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Table of Contents

• Here comes summer!
• It’s time for second estimated tax payment.
• Can we save you mortgage dollars?
• IRS issues guidelines for 30% depreciation.
• Increase in first-year luxury car depreciation limit.
• IRS issues guidelines for net operating loss carryback.
• IRS issues guidelines for non-qualified stock options in a divorce.
• Questions and Answers

  Can I use my new house as property received in a tax deferred exchange?

  Where can I find a list of vehicles that are exempt from luxury tax?

  Does a trust have a tax identification number?

  Can I get a home office deductions for a separate structure on my property?

  How can I report someone who isn’t paying employees social security?

  How should I figure capital gains on my property?

  What is the authority for a 25% limit for SEP contributions?

• Do you have employee stock options?
• Visit our new articles
• Subscribe/Unsubscribe from our newsletter.
• PS Marché Aux Fleurs

Here comes summer!

Last Friday, my son James came home from UC Berkeley. On Monday (Memorial Day), we enjoyed a family outing to the Giants game at Pac Bell park, including a CalTrain ride up to the doorstep of the park. Fun! Convenient.

Janet and I will be leaving for a family vacation in Hawaii on June 7 and returning on June 17. Danny Quan and Dawn Gray will "hold down the fort" in my absence. Aloha!

Hope you have a safe and enjoyable summer.

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It’s time for second estimated tax payment.

The second estimated tax payment for 2002 is due no later than June 17. You should discuss with your tax advisor what the appropriate payment is for you or whether you can handle your estimated tax obligation through your withholding. Remember for 2002 a "protected" estimate based on last year’s tax would be 112% of the tax on your 2001 income tax returns, including alternative minimum tax.

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Can we save you mortgage dollars?

For over a year, we have been helping existing clients reduce their interest rates, finance remodeling their homes and finance building new homes through our mortgage brokerage business. Now we can extend this service to readers of this newsletter who live in California. We specialize in no cost, no fee refinancing. (No cost, no fee refinancing is not available for home purchases, deferred interest or loans under $175,000.) Through our strategic partner, Wymac Capital, Inc., we can offer very competitive rates through a range of lenders. We also have a "rate watch" service to notify you when the rates have fallen enough for you to benefit from refinancing. For a complementary, no-obligation mortgage consultation, please call Mike Gray at 408-918-3161.

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IRS issues guidelines for 30% depreciation.

The major benefit of the Job Creation and Worker Assistance Act of 2002 is 30% bonus depreciation. The type of property eligible for the allowance includes new MACRS property for which the recovery period is 20 years or less, MACRS water utility property, computer software which is depreciable under Internal Revenue Code Section 167 (not acquired in a business acquisition), and qualified leasehold improvement property.

Bonus depreciation generally applies for property acquired after September 10, 2001 and before September 11, 2004, and placed in service before January 1, 2005.

Note that listed property, such as an automobile, that is not used more than 50% for business doesn’t qualify for bonus depreciation. If the business use falls to 50% or less after the vehicle is placed in service, the 30% allowance will be recaptured.

Leasehold improvements won’t qualify if the lease is between related taxpayers. The improvement must be placed in service more than 3 years after the date the building was first placed in service. The interior of the building must be occupied exclusively by the lessee or sublessee.

The allowance is 30% of the adjusted basis of the property after reduction by any expense allowance. Regular MACRS depreciation is computed after reducing the basis by the expense allowance and 30% bonus depreciation.

The taxpayer may elect to not compute the 30% allowance for any class of property. The classes of property for which an election is made are based on the MACRS depreciable life.

The IRS has issued a new depreciation form, Form 4562 to incorporate the new rules. In addition, the IRS issued Revenue Procedure 2002-33 to explain how to apply the new rules for 2001. A key provision in the Revenue Procedure is that if a taxpayer filed a tax return for 2001 or a fiscal year ended in 2001 before June 1, 2002 and does not amend the return within 6 months from the due date of the return, including extensions, the taxpayer is deemed to have made an election to not deduct 30% bonus depreciation.

