Michael Gray, CPA's Tax and Business Insight

Table of Contents

• Hope you're enjoying your summer.
• Extended due dates are approaching.
• On the stock market.
• Depressed stock market creates refinancing opportunity.
• Small employer VEBAs threatened.
• Charitable deduction allowed for donation of credit card rebate.
• IRS issues updated regulations for split-dollar life insurance.
• How are short sales of stock taxed?
• Questions and Answers

  Can I deduct interest on a loan paid before home improvement construction?

  Does the $250,000/$500,000 exclusion apply to my 2nd home?

  Can a Canadian invest in American tax liens?

  Are all properties acquired after marriage community property?

  Are one-man LLCs subject to self employment taxes?

  Do you recommend enrolled agents?

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

Hope you're enjoying your summer.

Summer is the time we traditionally enjoy the fruits of our labor. Hope you and yours have a safe and fun vacation this year. I've even heard that some people who were laid off their jobs are taking some time to "smell the roses."

Return to Table of Contents

Extended due dates are approaching.

The initial extended due date for individual income tax returns is August 15. If you need additional time to file, you can apply for a second extension to October 15, using Form 2688. The second extension is not automatic, so you must state a reason for your request.

The extended due date for calendar year corporations is September 15. There is no second extension for corporations.

Return to Table of Contents

On the stock market.

The stock market is suffering from a lack of trust because of a number of revealed frauds by major companies. It has been too common for companies to play games with their numbers on their financial statements during recessionary periods. The scope of the losses from these scandals is unprecedented.

The audit failures of major CPA firms relating to these frauds is an embarrassment to a profession that has traditionally been our country's most trusted advisors.

President Bush has just signed legislation that will eliminate self-government for the accounting profession. An unfortunate result of this necessary action is to make the government of the accounting profession more subject to political influence.

In addition, key executives of major corporations may no longer borrow money from the corporations as part of their compensation packages, some must certify the accuracy of their company's financial statements, and those involved in frauds will be subject to tougher criminal penalties.

Commenters have said recruiting chief executives will be more difficult and more expensive as a result.

We can't legislate morality, but we can increase the penalties for those who commit crimes.

As we have seen in the last few weeks, the market is very volatile. It is probably not going to make a "smooth" recovery, but will have occasional big movements up and down. It is not the place for the weak of heart.

Return to Table of Contents

Depressed stock market creates refinancing opportunity.

In a depressed stock market, investors move their investments out of stocks and into bonds. The increased demand for bonds increases bond prices, decreasing interest yields. Consequently, mortgage interest rates have been very low recently.

Some of our clients have refinanced two or three times in the last year.

Interest rates fluctuate, closely following (in reverse) the stock market. We don't know how long the low rates will last, so you should consider taking action.

We can provide competitive mortgage refinancing services to our subscribers who are California residents through our strategic partner, Wymac Capital. For a complimentary rate quote, call Mike Gray at 408-918-3161. If you wish, we can track rates relating to your mortgage and tell you when there is a refinancing opportunity.

Return to Table of Contents

Small employer VEBAs threatened.

The IRS has issued proposed regulations for welfare benefit plans. These regulations include requirements for Voluntary Employee Benefit Associations (VEBAs). The regulations include a prohibition against experience rating in 10-or-more employer groups (Internal Revenue Code § 419A(f)(6)) on an individual employer basis. If you are an employer with a VEBA, you should consult with your tax advisor about whether these proposed regulations will disqualify your plan. (REG-165868-01.)

Return to Table of Contents

Charitable deduction allowed for donation of credit card rebate.

The IRS issued a private ruling indicating that an individual would not have taxable income for a rebate from a credit card and would receive a charitable deduction for the amount of the rebate donated to a qualifying charity. (Letter Ruling 200228001.)

Return to Table of Contents

IRS issues updated regulations for split-dollar life insurance.

Split-dollar life insurance arrangements involve two parties sharing a life insurance policy. An employer or donor usually is entitled to recover payments for the insurance coverage. An employee or beneficiary is entitled to the coverage in excess of the recovery amount. The IRS has been re-examining how the benefit to the employee or beneficiary should be taxed. Old guidelines were issued under Revenue Rulings 64-328 and 66-110, before the guidelines for below-market rate loans were issued.

