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• The home stretch.
• Extensions - and when you don't have the money to pay the tax.
• First individual estimated tax payment is due April 15.
• We can track mortgage rates for you.
• Questions and Answers
  • Can I claim my son as a dependent if his mother agrees?
  • Are California taxes levied on interest income for non-residents?
  • Can I make a SEP contribution for 2003 yet?
  • Will the income from my ISO sale be reported on form W-2?
  • What are the capital gains laws for rental property sales?
  • How much can I contribute to my SEP account?
  • Are leased vehicles subject to luxury tax?
• If you have employee stock options...
• Subscribe/Unsubscribe from our newsletter.
• PS Marché Aux Fleurs

The home stretch.

This year's tax season deadline is actually April 15 - no "grace days" for falling on a weekend. Also, Easter is the weekend after April 15, which will make it much more enjoyable for me. If you plan to have us prepare your extension and haven't delivered your information to us yet, please do so immediately.

We just had a very sad event in my family. My brother-in-law for not even two months, Rich McLean, suddenly passed away. He was a long-time companion of my sister before their marriage. They enjoyed many happy days together traveling and working on their properties business. He loved fishing - he had a prized marlin trophy from a trip to Mexico.

This is a reminder that the unexpected can happen. You would be shocked to know that most of our new clients have no will or trust. We encourage them to get an estate plan in place as soon as possible. If you don't have one, I hope you'll make it a goal for this year.

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Extensions - and when you don't have the money to pay the tax.

What do you do when you don't have the money to pay the tax?

My first recommendation is to file your income tax returns, certified mail, by the initial filing date. One of the nastiest penalties in the IRS's arsenal is for late filing - 5% per month to a maximum of 25%. Some people who owe money don't file their returns because they are afraid. THIS IS A HUGE MISTAKE! The best approach is to be honest about your situation and work with the tax authorities to resolve it.

When your file an extension, any balance of tax due when the tax return is filed represents an exposure for the late filing penalty.

Please don't misunderstand me. I regularly use extensions for my clients and myself as a workload "safety valve". We often don't have the information to complete a return by the due date. They just aren't appropriate when there will be a significant balance due that won't be paid by the original filing due date.

According to the Treasury regulations for the requirements to file a valid automatic extension request, "an application for extension must show the full amount properly estimated as tax for the taxable year." (Reg. § 1.6081-4(a)(4).) The regulations relating to reasonable cause for failure to file a tax return state that if a taxpayer satisfies the requirement of showing the full amount estimated as tax, the taxpayer has a reasonable cause for failure to file during the extension period provided (1) the excess of the amount of tax shown on the return over the amount of tax paid by the original filing date (including the amount paid with the extension form) is no greater than 10 percent of the amount shown on the return (restated - 90% of the tax is paid by the due date), and (2) any balance due shown on the return is paid with the return. (Reg. § 301.6651-1(c)(3).)

(For California taxpayers, the extension is paperless so the amount of the tax need not be stated. You are still required to pay at least 90% of the tax by the original due date to avoid the late filing penalty.)

If you have filed an income tax return for 2001, you can process your federal extension electronically or by telephone - call 888-796-1074 by April 15. Better call early to beat the rush! Mailing a paper form is still acceptable and is the only way a person who didn't file a 2001 income tax return can request an automatic extension.

A taxpayer can still avoid the late filing penalty by demonstrating a "reasonable cause," but this can be a hassle and the taxpayer is at the mercy of the subjective judgment of a representative of the tax authority.

Remember you may now pay income taxes using a credit card. Call 800-272-9829, or try the web site, www.officialpayments.com. The extension for California is 1555. You can also call 888-729-1040. Maybe you can find a card offering a low interest rate promotion that will work for your situation.

Should you borrow using a margin account? In most cases, this is not a good choice because of the exposure to margin calls if the market declines.

Should you use an equity advance loan, secured by your principal residence? In some cases it might be to your advantage, if you can get a favorable interest rate. Remember interest for an equity loan not used for a home improvement is only deductible on a loan amount up to $100,000. This interest is not deductible when computing the alternative minimum tax.

Remember that IRA accounts and other retirement accounts can be temporary sources of funds. Distributions from IRAs which aren't minimum required distributions can be rolled over to another IRA or returned to the same IRA within 60 days after a withdrawal. This exception only applies to one rollover per year. (You must wait more than one year after a rollover is completed before making another one.)¹

Certain distributions from other qualified plans can also be rolled over within a 60-day period to an IRA or another qualified plan.² Using IRAs or qualified plans as a temporary source of funds to pay taxes can be useful if the funds to complete the rollover will soon be available, such as when there is a lockout "window" that will soon be open. The cost of an error can be high, because if the rollover isn't completed before 60 days have expired, the distribution may be subject to tax as ordinary income plus a 10% early distribution penalty.³

The IRS has a form for installment agreements, Form 9465. They would prefer that you submit the form with your income tax return. You can take up to five years to pay off your tax liability. An advantage of arranging an installment agreement is the penalty for late payment of tax is reduced from 1/2% per month to 1/4% per month. In addition to penalties, interest is charged for late tax payments. The interest rate is adjusted quarterly. Recently, the rate has been five percent.

Another alternative is to make an Offer in Compromise, Form 656. With this procedure, the IRS actually can reduce your tax based on your ability to pay. You don't have to wait until you have owed the tax a long time to use this procedure. I think it's best to work with an attorney, CPA or enrolled agent when making an Offer in Compromise. If the amount is large, an attorney is probably the best choice.

Although it may provide relief from your other creditors, bankruptcy doesn't offer much help for recent debts for income taxes. When you make payments on your tax bill, be sure to specify to apply the payments to taxes due. Penalties and interest are dischargeable in bankruptcy, but income taxes aren't.