The taxpayer may claim the allowance by filing an amended income tax return within the six-month period described above. (For a calendar year individual or partnership that filed a 2001 return on or before April 15, 2002, the amended return should be filed by October 15, 2002. For a calendar year corporation that filed a 2001 return on or before March 15, 2002, the amended return should be filed by September 15, 2002.)

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Increase in first-year luxury car depreciation limit.

Another provision of the Job Creation Act is an increase in the first-year depreciation limit for "luxury automobiles" by $4,600 to $7,660 for 2001 and 2002. The vehicle must be acquired after September 10, 2001 and placed in service before January 1, 2005 to qualify for the $4,600 increase. Also, the vehicle will not qualify for the increased limitation unless 30% bonus depreciation is allowed and claimed for the vehicle.

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IRS issues guidelines for net operating loss carryback.

The carryback period for net operating losses for tax years ending in 2001 and 2002 was extended by the Job Creation Act from two years (three years for NOLs resulting from certain casualty, theft and disaster-related losses) to five years.

For each tax year, a taxpayer may elect irrevocably to waive the five-year period and use the two- or three-year period, or to waive carryback entirely. Generally, the election must be made on a timely-filed income tax return.

In Revenue Procedure 2002-40, the IRS has extended the time for making a timely election..

Any taxpayer that previously elected to forgo the carryback period for an NOL for any taxable year ending in 2001 or 2002 may revoke the election and claim a 5-year carryback by filing a carryback claim form (1139 or 1120X for corporations, 1045 or 1040X for individuals, amended 1041 for estates and trusts) no later than October 31, 2002. Mark the form "Revocation of NOL carryback waiver pursuant to Rev. Proc. 2002-40."

Any taxpayer that previously elected to forgo the carryback period for an NOL for any taxable year ending in 2001 or 2002 that also wishes to forgo the 5-year carryback period need not file an amended return. The election is deemed to be extended to the 5-year carryback period.

A taxpayer that previously filed a carryback claim based on the two- or three-year carryback period may claim the five-year carryback period by filing another carryback form by October 31, 2002. Mark the top of the form "Amended refund claim pursuant to Rev. Proc. 2002-40."

If a taxpayer that previously filed a carryback claim based on the two- or three-year carryback period does not want to claim the five-year carryback, nothing more needs to be done. Filing the original claim without correction is deemed to be an election out of the five-year carryback.

A taxpayer that previously filed a federal income tax return for a taxable year ending in 2001 or 2002 but made no election to forgo the carryback period may apply the two- or three-year carryback period by filing a carryback claim by October 31, 2002.

A taxpayer that previously filed a federal income tax return for a taxable year ending in 2001 or 2002 but made no election to forgo the carryback period may apply the five-year carryback period under operation of law. (The October 31, 2002 deadline does not apply in this case.)

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IRS issues guidelines for non-qualified stock options in a divorce.

For the details, see the May 29, 2002 issue of the ESOAA Option Alert. For a free subscription, visit www.stockoptionadvisors.com/optionalert.

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Questions and Answers

Question

I have some rental property that I am planning to sell and I am also buying a new home.

Am I allowed to use my new house, which I plan to use as my primary residence, as my "upleg" (property received in a tax deferred exchange)?

Answer

On property held for productive use in a trade or business or for investment qualifies for exchange treatment. To be "like kind" the property received must also meet this requirement. A principal residence is considered a personal-use asset and doesn’t qualify.

Question

Where can I find a list of vehicles that are exempt from luxury tax due to weight?

Answer

I don’t have a list.

Ask auto dealers for makes and models you are interested in which vehicles are exempt. They should know.

Question

Does a trust have a tax identification number?

Answer

An identification number is required for many trusts. For example, after a death, an irrevocable trust may hold the assets of a decedent. The income and deductions are reported on an income tax return for the trust, and the beneficiaries’ shares of any income that is distributed or distributable are reported on Schedule K-1 for inclusion on the beneficiaries’ individual income tax returns. Since a separate income tax return is required for the trust, an identification number should be applied for in this situation.

