TIME Companies

Companies Should Think Twice Before Making Blatant Tax Dodges

Call it inversion reversion. Or, don’t bite the hand that feeds you. After considering a tax-avoidance strategy by which it would buy a United Kingdom based company and move there to lower its tax bill, Walgreens is staying put in Chicago. But America’s biggest drug store chain is still going ahead and exercising an option to buy the 55% of the U.K.’s Alliance Boots that it doesn’t already own for $15 billion.

The combined company will be called Walgreens Alliance Boots and have 11,000 stores in 10 countries, plus a pharmaceutical wholesale and distribution network.

In remaining true to its Midwestern roots, Walgreens is eschewing the latest trend in corporate tax avoidance, known as inversion. Earlier this year companies including AbbVie and Mylan, have announced mergers with European based companies and intend redomicile there—that is, more their legal residence while pretty much staying put— because the tax rates are lower than the 35% corporate statutory rate in the U.S. Although the effective tax rate that most U.S. companies actually pay is much lower, the opportunity to replant a corporate flag in, say, Ireland, where the economy sucks but the corporate tax rate is 12.5%, has been too much to resist.

The corporate migration to foreign shores has been gaining momentum, led by pharmaceutical and medical companies. In addition to AbbVie and Mylan, Salix, Horizon Pharma and Medtronic have acquired firms in the UK, the Netherlands, and Ireland. Pfizer tried to buy the U.K.’s AstraZenica but was rebuffed. For the American multinational RX firms in particular, the lure of not repatriating foreign earnings, which would be taxed at U.S. rates, is powerful. By moving to Ireland, say, companies pay a territorial tax rate—that is, they are taxed only on domestic profits. The U.S. taxes corporations on their worldwide profits, which is one reason why many American multinational hold substantial profits overseas. According to the Congressional Research Service, a Pfizer inversion would have cost the U.S. $1.4 billion in lost tax revenues annually.

Walgreens said that it had given the inversion strategy careful consideration, as some of its stockholders had demanded. But in a statement, CEO Greg Wasson said the company concluded “it was not in the best long-term interest of our shareholders to attempt to re-domicile outside the U.S.” (Translation: the lawyers said no.) But Walgreens also acknowledged that as a U.S. company that derives almost all of its sales from U.S. consumers—not to mention from reimbursement from Medicaid and other government programs—it felt a patriotic tug, too.

U.S. Treasury Department Secretary Jacob J. Lew has been howling about corporations’ lack of “economic patriotism” and talking up retroactive legislation that can effectively undo some of the deals that have already taken place. Earlier this year, Treasury suggested changing the rules that govern such transactions. Currently, a company can take advantage of the tax benefits of an inversion deal only if the original U.S. stockholders own less than 80% of the new overseas company. Treasury wants to lower that threshold to 50% to make the deals less attractive. It also proposed denying tax benefits if the new entity is “primarily managed and controlled in the United States” regardless of the new shareholding distribution.

This is the second time in the last two decades that Treasury has led the charge to stem inversion schemes. In the 1990s and 2000s, companies such as Ingersoll-Rand, Tyco, the PXRE Group, Foster Wheeler, Nabors Industries, and Coopers Industries blew town to replant themselves in other nations, some in those great manufacturing centers known as Bermuda or the Cayman Islands. Congress put a halt to that naked tax dodging with the American Jobs Creation Act of 2004.

There is no disagreement among Democrats and Republicans that the corporate tax code needs to be overhauled to make it less complex and to impose tax rates that are competitive with other countries. “We want our tax code to have incentives for investing in the United States and disincentives for taking business out of the United States,” Lew said at a CNBC conference this week. That, however, will take another act of Congress, a body more inclined to do nothing. That would not describe America’s dealmakers and tax lawyers who continue to demonstrate that they have no aversion to inversion whatever.

MONEY Ask the Expert

Can Rental Income Save Your Retirement?

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Robert A. Di Ieso, Jr.

Q: Is rental income a good way to diversify my retirement portfolio?

A: For some people, yes. “Rental property can provide another stream of income, a hedge against inflation if rental prices rise and an asset that hopefully will appreciate over time,” says Diann McChesney, a certified financial planner at Asset Strategies Inc. in Avon, Conn. But being a landlord isn’t for everyone and not all properties are a good investment, says McChesney.

