Michael Gray, CPA's Tax and Business Insight

Table of Contents

• Enter our "Name our Newsletter" contest.
• My youngest child goes to Cal Berkeley.
• Enron scandal is a huge black eye for the CPA profession.
• State non-conformity delays adoption of retirement plan changes.
• Luxury tax decreases for 2002.
• Withholding form should be re-submitted for 2002.
• California businesses must resubmit Form 542.
• Supreme Court decides if IRS may assess employer FICA on tips.
• IRS issues new guidance for split-dollar life insurance.
• Questions and Answers

   What is the tax on game show winnings?

   What happens if two people claim the same dependent?

   Can I sell a rental home and buy a mobile home?

   Can I claim my grandparents as dependents?

• If you have employee stock options...
• PS Marché Aux Fleurs.
• Visit our new articles.
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax and Business Insight.

Enter our "Name our Newsletter" contest.

We can no longer use the former title of our newsletter and need a new one. We're looking for something that's descriptive of our content of personal tax, financial and business news and advice. Please send us your suggestions no later than February 20, 2002. We will select our favorite, subject to approval by our attorneys as not apparently being in conflict with someone else's trademarks. If the winner lives in the area including San Francisco Bay, Silicon Valley or Marin County, he or she will receive a $100 gift certificate for Marché Aux Fleurs, the Southern French restaurant located in Ross, California owned by my daughter, Holly Baker and her husband, Dan. You will enjoy the best meal of your life!

If the winner lives outside the area, he or she will receive a $100 gift certificate for the Outback steakhouse or the restaurant of his or her choice.

I hope to announce the winner in the next newsletter.

Return to Table of Contents

My youngest child goes to Cal Berkeley.

James has moved to a dormitory to study Philosophy as a Junior at the University of California at Berkeley. Although he seemed very sad when we moved him in, he said "No way!" when we invited him to come home last weekend. As long as he has a fast internet connection for his computer, he's at home!

Return to Table of Contents

Enron scandal is a huge black eye for the CPA profession.

We are called Certified PUBLIC Accountants because, although an audit client may pay the fee, our first duty when performing a financial statement audit is to protect public investors who rely on the financial information for which we give a "clean" opinion. The revelation of possible conflicts of interest for Arthur Andersen, the auditors of Enron, and that the auditors destroyed documents after Enron declared bankruptcy and was using questionable accounting procedures is a huge scandal, threatening the continued viability of the independent audit profession.

The Securities Exchange Commission, the American Institute of Certified Public Accountants and the Big Five firms are working on developing new safeguards to preserve the role of CPAs in the American economy.

Here are a few of my superficial observations about this situation. First, it's difficult to handle an organization where a fraud is perpetrated from the top down. Second, the CPA profession has been encouraged to promote its role as a business partner with their clients. This role is immensely more profitable than the role of auditor or policeman. The fees of the large firms from consulting and ancillary services dwarf their audit fees. Audits have long been treated as loss leader services, with cutthroat bidding, within the CPA profession. The low fees and the huge potential liabilities for shareholder lawsuits have driven out CPA firms other than the Big Five firms from auditing companies with securities traded on the public securities markets.

Despite the vital role that audits play in the marketplace, giving assurance of the reliability of reported information, CPAs have promoted the idea within the profession that an audit is a commodity service of little value to the client.

The development of enormous businesses with economic power exceeding most countries has stretched the capabilities of audit firms to perform reliable work for a reasonable fee. In short, if the client is lying, the CPA firm is screwed. The most important decision for reliable audit work is client selection.

It may be that CPA firms will be prohibited from auditing businesses for which they perform ancillary services, especially internal audit work.

Arthur Andersen and KPMG have already spun off the consulting divisions of their firms, and have started competing with them! There is a remote chance the SEC will require a separation of the audit part of the practice from other client services. I'm not sure who would staff the separate companies, because they would currently be unprofitable. Could the Government Accounting Office take over the audit function for companies with traded securities? (Probably not.)

Destroying evidence is already a crime. No changes are required here, just enforcement of the law. We have laws against shoplifting and systems to defend against it, but it still happens. The same reasoning applies to destroying evidence.

We can only watch with fascination to see if any meaningful changes are adopted.

Return to Table of Contents

State non-conformity will delay adoption of retirement plan changes.

Contribution limitations and the ability to transfer retirement account balances were dramatically enhanced under the 2001 federal tax law changes, mostly effective in 2002. Most of the states haven't adopted the changes yet, and are under economic pressure of deficits from the recession. If employers and taxpayers in those states adopt the changes for their retirement plans, including higher IRA contributions, they risk disqualifying the plans under state law, resulting in early distribution penalties and accelerated taxable income for plan beneficiaries.

The California legislature is working on fast-track legislation to adopt the retirement plan changes.

Employers should not adopt the federal changes until the states they are doing business in or employees are taxable in adopt the changes.

Return to Table of Contents

Luxury tax decreases for 2002.

For some reason, I get a lot of questions about the luxury tax! The luxury tax for certain automobiles for 2002 is 3% for vehicles with a sales price exceeding $40,000. The tax will expire on December 31, 2002. The auto dealers that sell luxury vehicles will compute the tax and collect it when the automobile is sold. I know they will be relieved when (if) the tax goes away next year!

Return to Table of Contents

Withholding form should be re-submitted for 2002.