For other trusts, no identification number is required. For example, revocable living trusts are a very popular estate planning technique. Since the person who creates the trust, called the grantor, has retained the power to revoke the trust, the trust is disregarded for income tax reporting. The income and deductions of the trust are reported on the income tax return of the grantor. Since a separate income tax return is not required for the trust, no identification number should be applied for a revocable trust during the grantor’s lifetime.

The form for applying for an identification number for a trust is Form SS-4.

Since there are many different types of trusts, you should consult with a tax advisor to determine whether an identification number is required for the particular trust you are dealing with.

Thanks to Jim Carolan, Vice President Trust Advisor at Bank One, Flint, Michigan for suggesting that we expand our response on this issue.

Question

Can the square footage of a separate structure be combined with a principal residence for home office percentage calculations?

Answer

It depends.

First, the separate structure status is important to qualify for deductions that you otherwise might not receive for the residence itself. (Internal Revenue Code Section 280A(c)(1)(C).)

Under Proposed Regulations Section 1.280A-2(i)(3), a taxpayer may determine the expenses allocable to the portion of the unit used for business purposes by any method that is reasonable under the circumstances. Expenses which are attributable only to certain portions of the unit shall be allocated in full to those portions of the unit. Expenses which are not related to the use of the unit for business purposes, such as for lawn care, are not taken in account.

It seems to me the separate structure should be separately depreciated. If there aren’t separate utilities for the structure, you might allocate based on a combined square footage basis. You could also use a combined square footage approach to allocate combined expenses, like property taxes. Personally, I would prefer separate utilities and separate accounting. You will probably find you have a bigger deduction due to energy used for business equipment. Also, your documentation is cleaner.

See IRS Publication 587, Business Use of Your Home.

Question

How would you go about reporting someone that you know is running a business and paying some of her employees cash, and not doing the social security stuff she should be?

Answer

You can call the Internal Revenue Service. They are listed in the Federal Government section of the white pages in your telephone book. These situations often come to light when "employees" file for unemployment benefits after termination.

Question

HELP, I am confused! I own one million dollars worth of real estate. There is a house on the property. I’ve made $250,000 of improvements to 10 acres in 25 years. There is a $25,000 homestead exemption in Florida. How do I figure capital gains?

Answer

Either get a referral from a friend or look up "accountants-certified public accountants" or an enrolled agent (EA) under "tax return preparation" in the yellow pages and pay someone to help you. That’s their function.

Question

What is the authority for a 25% limit for SEP contributions?

Answer

Remember this limit is not effective for calendar year taxpayers until 2002. It was adopted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001, which was signed by President Bush on June 7, 2001.

I’m afraid the explanation is confusing, but a friend who is a pension attorney confirmed the reasoning.

As amended, Internal Revenue Code Section 408(j) states the maximum contribution for Simplified Employee Pension plans is based on Section 415(c)(1)(A).

According to amended Section 415(c)(1)(A), the maximum contribution to a defined contribution plan is $40,000.

According to amended Section 404(a)(3)(A)(i), the maximum deduction for an amount contributed to a profit sharing plan, such as a SEP, is limited to 25% of compensation.

To determine the SEP contribution for a self-employed person, the contribution is computed based on income after deducting the contribution amount. Therefore, the maximum self-employment income on which the maximum deduction is computed is $200,000. ($200,000 - $40,000 = $160,000. $160,000 X 25% = $40,000.)

Also remember there is a controversy because many of the states haven’t conformed their retirement plan limits to the new Federal rules. California recently enacted legislation to conform, but certain taxpayers’ rights groups claim the new law is invalid because it wasn’t passed by more than two-thirds of the legislature.

Hopefully most of the mess will be cleaned up before tax season, 2003.

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

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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.

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Visit our new articles!

• "Marketing Outrageously" Book Review

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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.

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P.P.S.

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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.