the moment, nothing is certain these days. Right?

During periods of deflation, TIPS principal balances are adjusted downward twice a year. The twice-yearly interest payments are also adjusted downward—because they are based on a declining adjusted principal balance. The stated fixed interest rate itself doesn’t change.

But even in the worst-case scenario of significant deflation during your ownership period, the results of owning a TIPS bond won’t be catastrophically bad, as long as you hold the bond to maturity. That’s because you’re guaranteed to receive at least the face value of the bond at maturity, even if the adjusted principal balance has fallen below that number. If the inflation-adjusted principal balance exceeds the face value, you’ll receive the larger inflation-adjusted number.

Best Way to Invest in TIPS

You can purchase TIPS upon original issue directly from the government, through the online TreasuryDirect program. If you invest this way, your principal is never at risk.

The TreasuryDirect option is available only for TIPS purchased for taxable accounts. You cannot use a tax-favored retirement account, such as an IRA, to buy TIPS upon original issue via TreasuryDirect.

If you buy a newly issued TIPS bond via TreasuryDirect, you’ll receive at least the face value of the bond if you hold it to maturity, even if there’s significant deflation. In other words, if you buy $100,000 of bonds via TreasuryDirect and hold them to maturity, then you receive no less than $100,000. Your principal is never at risk.

TIPS Tax Considerations

Cash interest payments from TIPS and non-cash increases in the principal of TIPS are subject to federal tax at ordinary income rates, but exempt from state and local income taxes.

TreasuryDirect reports the TIPS amounts subject to the federal income tax on two information forms:

• Form 1099-INT shows the sum of the semiannual cash interest payments made to you in a given year.
• Form 1099-OID shows the amount by which your TIPS principal amount increased or decreased due to inflation.

If you would like to discuss TIPS, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 16, 2022

Here’s a question I received from one of my clients:

I will hire my 15-year-old daughter to work in my single-member LLC business, and I expect to pay her about $12,000 this year. Do I pay her through payroll checks and file a W-2?

My Answer

Yes. And W-2 payment is essential. If you pay her on a 1099, she will pay self-employment taxes.

When you pay her on a W-2, neither you nor your daughter pays any Social Security or Medicare taxes, and in most states, you also don’t pay any unemployment taxes.

Key point 1. Your single-member LLC is a “disregarded entity” for federal tax purposes. It’s taxed as a sole proprietorship (unless you elect corporate treatment). In this instance, you are the child’s parent, enabling “no Social Security or Medicare taxes” for both your child and your proprietorship.

Key point 2. Your daughter has a $12,950 standard deduction. This means she also pays zero tax on earned income up to that amount.

If you have questions on the hire-your-child strategy, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 10, 2022

Through October 2022, you can buy Series I bonds that pay 9.62 percent interest.

And you receive that rate for six months from the time of purchase.

What happens after that? On November 1, 2022, the U.S. Treasury Department sets a new six-month rate equal to the fixed rate (currently zero) plus the Consumer Price Index inflation rate.

The interest you earn for the first six months gets added to the principal, and you earn interest on that interest during the next six months (think compound interest).

Sounds too good to be true. There’s a trick, right? Not really, but the government keeps your money, both your principal and your interest, for at least one year.

Mechanics

It works like this: You are buying a 30-year bond. The interest rate changes every six months. You can cash out anytime after one year, but if you cash out before five years, you have to forfeit three months of interest (no big deal).

You don’t pay taxes on the interest until you cash out. You get the compounding effect tax-free. It’s like a Roth IRA without age limits and penalties.

Key point. You can’t lose the money you invest or the interest you earn, other than the three months’ worth if you cash in before five years.

When you do cash in, you pay federal income taxes on the interest, but you don’t pay state, county, or city income taxes.

It is possible (albeit unlikely for many of you) to avoid taxes on the interest altogether if you use the monies for qualified higher education expenses.

Okay, So What’s the Downside?

You can’t buy more than $10,000 per year, although if you buy from TreasuryDirect and also utilize your tax refund, you can acquire $15,000 of bonds per year.

If you’re married, your spouse can do the same, so now you’re up to $30,000 per year.

Now, let’s add in your corporation or corporations. Such entities can purchase up to $10,000 of such bonds per calendar year.

Example. Sam, his spouse, and his two corporations are hot for the 9.62 percent of tax-deferred interest. He has not yet filed his 2022 tax return, which shows a tax refund. With Sam, his spouse, and his two corporations, Sam can buy $50,000 of I bonds in calendar year 2022.

He can do the same during calendar year 2023.

The major downside to the bonds is that you cannot buy more than the annual limits above. There’s no overall limit, just the annual limits.

Inflation and Deflation

The Series I bond is based on inflation. So if inflation drops to zero, cash out that bond. Meanwhile, ride this inflation wave. And remember, your Series I bond cannot go down in value. If your $10,000 I bond earned $985 in interest, the new principal balance is $10,985 and that principal balance never does down. Deflation can’t hurt it.

If you would like to discuss I bonds, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 8, 2022