The Brass Tacks

Passive Income Report - March 2008

It seems like the thing to do on finance-oriented blogs is to report your passive income every month. I guess I'll do the same! Here we have my passive income report for March 2008. This is the first month, so there is nothing to report for "percentage change."

	March	Estimated Annual
Interest	$59.26	$716.23
Dividends	$117.09	$1,292.00
Royalties	$0.00	$3.66
Online Music Sales	$270.48	$1,945.92
Total	$446.94	$3,957.81
Percentage Change	N/A	N/A
Goal	$2,000/month	$24,000/year

Avoiding Double Social Security Coverage

Self-employed U.S. Citizens residing in Canada can find themselves paying a lot more tax than they should, due to the need to pay into both the Canada Pension Plan (CPP) and U.S. Social Security on their earnings. Fortunately, there is a way to avoid this problem with a little paper work.

The United States and Canada have agreed to eliminate dual coverage under each country's social security systems for the same income. If you are up for it, you can read all about it in the Office Consolidation of the Agreement Between the Government of Canada and the Government of the United States of America with Respect to Social Security.

If you don't want to wade through all that legalese, the important part is summarized neatly in IRS Publication 54 Tax Guide for U.S. Citizens and Resident Aliens Abroad, available in pdf or html format. The IRS seems to be having some trouble with its website this year and those links aren't always working, so I'll type out some of it here:

Exemption From Social Security and Medicare Taxes
The United States may reach agreements with foreign countries to eliminate dual coverage and dual contributions (taxes) to social security systems for the same work...As a general rule, self-employed persons who are subject to dual taxation will only be covered by the social security system of the country where they reside.

To exempt your earnings from U.S. Social Security Tax, you need to obtain a certificate of coverage from Canada Revenue Agency stating that your earnings are covered under CPP. The form CRA provides for this purpose is Form CPT56, Certificate of Coverage Under the Canada Pension Plan Pursuant to Article V of the Agreement on Social Security Between Canada and the United States. Download the form, fill it out, and send it to CRA at the following address:

Canada Revenue Agency
333 Laurier Ave. W.
Ottawa, ON  K1A 0L9
ATTN: Social Security Rulings

CRA doesn't provide the above address anywhere on their website (at least where I can see it), and it seems to change periodically. I obtained the address by calling them and asking–at present it seems to work but you might want to verify it with them.

The office that handles these requests might need you to provide copies of your Canadian tax returns, proving that you do indeed pay into CPP, especially if you are a new Canadian resident. You could proactively send copies in with your original CPT56, just to speed things along.

Once you have the certified CPT56 form, send it to the IRS attached to your U.S. income tax return. You apparently only need to do this once, but of course its good sense to keep copies of the form in your files, in case you need to provide it again. Congratulations: you are now entitled to enter "nil" on Lines 27 and 58 of your Form 1040!

The IRS provides a similar form for people in the reverse situation, with earnings that should be exempt from CPP and covered under U.S. self-employment (Social Security) tax. According to Publication 54, you can request a certificate of coverage from:

Social Security Administration
Office of International Programs
P.O. Box 17741
Baltimore, MD 21235-7741

Related Websites

Social Security Administration
Canada Pension Plan

Some Favorite Financial Sites

Dividend Blogs

The Dividend Guy Blog
"One guy's journey to passive income through dividend investing."

Dividends Matter
"Everyone else gets paid. Why shouldn't you?"

Living Off Dividends
"Make your money work hard, so you don't have to."

Dividends4Life
"Dedicated to the process of identifying superior dividend investments..."

Other Recommended Reading

Stingy Investor
Norm Rothery's blog has good information on picking undervalued Canadian stocks.

Million Dollar Journey
"The making of a millionaire–a Canadian personal finance blog."

LongLeaf Partners Funds
I like to read their quarterly and annual reports.

Warren Buffett Letters to Shareholders
Words from the greatest investor of all time.

My Investment Philosophy

In the last post I wrote out my notes after reading Robert Miles' book Warren Buffet Wealth. One of the recommendations in the book is that you come up with your own investment philosophy. Rather than blindly following the Buffet principles, you should adapt them to your own situation, taking into account the kind of investor you are.

Warren Buffet wealth comes from investments that produce cash flow, which for him–as the outright owner of a business–means business profits that flow right into his pocket. Smaller shareholders are advised to consider Earnings per Share to be a form of "look-through" earnings that will reward them in the long term with appreciating stock prices.