To get the most out of a rental property, be judicious about where you buy. Like most things in real estate, location is critical. Buy in a place where there is strong demand for housing so you can command a good rent and you don’t have a hard time finding tenants. You may not want the hassle of owning it in your older retirement years, If you plan to sell it down the road, it’s important to own a property that will be attractive to other investors.

A good rental property has many of the same things you look for in a home: A nice neighborhood, well-regarded schools and jobs that attract people to the area. Be careful about buying a fixer-upper. Unless you are handy or have a lot of time to handle repairs, maintenance problems will eat into the income. Today’s low interest rates make taking on a mortgage reasonable but the real key is ensuring that the rental income generates positive cash flow. If you want an income from the property, rent should more than cover your mortgage, property taxes, maintenance and repairs, says McChesney.

Keep in mind that banks require a larger down payment for—20% to 25%—and charge higher rates. It’s also an illiquid asset, so you won’t be able to tap your investment as easily as you can money in, say, an IRA. While you can get a tax break writing off expenses while you hold the property, once you sell it you’ll pay taxes on that depreciation.

The bottom line: A rental property can be a good way to diversify your retirement portfolio and provide another source of income in your later years. But “there’s a lot more to it than collecting rent,” says McChesney.

MONEY Roth 401(k)

The Great Retirement Account You’re Not Using

diamond in dirty hands
RTimages—Getty Images

Roth 401(k)s are showing up in more workplaces, but only about 10% of eligible workers saved in one last year. That's a big mistake.

Since they were launched in 2006, Roth 401(k)s have been typecast as the ideal plan for millennials. Paying taxes on your contributions in exchange for tax-free withdrawals, the reasoning goes, is best when your tax rate is lower than it’s likely to be in retirement. It turns out Roth 401(k)s may be the better option for Gen Xers and baby boomers too.

That’s the conclusion of a recent study by T. Rowe Price, which found that Roth 401(k)s leave just about all workers, regardless of age or tax bracket, with more money to spend in retirement than pretax plans do. “The Roth 401(k) should be considered the default investment,” says T. Rowe Price senior financial planner Stuart Ritter.

Yet few workers of any age invest in Roth 401(k)s, which let you set aside $17,500 in after-tax money this year ($23,000 if you’re 50 or older), no matter your income. Just as with a Roth IRA, withdrawals are tax-free, as long as the money has been invested for five years and you are at least 59½. Some 50% of employers now offer a Roth 401(k), up from just 11% in 2007, according to benefits consultant Aon Hewitt. But only 11% of workers with access to a Roth 401(k) saved in one last year. Big mistake. Here’s why:

Higher income. Every dollar you save in a Roth 401(k) is worth more than a dollar you put in a pretax account. That’s because you’ll eventually pay income taxes on those pretax dollars, while you get to keep every penny in a Roth. Granted, you get an upfront tax break by saving in a traditional 401(k), and you can invest that savings. Even so, a Roth almost always overcomes that headstart, the T. Rowe Price study found.

The fund company’s analysis looked at savers of different ages and tax brackets, both before and after retirement. As the graphic shows, a Roth 401(k) pays more even if you face a lower tax rate in retirement than you did during your career. The only group that would do significantly better with a pretax plan: investors 55 and older whose tax rate falls by 10 percentage points or more, which would mean up to 6% less income.

roth edge

Greater flexibility. With a tax-free account, you can avoid required minimum withdrawals after age 70½ (as long as you roll over your Roth 401(k) to a Roth IRA). You can also pull out a large sum in an emergency, such as sudden medical bills, without fear of rising into a higher tax bracket.

Tax diversification. Having tax-free income can keep you from hitting costly cutoffs. For every dollar of income above upper levels, 50¢ or 85¢ of your Social Security benefits may be taxable. “Many retirees in the 15% bracket actually have a marginal tax rate of 22% or 27% when Social Security taxes are added in,” says CPA Michael Piper of ObliviousInvestor.com. And if you retire before you’re eligible for Medicare and buy your own health insurance, a lower taxable income makes it more likely you’ll qualify for a government subsidy. In short, when it comes to retirement, tax-free money is a valuable tool.