It may be to your advantage to plan how to use regular tax or alternative minimum tax capital loss carryovers or minimum tax credit carryovers. You might need to generate capital gains, which can be difficult when you're in financial distress.

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First individual estimated tax payment is due April 15.

Remember to review your estimated tax situation for 2003.

There is no estimated tax penalty provided the taxpayer pays at least 90% of the tax (including AMT) on the current year's tax return through withholding and/or equal quarterly estimated tax payments.

For taxpayers who have no more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year's income tax return, there is no penalty for underpayment of estimated tax provided at least the income tax on the previous year's income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.⁴ For taxpayers who have more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year's income tax return, there is no penalty for underpayment of estimated tax provided at least, for 2003, 110% of the income tax on the previous year's income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.⁵

Taxpayers who have uneven income and deductions may also compute their estimated tax on an "annualized" basis. You multiply the year to date income and deductions to arrive at amounts for a year, compute the tax for that amount, then pay amounts to cumulatively pay in 1/4, 1/2, 3/4 and 100% of those amounts. You should probably get help from a professional tax return preparer to do this.

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We can track mortgage rates for you, so you don't have to.

This is still a great time to refinance, whether to get cash for remodeling your home, to finance a new business, to buy your dream yacht, or to just save interest dollars.

At no charge or obligation, we can track your home mortgage and notify you when refinancing is to your advantage.

Remember, we offer home mortgages as a service to our clients and newsletter subscribers located in California through our strategic partner, Wymac Capital. We specialize in financing with no points and no costs, if certain conditions are met.

To find out if we can reduce your home mortgage costs or help provide financing for education, home improvements, a vacation, or a new home, please call Michael Gray at 408-918-3161. There is no fee or obligation for this service.

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Questions and Answers

Question

Someone told me I can claim a personal exemption for my son if his mother agrees to it. He lives with his mother. We were never married, but I pay child support. Is this true? Do I use Form 8332 or Form 2120?

Answer

According to the IRS, only persons who were formerly married can make the election to permit a non-custodial parent to claim a dependency exemption. However, the Tax Court said in Kerry L. Brignac (TC Memo 1999-387) that people who were never married can make the election.

The instructions for Form 8332 say you must have been married before to use the form. Form 2120 does not apply to this situation.

Therefore, I suggest that your son's mother write a letter to you, similar to Form 8332, agreeing to not claim the dependency exemption for your son for the applicable years. (Remember that to qualify to claim the exemption, you must provide more than one-half of your son's support.)

Question

After my wife and I move to Nevada, our primary income will be interest derived from a mortgage received from the sale of California real estate. I believe the capital gain will be subject to California taxes. What about the interest?

Answer

The interest will not be taxable by California. See FTB Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency.

Question

Can I make a SEP contribution for 2003, or does it have to be for the previous year?

Answer

You can designate advance payments for your 2003 SEP contribution during 2003. If you pay in more than the finally determined contribution amount, you will have to withdraw that amount plus any related income before the due date of your 2003 income tax return.

Question

We sold some ISOs to make a cashless exercise to purchase other ISOs. Will the income from the disqualified disposition be reported on Form W-2? Is the AMT adjustment eliminated for same-day sales?

Answer

The employer should report the income from the disqualified disposition on Form W-2. No income tax withholding or employment taxes are required for this income under the rules now in effect.

There is no AMT adjustment required when there is a disqualifying disposition of ISO stock in the year of exercise. I don't have time to document this answer. You can find an abundance of reference material in my book, Secrets of Tax Planning for Employee Stock Options, available through the Employee Stock Option Advisors Association, LLC at www.stockoptionadvisors.com/manual.shtml.

Question

What are the current laws regarding capital gains on the sale of rental properties (such as a single family house)?

Answer

This is not a short answer question. See Form 4797, Schedule D and the related instructions. It depends on when the property was acquired. There may be ordinary income for depreciation recapture in some cases. In others, the gain up to the amount of accumulated depreciation is taxable at a 25% maximum tax rate. I recommend that you consult with a tax advisor for more details.

Question

I am an un-incorporated sole proprietor. I have no employees. I have a SEP-IRA. I have $100,000 in income. I would like to contribute 25% ($25,000) into my SEP. From the IRS worksheet, it looks like I'm limited to 20% ($20,000). What happened to the other 5%?

Answer

The SEP contribution and the deductible 1/2 of your self-employment tax are both subtracted from your other self-employment income to determine your maximum SEP contribution. Rough and dirty, $100,000 - $20,000 = $80,000 X 25% = $20,000.

Question

We leased a vehicle in August 2000 and the company is now telling us that we owe $1,900 + for luxury tax. Do we owe the tax, considering we only leased the car?

Answer

According to Internal Revenue Code Section 4002(c)(1), the lease of an item by any person is considered a sale of the item at retail. Rules are specified when a long-term lease of a vehicle is treated as the first retail sale of the vehicle. It's too bad the dealer didn't take care of this when you originally leased the car.

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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 www.stockoptionadvisors.com. You can review our last issue at www.stockoptionadvisors.com/optionalert/news.shtml.

Advisors may find information about joining the Employee Stock Option Advisors Association, LLC and training materials about tax planning for employee stock options at www.stockoptionadvisors.com/seminar.shtml.

Employee option holders may find information about self-study materials relating to planning for employee stock options at www.stockoptionadvisors.com/seminar.shtml.

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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 taxtrimmers.com/directions.shtml.

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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.

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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.

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1 Internal Revenue Code § 408(c)(3)
2 Internal Revenue Code § 402(c)
3 Internal Revenue Code § 72(t)
4 Internal Revenue Code § 6654(d)(1)
5 Internal Revenue Code § 6654(d)(1)(C)