Employees should resubmit Form W-4 each year. For some reason, the forms are being issued late, this year. Since the tax rates are being reduced for 2002, you might need to request extra withholding to have enough to avoid underpayment penalties based on last year's income.

Return to Table of Contents

California businesses must resubmit Form 542 for independent contractors.

California businesses must report independent contractor information to the Employment Development Department using Form DE 542 within 20 days of either making payments totaling $600 or more or entering into a contract with an independent contractor in any calendar year, whichever is earlier. The form must be resubmitted each year the independent contractor is paid. The purpose of the form is to trace "deadbeat" parents who aren't making child support payments, but takes the shotgun approach to avoid claims of discrimination.

Return to Table of Contents

Supreme Court to rule whether IRS may assess employer FICA on estimated unreported tips.

The Supreme Court will review Fior D'Italia, Inc. v U.S., (CA9 3/7/2001) 87 AFTR 2d 2001-1118. This ruling is especially important for the restaurant industry.

Return to Table of Contents

IRS issues new guidance for split-dollar life insurance.

Last year, the IRS issued new rules for split-dollar life insurance. (Notice 2001-10.) Now they have said they will issue new regulations requiring the taxation of parties to a split-dollar life insurance arrangement under one of two mutually exclusive methods. Under one method, the economic benefits are generally treated as transfers to the benefited party. Under the other method, payments on the policy are treated as a series of loans to the benefited party.

Until future guidance is issued, taxpayers may use the premium rate table in Notice 2002-8 to determine the value of current life insurance protection on a single life.

The P.S. 58 rates may be used for split-dollar arrangements entered into before January 28, 2002, if the contract provides that those rates will be used.

This may be "Greek" for many readers, but its an important development for people in the life insurance business and businesses that provide this benefit for their employees.

(Notice 2002-8)

Return to Table of Contents

Questions and Answers

Question - I was on a game show a few months ago and won a substantial amount of money. What would be the tax on something like this? Does the luxury tax apply?

Answer - Game show prizes are taxable income. You should receive a 1099 for the prizes you received and report them as miscellaneous income. Sometimes, income taxes are withheld from cash prizes, in which case you should attach the 1099 to your income tax return.

Luxury tax only applies to the purchase of a luxury vehicle.

Question - My boyfriend claimed my son the same year I did. Now I do not know where to go for help or what I need to do.

Answer - There is a good chance the IRS will discover this error by matching the your son's social security number on your return and your boyfriend's. You need to resolve the conflict of who is entitled to the exemption. Usually it's the custodial parent. If you or your boyfriend files an amended return without the exemption, you will eliminate the issue. Go to a tax return preparer for help.

It sounds like you might have a more serious problem than the exemption. It may be you are involved in an abusive relationship. Please get some counseling.

Question - I am trying to find out if selling a rental home and buying a mobile or modular home is legal as far as capital gains goes.

Answer - Yes, it's legal. I'm not sure if I understand your questions. If you want to plan a tax-deferred exchange, please seek professional help.

Question - I would like to claim my grandparents as dependents. I meet all the criteria of the 5 tests, but I am finding it hard to prove. My grandparents' house is paid off and is still in their name. All the bills come in their name, so it is just easier for me to continue paying the bills under their name instead of changing everything over into my name. The only income they have is social security and my grandfather has a pension. Neither one will be filing. Can I claim them?

Answer - First, remember under the income test, your dependent may not have taxable gross income more than the exemption amount, or $2,900 for 2001. If your grandfather has a community-property pension of $6,000, your grandparents don't qualify as dependents.

Also, since your grandparents are living in their own home, they are considered to having contributed the fair rental value of the home for the year, less any amounts you pay for upkeep, for their own support. This, plus any amounts they spend from your grandfather's pension and their social security for support items could result in your failing the support test.

Otherwise, I suggest that you keep a separate checking account and credit cards for items that you pay for your grandparents to prove you meet the test of providing more than half of their support. If you can document you paid these items for 2001 and meet the other tests, including the income and support tests, you can claim them.

* * *

Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

Return to Table of Contents

If you have employee stock options, have you subscribed to the ESOAA Option Alert?

To subscribe, go to http://www.stockoptionadvisors.com. You can review past issues at http://www.stockoptionadvisors.com/optionalert/.

Advisors may write for an information package about joining the Employee Stock Option Advisors Association, LLC and training materials about tax planning for employee stock options by sending name, company name, address, email address, telephone number, and fax number to Dawn Gray at info@stockoptionadvisors.com.

Employee option holders may write for an information package about self-study materials relating to planning for employee stock options by sending name, company name, address, email address, telephone number, and fax number to Dawn Gray at info@stockoptionadvisors.com.

Return to Table of Contents

P.S.

My daughter and her husband, Holly and Dan Baker, have opened a Southern French Restaurant at 23 Ross Common, Ross, California, about 15 minutes north of the Golden Gate Bridge. The name of the restaurant is Marché Aux Fleurs. For the best meal of your life, call 415-925-9200 for a reservation and give them a try soon! For directions, visit our website at http://www.taxtrimmers.com/directions.shtml.

Return to Table of Contents

Visit our new articles!

• "Selling Rules!"
• "What to do when you make a service error"

Return to Table of Contents

P.P.S.

To receive the next issue of Michael Gray, CPA's Tax & Business Insight with more tax developments, another book review, and upcoming deadlines automatically via email, subscribe by filling out the form below.

Return to Table of Contents

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.