Under the new regulations, the tax consequences are determined under two mutually-exclusive regimes -- the economic benefit regime and the loan regime. Under the economic benefit regime, the owner of the contract is treated as providing economic benefits to the non-owner. Under the loan regime, the non-owner of the contract is treated as loaning premium payments to the owner.

The proposed regulations are not retroactive, but will apply to split-dollar arrangements entered into after final regulations are published.

This is a complex area. If you have a split-dollar arrangement, consult with your tax advisor for an update about how these new regulations affect you. Life insurance agents will want to study the new regulations carefully in constructing plans for their clients. (REG-164754-01)

Return to Table of Contents

How are short sales of stock taxed?

The IRS issued a revenue ruling about how a short sale of stock is taxed when the taxpayer doesn't hold the stock (not against the box). The tax treatment is especially important when the short sale is closed out close to the end of a tax year. Under the ruling, a loss on the short sale is recognized on the settlement date. A gain on the short sale is recognized on the trade date.

For example, John Smith makes a short sale of XYZ stock for $3,500 on December 1, 20X1.

If John closed out the short sale by buying the XYZ stock for $4,000 on December 31, 20X1, to be settled on January 5, 20X2, John would report the $500 loss as of January 5, 20X2.

If John closed out the short sale as above, but for $3,000, he would report the $500 gain as of December 31, 20X1. (Revenue Ruling 2002-44.)

Return to Table of Contents

Questions and Answers

Question

I want to refinance and take out cash to do a major home improvement. The construction probably won't start until November, but I might do the loan now because the rates are so great. Can I deduct the interest I pay before and during the construction?

Answer

The rules for deduction of interest relating to a residence are among the most complex in the tax law. This is a shame, since this deduction is one of the most common ones on individual income tax returns.

The rules for this type of a transaction are outlined in Temporary Treasury Regulations 1.163-10T and Notice 88-74.

Interest for debt incurred up to two years before the completion of construction of a major improvement or up to 90 days after completion can be qualifying residential indebtedness.

It appears you may borrow the money before the work is started. I recommend that you deposit the funds in a separate bank account and pay the construction bills from that account. Be sure the construction is completed within the two-year window.

Also, remember the construction loan must be secured by the residence for which the construction is done, and that you may only deduct qualified residential interest for your principal residence and a second residence.

Question

I have a 2nd home in the same city as my primary residence and I let my relatives live there free for many years. If I sell this 2nd home, does the $250,000/$500,000 exclusion apply to the gain?

Answer

No. The exclusion only applies to your principal residence, when you meet certain requirements I'm not going to detail here.

Question

Is it possible for someone in Canada to invest in American tax liens or other safe investments to yield a 15% return?

Answer

I'm not aware of any requirement that an investor should be a US resident to invest in US tax liens. The travel costs for you to perform due diligence will eat into your return. Maybe you should look into investing in trust deeds at home?

Question

I am legally married but not living with my husband. Are all our properties and monies acquired during the course of our marriage owned 50% each, even if acquired with someone else?

Answer

Not necessarily. I can't go into the details of title here, but you can acquire property that is not community property. For example, if you inherit property during your marriage, it is probably separate property. Also, since you are not living together, if you do not intend to get back together, your earnings may be separate property. I recommend that you consult with an attorney who specializes in family law to find out about your individual situation.

Question

In 1998, I attended a seminar during which we were told that a one-man LLC was not subject to SE/FICA under any circumstances. However, I have not been able to determine this on my own. Might you help? If so, with your answer please show citations.

Answer

The IRS has not issued any guidelines about how SE tax applies to an LLC. Preliminary regulations were withdrawn. A one-person LLC is a disregarded entity. Income from the LLC for a business will be reported on Schedule C. I think it is very risky to not report self-employment income when you are reporting on a Schedule C.

I recommend that you seek help from a CPA or tax attorney.<

Question

Are you kidding recommending an enrolled agent? Bad enough recommending a CPA these days, but an enrolled agent?

Answer

I felt an enrolled agent was appropriate for the person who directed a question to me. I didn't think that person could afford a CPA or attorney, and an enrolled agent could provide the support needed. There are some enrolled agents who are extremely knowledgeable and qualified. For example, Bob Spidell published a California Tax newsletter for years that California CPAs have long depended on, including me.

---

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/.

Return to Table of Contents

Visit our new articles!

• The Elements of a Successful Marketing Campaign
• Getting Everything You Can Out Of All You've Got Book Review

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 directions page at http://www.taxtrimmers.com/directions.shtml.

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.