More from the Ultimate Retirement Guide:
What Is a Roth 401(k)?
Which Is Better for Me, Roth or Regular?
Why Is Rolling Over My 401(k) Such a Big Deal?

 

MONEY inversions

WATCH: Stephen Colbert and Jon Stewart Slam “Corporate Deserters” Who Flee U.S. Taxes

The late night duo are the newest celebrities to speak out against corporate inversions.

Last night the Comedy Central dream team of Jon Stewart and Stephen Colbert each took a moment on their respective shows to attack the growing number of American corporations moving their official addresses abroad to escape U.S. taxes.

The specific kind of tax flight the duo is talking about is known as an inversion, and these maneuvers have become all the rage in recent months. As MONEY’s Pat Regnier explains, an inversion is when a U.S. company merges with a (typically smaller) foreign company in tax-friendly country. The U.S. company then claims it is now based in the foreign company’s nation and thus avoids paying U.S. taxes while continuing to enjoy many benefits of essentially remaining an American company.

“It’s like me adopting an African child, and then claiming myself as his dependent,” quipped Colbert.

This practice has been widely condemned as unpatriotic and unfair to American taxpayers who will be stuck footing the bill if the government needs to replace corporate tax dollars with new sources of revenue. The anti-inversion chorus has so far included public figures ranging from President Obama to entrepreneur and Dallas Mavericks owner Mark Cuban, who recently advised his Twitter followers to divest from inversion-happy corporations.

On Wednesday, Stewart and Colbert added their own two cents, with Colbert bringing on Fortune’s Allan Sloan, author of a recent seminal article on inversions, to talk about the problem.

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MONEY Social Security

The 5 Key Things to Know About Social Security and Medicare

No need to panic, but both Social Security and Medicare face long-term financial challenges, this year's trustees report finds. There's still time to make fixes.

If you worry about the future of Social Security and Medicare, this is the week to get answers to your questions. The most authoritative annual reports on the long-term health of both programs were issued on Monday, and while the news was mixed, there are reasons to be encouraged about our two most important retirement programs.

Under the Social Security Act, a board of trustees reports annually to Congress on the status and long-term financial prospects of Social Security and Medicare. The reports are prepared by the professional actuaries who have made careers out of managing the numbers and are signed by three cabinet secretaries, the commissioner of Social Security and two publicly appointed trustees—one Republican, one Democrat.

Here are my five key takeaways from this year’s final word on our social insurance programs.

* Imminent collapse nowhere in sight. Social Security and Medicare face long-term financial problems, but there’s no cause for panic about either program.

Social Security’s retirement program is fully funded for the next 19 years. It has $2.8 trillion in reserves, and that figure will rise to $2.9 trillion in 2019, when the surplus funds will begin depleting rapidly as baby boomer retirements accelerate. Although you’ll often hear that Social Security spends more annually than it receives in taxes, the program actually took in $32 billion more than it spent last year, when interest on bond holdings and taxation of benefits are included.

The retirement trust fund will be depleted in 2034, at which point current revenue would be sufficient to pay only 77% of benefits—unless Congress enacts reforms to put the program back into long-term balance.

Medicare’s financial outlook improved a bit compared with last year’s report because of continued low healthcare inflation. The program’s Hospital Insurance trust fund – which finances Medicare Part A— is projected to run dry in 2030, four years later than last year’s forecast and 13 years later than forecast before passage of the Affordable Care Act (ACA).

In 2030, the hospital fund would have enough resources to cover just 85 percent of its expenditures. (Medicare’s other parts—outpatient and prescription drug services—are funded through beneficiary premiums and general revenue, so they don’t have trust funds at risk of running dry.)

Could healthcare inflation take off again? Certainly. Some analysts—and the White House – chalk up the recent cost-containment success to features of the ACA. But clouds on the horizon include higher utilization of healthcare, new medical technology and a doubling of enrollment by 2030 as boomers age.

* Medicare is delivering good pocketbook news. The monthly premium for Medicare Part B (outpatient services) is forecast to stay put at $104.90 for the third consecutive year in 2015. That means the premium won’t take a larger bite out of Social Security checks, and that retirees likely will be able to keep most— if not all—of the expected 1.5% cost-of-living adjustment (COLA) in benefits projected for next year. (Final numbers on Part B premiums and the Social Security COLA won’t be announced until this fall.)

