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• Opportunity for fun and learning about one of America's most beloved personalities
• Share your story and receive free show tickets
• New Employee "Super" Stock Option Proposed
• Cash method allowed for more small businesses
• IRS expands tip compliance agreements
• Supreme Court to decide S Corporation debt cancellation issue
• Home sale exclusion not allowed for an income interest in a trust
• Developer not allowed to depreciate improvements deeded to city
• Shareholder investment disallowed for S Deduction under At-Risk rules
• Substantiation of business expenses
• Non-competition agreement spoils charitable trust plan
• California's treasury overfloweth
• Visit our new articles
• Subscribe to Michael Gray, CPA's Tax and Business Insight

Here's an opportunity to have a fun evening learning about one of America's most beloved personalities.

Who used to talk through newspaper columns and radio shows to 40 million Americans a week, when the population of the United States was only 120 million? Who was the most popular male movie star of his time - more popular than Clark Gable, Fred Astaire, Wallace Beery and James Cagney - but didn't consider himself an actor? Who performed a "new" act each time he stepped on the stage in vaudeville? Who was considered the greatest political analyst and humorist of his time? When our country faced its greatest challenge - the Great Depression - who was considered a friend by most Americans, sharing words of encouragement on the radio? Who tirelessly raised funds for relief and gave enormous sums himself to the Red Cross and the Salvation Army? Who was a great early promoter of air travel and traveled the world, sharing his experiences through newspaper and magazine articles?

A few of you readers might have recognized Will Rogers.

Although Will Rogers was considered the most influential man of his time, he hasn't received the attention he deserves in our history books and classrooms. Since he died in an airplane crash in 1935, you would have to be at least 65 years old in order to have had any "live" exposure to him. Many people know nothing about him, except possibly that he said, "I never met a man I didn't like."

Now you have an opportunity to learn more about this man and experience his keen insight and humor that inspired us to laugh at ourselves and think at the same time. His life story is recreated in the style of the Ziegfield Follies, which were considered the most entertaining shows of the early twentieth century, featuring music, dancing and beautiful women in daring, exquisite costumes. This is a fabulous musical production that your whole family should go see.

West Valley Light Opera will present The Will Rogers Follies - A Life in Review from June 24 through July 29. I will be performing offstage as the voice of Florenz Ziegfield. The location is the Saratoga Civic Theater, 13777 Fruitvale Ave., Saratoga (across from West Valley College.) For tickets, call (408)268-3777. For more information, visit the West Valley Light Opera Web Site at www.wvlo.org.

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Share your story and receive show tickets as a thank you gift.

One of the best ways for us to show prospective clients the benefits they will receive as a client of our CPA firm is to let them read the experiences of our clients. It would be very helpful to us if you would write a letter to us telling about one or more challenges or situations you were dealing with and how we helped you. In other words, just write how working with us as your accountants has been helpful to you, your family, your business. Please be as specific as you can. Also, at the end of the letter, please give us permission to use the letter and your name in our written promotional material and on our web site.

Please send the letter as soon as possible, but no later than July 15, 2000. As a thank you gift, you will receive two tickets to the West Valley Light Opera show, The Will Rogers Follies. Please send your story early, because the best seats will be sold soon, and we can only honor this offer as long as tickets are available.

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New Employee "Super" Stock Option Proposed.

Representative John Boehner (R-OH) has proposed a stock option program intended to encourage stock ownership by employees in employer corporations. The title of the legislation is the Wealth Through the Workplace Act, HR 3462 IH. The plan could be viewed as a substitute or a replacement for an ESOP.

In order to participate in the plan, a person must be an employee of a publicly-traded corporation who owns less than 5% of the combined voting power or value of all classes of stock of the employer corporation or of its parent or subsidiary corporations. The employer must grant the options to at least 50% of all of its employees. If any employee of a parent or subsidiary corporation of the employer corporation is covered under the arrangement, 50% of the employees of the parent or subsidiary corporation must also participate.

Employees may be disregarded (i) who have been employed less than 2 years, (ii) whose customary employment is 20 hours or less per week, (iii) whose customary employment is for not more than 5 months in any calendar year, or (iv) who are not U.S. citizens or permanent residents of the U.S.

Like employee stock purchase plans, the option price may not be less than 85% of the fair market value of the stock on the date the option is granted.

The excess of the sales price of the stock over the option price will be taxed as a long-term capital gain provided the holding period requirements are met. Like employee stock purchase plans and incentive stock options, the holding period requirement is more than two years after the option is granted and more than one year after the option is exercised. If the holding period requirement is not met, the employee will report ordinary income for the excess of the fair market value at exercise over the option price.

Employers will be encouraged to adopt these plans by allowing a deduction to the employer in the year of exercise for the excess of the fair market value of the stock at exercise over the fair market value on the date of grant.

So far, it doesn't appear the excess of the fair market value of the stock at the date of exercise over the option price would be a tax preference for the alternative minimum tax.

These provisions are still being negotiated and may be changed, or the program may not be adopted at all.

Here are a few observations if it is adopted. (1) The program is intended to make participation in equity-based compensation more broad based. The current incentive stock option and nonqualified option plans favor key executives. (2) Employees will still need to evaluate the risk of holding the employer stock and how the expected risk and return for this type of investment compares to alternative investments. (3) Allowing a deduction to the employer for granting this type of option is a significant tax benefit, similar to to the ESOP concept. (4) A significant part of the "rank and file" workforce will not be able to participate in the program. For example, independent contractors will not qualify because they aren't employees. We could see more lawsuits from unhappy independent contractors claiming to be employees, as Microsoft recently experienced. Most of the job growth in our country is at non-publicly traded companies. Employees for these companies don't qualify to participate in this type of plan. (5) This program discriminates against small companies and may place them at a competitive disadvantage. A small software company that isn't publicly traded won't qualify for a program like this, but Microsoft and Oracle will.