Buffet doesn't seem to be that concerned with dividends, perhaps because of the potential for double taxation in the United States. In Canada where I live double taxation of dividends isn't much of an issue, due to the Dividend Tax Credit mechanism in the tax system. Here then is a difference between me and Mr. Buffet: I believe that dividends are more important as an investment goal. EPS should of course be used to evaluate the strength and prospects of a company, but beyond that, a company should pay good dividends to compensate me for taking a risk on their stock.

I intend to invest for cash flow, looking for solid Canadian companies with good dividend yields. Dividends should compensate for risk by exceeding GIC rates. If a stock is generating good dividends for me, I won't sell it unless something better comes along.

My strategy is to estimate future dividend yields and EPS with the tools available at RBC Action Direct, then figure out what price I would pay today for those future earnings. I set up an Excel spreadsheet that calculates Present Value based on future estimates. I plunk the numbers into the spreadsheet and use it to compare PV between different companies, and to see how much I will pay for the company's assets.

It's hard to find the perfect investment according to Buffet criteria, so I enter positions a little at a time, expect the worse, and always keep some cash in reserve.

Creating Warren Buffet Wealth

Recently I read Warren Buffet Wealth by Robert Miles. I liked this book a lot because the concepts were relatively easy to understand, and I can imagine ways to implement them using the tools at my disposal. Here are some notes from the book.

Buffet Criteria for Selecting a Company to Buy

• At least $50,000,000 in consistent annual earnings
• Little debt
• Good managers in place
• Simple, old-economy business
• Attractive offering price

Stick with what you understand. Look for old-economy products that are needed by families. The average founding year of a Buffet company is 1909.

Determine what the company will earn over the next 10 years and discount that to today's Present Value (PV). There should be demonstrated, consistent earnings: future projections are meaningless.

Buy companies with shares priced at a discount to their intrinsic value. Buy for less than you think it is worth.

Some Buffet definitions:

• Book value = assets minus liabilities
• Intrinsic value = lifetime earnings of the business
• Market value = current asking price

Think like a business owner, not a market trader. Buying an entire company or a piece of a company are almost the same thing, so look for similar criteria. The main difference is that when you own only a share, you benefit from "look-through" earnings (LTE) rather than actual earnings.

LTE is less tangible than actual earnings but ultimately pays off with renewed financial strength of company and increased dividends. When LTE goes up, EPS goes up. Potential look-through earnings (LTE = #shares x EPS)

Buy $1 of assets for $.50 (or even $.40), or $1 of annual earnings (look-through) for $1. Look at the asset worth of a company and its outstanding stock value. Divide stock value into asset value (its "beta").

Other considerations:

• What percentage of price are Earnings per Share (EPS)?
• What is the Return on Equity?
• What are the Profit Margins?
• What percentage of Net Worth is the company's Debt Load?

General Strategies

The minimum holding period of any stock should be at least three years. Ten years is even better. Don't invest unless you can watch market value decline by 50% with equanimity.

Don't lose capital. Given the previous note, I take this to mean "don't sell at a loss."

Make twenty investment decisions over a lifetime.

Ignore the crowd. Don't fall for the obvious, and don't be in a hurry. If it's too good to be true it probably is.

Forget age-based allocation, and don't diversify. Buy a few companies that you understand. Stick to local stocks. Become a satisfied customer of the company first.

Buy a lot of a few, concentrated amounts of stock. Choose companies you know something about that have good financial statements. Have the courage to put 10-40% of net worth in one stock.

Always spend less than income! Track your investment performance with book value, not market value.

Visit the business, talk to management, count how many customers are on the premises, and come up with your own estimate of annual earnings. Read everything you can about the business. Do the research and think about it. (On the other hand, he also says to not get bogged down in too much information, or paralysis by analysis.)

Look for management buying back shares (adds value to existing shares). Look for management that owns stock in its own ventures. Look for CEOs who admit their errors.

Stock splits are meaningless. All they do is increase brokerage sales commissions.

Businesses need a durable competitive advantage. Invest in the right industry. Don't buy if it can be outsourced to Asia.

Work only with people you like, trust, and admire!

Further Reading Recommended in Warren Buffet Wealth

B. Graham and D. Dodd - Security Analysis
B. Graham - The Intelligent Investor
R. Miles - 101 Reasons to Own the World's Greatest Investment

IRS Has $1.2 Billion for People Who Haven't Filed a 2004 Tax Return

The IRS reported today that $1.2 billion in unclaimed refunds awaits 1.3 million people who failed to file a federal income tax return for 2004. 

Here is an estimated state-by-state breakdown of individuals who could file a 2004 return and collect a refund. Are you among them? You have until  April 15, 2008 to file your 2004 return and get your money, plus interest!

Automate PC Maintenance

Here's a great little article for Windows XP Luddites, by technology writer Chris Tull:

Put your PC Maintenance Routine on Autopilot