* Social Security Disability Insurance (SSDI) requires immediate attention. The program faces a severe imbalance, and only has resources to pay full benefits only until 2016; if a fix isn’t implemented soon, benefits would be cut by 20 percent for nine million disabled people.

That can be avoided through a reallocation of a small portion of payroll tax revenues from the retirement to the disability program – just enough to keep SSDI going through 2033 while longer-range fixes to both programs are considered. Reallocations have been made at least six times in the past. Let’s get it done.

*Aging Americans aren’t gobbling up the economic pie. Social Security outlays equalled 4.9% of gross domestic product last year and will rise to 6.2% in 2035, when the last baby boomer is retired. Medicare accounted for 3.5% of GDP in 2013; it will be 3.7% of GDP in 2020 and 6.9% in 2088.

* Kicking the can is costly. There’s still time for reasonable fixes for Social Security and Medicare, but the fixes get tougher as we get closer to exhausting the programs’ trust funds. Social Security will need new revenue. Public opinion polls show solid support for gradually eliminating the cap on income subject to payroll taxes (currently $117,000) and gradually raising payroll tax rates on employers and workers, to 7.2% from 6.2%. There’s also strong public support for bolstering benefits for low-income households and beefing up COLAs.

Medicare spending can be reduced without resorting to drastic reforms such as vouchers or higher eligibility ages. Billions could be saved by letting the federal government negotiate discounts on prescription drugs, and stepping up fraud prevention efforts. And an investigative series published earlier this summer by the Center for Public Integrity uncovered needed reforms of the Medicare Advantage program, pointing to “tens of billions of dollars in overcharges and other suspect billings.”

Your move, Congress.

Related stories:

How to Fix Social Security—and What It Will Mean for Your Taxes

Why Taxing the Rich Is the Wrong Way to Fix Social Security

3 Smart Fixes for Social Security and Medicare

 

MONEY Savings

5 Ways to Keep a Crisis From Crushing You

Falling anvil with inadequate parachute
A majority of Americans are unprepared for a financial emergency. Michael Crichton + Leigh MacMill; Prop Styling by Jason MacIsaac

What would you do if you suffered an emergency that's bigger than your safety net? These strategies can cushion the blow.

You’ve no doubt diligently socked away a chunk of cash for a rainy day. But chances are it isn’t enough to keep you from worrying about being swept under by a passing financial storm. In a MONEY survey of 1,000 Americans conducted earlier this year, 60% of respondents said they didn’t feel they had enough emergency savings.

They’re probably right to be ­concerned: A new survey by Bankrate.com found that the majority of Americans making $75,000-plus have less than six months of emergency savings on hand. Meanwhile, experts typically recommend having at least that much and often as much as 12 months’ worth—lofty goals even for those who are otherwise well-off.

While you’re in the process of bulking up your kitty, lessen your anxiety by figuring out how you’d quickly lay your hands on cash if the roof fell in, literally and figuratively. “The goal is to reduce long-term damage to your finances,” says Scottsdale financial planner Brian Frederick. Putting the bills on a credit card can be a reasonable option for those able to pay off their debt in a jiffy, but carrying a balance for longer gets pricey when you’re talking about a 15% interest rate. Instead, keep these five better options in the back of your mind:

1. Crack a CD

In hopes of discouraging customers from fleeing when rates rise, banks have been hiking penalties for tapping a CD before its maturity date—six months’ interest is now common on a one-year certificate, and six to 12 months’ is typical on a five-year. Even so, “the interest is so small these days that a six-month penalty is almost meaningless,” says Oradell, N.J., financial planner Eric Mancini. On a $100,000, five-year CD at 2%, you’d give up just $100.

2. Sell Some Securities

Ditching money-losing stocks is clearly a better move than borrowing, says Frederick, given that you can use losses to offset up to $3,000 of capital gains for this year and carry any overage into future years. Everything in your portfolio on the up and up? While you’ll pay a 15% capital gains tax on the profits from any security you’ve held for more than a year, it might make sense to pare back on winners if your allocation has gotten out of whack.