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Cash method allowed for more small businesses.

The IRS has issued Revenue Procedure 2000-22, which allows businesses with average gross receipts of $1 million or less to use the cash method of accounting. Although the taxpayer is not required to "account for" inventories, the deduction for inventory sold is not allowed until the year the merchandise is consumed, used or sold. The main advantage of this change is the taxpayer is not required to report income until it is received. In addition, small C corporations that qualify for this exception may use the installment method of accounting.

In order to qualify to use the cash method, the taxpayer must also use the cash method for its books, records and reports. However, the isolated use of the accrual method, such as on a one-time basis to get a bank loan, doesn't violate this requirement.

The average gross receipts for the $1 million test is based on the average for the previous three tax years. Once the average gross receipts exceed $1 million, the taxpayer must change its accounting method to the accrual method.

A taxpayer that wants to change to the cash method under this procedure must follow the automatic change provisions of Revenue Procedure 99-49.

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IRS expands tip compliance agreements.

The IRS has expanded its voluntary tip income compliance agreements to all industries where tipping is customary. In the past, only the gaming, food and beverage, cosmetology and barber industries were able to make agreements with the IRS about employee education and reporting for tips. Now other employers may make agreements with the IRS for programs of their own design. (AdvAnn 2000-19, 2000-20, 2000-21, 2000-22, 2000-23.)

The IRS is planning to resume tip examinations and assessments for employer FICA only, effective October 1, 2000.

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Supreme Court to decide S Corporation debt cancellation issue.

The appeals courts for different parts of the country disagree about whether S corporation shareholders are able to adjust the tax basis for their stock when the S corporation has cancellation of debt income. The Supreme Court has agreed to rule on this issue. (David A. Gitlitz v. Com., (1999, CA10).)

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Home sale exclusion not allowed for an income interest in a trust.

The IRS has ruled that a beneficiary of a trust didn't qualify to use the $250,000 exclusion for the sale of a residence owned by the trust. The trust was established by the beneficiary's mother. At the death of the beneficiary, the principal of the trust will pass to her children, who are over age 21. The beneficiary did not qualify as the owner of the trust because she didn't have the power to vest the trust principal or income in herself. (Ltr Rul 20001704.)

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Developer not allowed to depreciate improvements deeded to city.

A developer deeded streets, sewers and other infrastructure improvements to a city after construction was complete. The IRS ruled that these improvements were not depreciable because the taxpayer did not retain ownership of the improvements and the city was responsible for maintaining them after the transfer. The improvements were nondepreciable intangible assets. The developer should have treated the property as nondepreciable and deducted the improvements as part of the cost of the related property that it developed when it was sold. The taxpayer was required to make an accounting method change. (Ltr Rul 20001704.)

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Shareholder investment disallowed for S Deduction under At-Risk rules.

Larry, a co-owner of an S corporation borrowed funds from another shareholder and loaned them to the S corporation. Larry used the investment in the loan as a basis for claiming the corporate losses on his individual income tax returns.

Under the at-risk rules (Internal Revenue Code Section 465(b)(3)(A)), amounts borrowed with respect to an activity are not considered to be at risk when those amounts are borrowed from any person who has an interest in the activity or from a person related to a person (other than the taxpayer) having such an interest.

This provision was originally designed to eliminate the ability of investors in tax shelters to get tax basis for amounts borrowed from the tax shelter promoter.

The Tax Court found that Larry failed this test, so he wasn't able to currently claim the S corporation losses. (Larry W. Van Wyk, 113 T.C. No. 29 (12/31/99.)

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Substantiation of business expenses.

The IRS has issued final regulations relating to documenting certain business expenses. The old guideline allowing deductions without documentation for up to $25 of expenses is out. Now up to $75 per event may be claimed for meals and entertainment without a document. (I don't recommend relying on this rule.) To claim travel expenses, you must have a receipt for out of town lodging. Generally you should have receipts, paid bills or similar evidence sufficient to support an expenditure. If a receipt is not readily available, such as for street parking, a bridge toll or a taxi, a narrative report should be sufficient documentation.

The hotel receipt should include the name, location, date, and separate amounts for charges for lodging, meals and telephone.

A restaurant receipt should include the name and location of the restaurant, the date and amount of the expenditure, the number of people served, and any charges for items other than meals and beverages.

There is a lot of flexibility in the regulations for future guidelines to be issued by the IRS.

(TD 8864, IRB 2000-7, 614 (February 14, 2000).)

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Non-competition agreement spoils charitable trust plan.

John Jorgl was selling his business. He contributed the business to a charitable remainder unitrust before the sale. Just before closing, the buyer required Jorgle to agree to a covenant not to compete. The Tax Court found that $350,000 of income from the covenant not to compete was Jorgl's, not the trust's. Arguably, Jorgl should be entitled for a charitable deduction for the $350,000 that went to the trust. He didn't get the result he intended. Evidently the seller inserted the value of the covenant not to compete just before closing, and Jorgl didn't realize the result of the allocation. (Jorgl v. Commr., T.C. Memo 2000-10 (1/11/00).)

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California's treasury overfloweth.

In case you've been living in a cave, the State of California currently has a big excess of funds over its commitments. From what I've been seeing, the reason is that California gives no break on capital gains and is collecting a huge amount of money from California residents cashing in their employee stock options. Since California has seen its fortunes change before, the legislature and the governor are afraid to make long-term commitments. Future revenues may not support them. There is a law that if the money isn't spent, it has to be refunded. So we can count on seeing some short-term expenditures and possibly a rebate before the end of this year.

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.