3. Take Out a 401(k) Loan

Most plans allow you to borrow half your vested amount, up to $50,000, with generous terms: no setup fees and a 4% to 5% interest rate, paid to yourself. Moreover, as long as you keep making contributions, you probably won’t sacrifice much growth. A five-year, $20,000 loan against a $250,000 401(k) would reduce your balance by just $9,000 after 20 years, assuming you continued to save $500 a month during the loan term. But should loan payments require you to pull back on contributions, your nest egg will take a hit (see the graphic). Another risk: If you leave your job for any reason before repaying, you must cough up the entire balance within 60 days, or else you’ll owe income taxes and a 10% penalty on the funds. “You can end up feeling stuck in your job,” says Edina, Minn., ­financial planner Kathleen Longo.

the 20k loan

4. Tap the House

Whether or not you have a home-equity line of credit already, you’ll benefit from today’s low rates. The average on a new line is about 5%, but if your credit is nearly perfect, you can get closer to 3%, with no setup fee, Bank­rate.com reports. Plus, interest payments are usually tax-deductible. The caveats: It may take a few weeks to open a new line. Also, HELOCs are var­iable rate, so your payments may rise if the Fed hikes interest rates. Finally, some banks charge a fee if you close the line early; look for one that doesn’t.

5. Borrow from a Stranger

Those who don’t have adequate home equity can still beat rates on credit cards and personal bank loans by nabbing a loan from a peer-lending site like LendingClub or Prosper. Rates on those sites can be less than 7%, plus an origination fee of 1% to 3%. Peer loans are a good option for those with sterling credit histories, says Steve Nicastro, investing editor at NerdWallet. Check what rate you’d get using the sites’ tools. Look good for you? After you fill out an online form, the sites will take a few days to verify your info, then send your loan out to prospective lenders. Most loans are funded within a week.

More on building a stronger safety net:

MONEY Ask the Expert

Why It Pays to Spend Down Your College Savings Plan Quickly

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Robert A. Di Ieso, Jr.

Q. I have enough in my daughter’s 529 to pay her full tuition for freshman year. Should I? — Andrea B., Location withheld

A. Yes, it’s best to use the savings sooner rather than later, says Raymond Loewe, an adviser with United Planners Financial Services. Given that your time horizon is short and the stock market has had a good run, it’s best to realize those tax-free gains now. Plus, spending down the 529 early could improve your odds for financial aid in future years, albeit slightly. Every $100 used can be worth $6 in aid, says Loewe. One caveat: The IRS won’t let you snag an education tax credit and take the 529 tax break for the same expenses. So to get the full $2,500 American Opportunity credit, for example, you’ll want to pay at least $4,000 with other money, says Joe Hurley of Savingforcollege.com.

More on college savings:

MONEY The Economy

WATCH: How Some U.S. Companies Are Dodging Taxes

Major American corporations are reincorporating overseas to avoid paying higher U.S. taxes.

MONEY

Mark Cuban to Investors: Get Out Of U.S. Companies That Run Overseas

Mark Cuban
Hey, you! Get back here! Mpu Dinani—Getty Images

Companies are merging with foreign competitors to get tax breaks. Here's what the notorious Mavs owner thinks of that.

Dallas Mavericks owner and investor Mark Cuban has taken to Twitter this morning with some big thoughts about the U.S. companies changing to foreign addresses to get tax breaks.

Such corporate relocations, known as inversions, have become a hot-button issue in recent days after several major corporations pulled the tax maneuver and President Obama began calling for Congress to block this virtual corporate exodus.

Cuban starts with what sounds like your basic economic patriotism argument:

 

And then things get more interesting.

 

By PE, Cuban means price-earnings ratio, the standard way investors value a stock. He means that if companies take the tax break, investors ultimately benefit because it raises earnings. (We recently discussed who really benefits here. Short answer: That’s true mostly for wealthy investors like Cuban.) And he says he’s wiling to live with lower earnings. But what does “risk doesn’t leave the system” mean?

This:

 

Of course, he adds, if you sell to punish a company for cutting its taxes, make sure it doesn’t mean you pay a bunch of taxes.

 

Activism has its limits, amirite?

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