Michael Gray, CPA's Tax and Business Insight

May 2, 2005

© 2005 by Michael C. Gray

ISSN 1539-395X

A monthly report to help you prepare for your financial future, keep more of what you earn by minimizing your taxes, and build an extraordinary business!

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Table of Contents

• There's still work to do for California amnesty.
• Sorry for any inconvenience...
• Mike Gray installed as president for Silicon Valley San Jose CPAs.
• Transfer to FLP disregarded.
• Refund allowed after three years.
• Election extension allowed to TurboTax user.
• Questionable W-4s no longer to be sent to IRS.
• President Bush signs Bankruptcy Act.
• IRS issues guidance on Health Savings Accounts (HSAs).
• IRAs are protected in bankruptcy, says Supreme Court.
• Documents for tax shelter case protected.
• Questions and Answers
  • Can I change my W-4 during the year?
  • How can I reduce taxes on my winnings?
  • Can I claim my grandchildren as dependents?
  • Do I have to sell before I can buy replacement property?
  • How can my parents avoid taxes on the sale of their home?
• Do you have employee stock options?
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

There's still work to do for California amnesty.

There are still requirements to be met for those who applied under the California tax amnesty plan. Completed income tax returns or amended income tax returns must be filed by May 31, 2005. The income taxes should also be paid by that date, or a qualifying payment plan must be in place.

Time passes quickly, and I will be out of town from May 18 through May 20, so if you need our help, call 408-918-3161 for an appointment now.

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Sorry for any inconvenience...

Dawn Siemer, who manages our email and web site, has been "drafted" to be on the Santa Clara County Grand Jury for three months. For a small firm like ours, this is a major inconvenience and means we will be less responsive to email. For a faster response, fax your request to 408-998-2766 or call 408-918-3162. Thanks!

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Mike Gray installed as president for Silicon Valley San Jose CPAs.

On April 29, Michael Gray was installed as the incoming president for the Silicon Valley San Jose chapter of the California Society of CPAs. The installation party featured a performance by "Murder on the Menu". We had a great time!

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Transfer to FLP disregarded.

A decedent transferred rental real estate from her revocable trust to a family limited partnership. The Tax Court found the decedent had an implied agreement with the partnership to retain the right to the property's rental income during her lifetime. The transfer was disregarded and the property was included in her taxable estate without the benefit of valuation discounts. (Estate of Virginia A. Bigelow, T.C. Memo 2005-65.)

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Refund allowed after three years.

A district court allowed a refund that would normally be lost under the statute of limitations. The court found Internal Revenue Code Section 6511, which normally bars filing a refund claim three years after the tax return is due, does not apply when a tax return is not required. (Wachovia Bank v. U.S., D.C. FL 3/18/2005, 95 AFTR 2d ¶ 2005-817.)

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Election extension allowed to TurboTax user.

A taxpayer who prepared his own income tax return using TurboTax income tax return preparation software missed an election that would enable him to deduct more than $270,000 of investment interest expense. An enrolled agent helped the taxpayer apply for an extension of time to make a late election, and the IRS granted the request. (From the April 15, 2005 issue of Tax Analysts' Tax Practice.)

(The missed election was to have long-term capital gains and qualified dividends that would otherwise be eligible for the 15% federal income tax rate taxed as ordinary income, subject to regular tax rates up to 35%. Investment interest expense is only deductible up to the amount of investment income received, which excludes long-term capital gains and qualified dividends. The election must be made by the due date of the income tax return, including extensions.)

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Questionable W-4s no longer to be sent to IRS.

The IRS issued temporary and proposed regulations relating to Form W-4 (withholding instructions to an employer). The new regulations, which are effective April 14, 2005, eliminate the requirement that employers must submit a copy of any Form W-4 on which an employee claims more than ten withholding exemptions. In addition, an employer isn't required to submit a copy of Form W-4 when an employee claims to be exempt from income tax withholding but the employer expects the employee's wages will be $200 or more per week. The employer now must submit a copy of the Form W-4 when directed to do so in a written notice to the employer by the IRS. (T.D. 9196.)

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President Bush signs Bankruptcy Act.

President Bush enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 on April 20. The Act allows debtors to exempt certain qualified plan retirement accounts from the bankruptcy estate. The exemption for Roth and IRA accounts (other than SEP accounts) is limited to $1 million.

There are many other tax-related provisions in the Act, including the requirement that a taxpayer must file all applicable federal, state and local tax returns before a Chapter 13 plan will be confirmed. If the bankruptcy debtor fails to file a tax return that is due after the case begins or to properly obtain an extension by the return due date, the IRS may request a court order converting or dismissing the case.

Most of the provisions of the Act will be effective for bankruptcy filings after October 16, 2005.

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IRS issues guidance on Health Savings Accounts (HSAs).

The IRS issued a revenue ruling explaining the eligibility for HSAs in different scenarios. A married individual who is married to a person who is covered in a non high-deductible health plan (non-HDHP) may still contribute to an HAS, provided he is not covered by his spouse's non-HDHP. (Rev Rul 2005-25.)

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IRAs are protected in bankruptcy, says Supreme Court.

The Supreme Court ruled that IRAs are sufficiently protected so that the accounts are not subject to the claims of creditors in bankruptcy. (Rousey v. Jacoway, US 2005.) This protection is apparently subject to limits under the new Bankruptcy Act.

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Documents for tax shelter case protected by tax practitioner privilege.

A district court has ruled that only one out of several hundred documents requested by the IRS in an investigation of a tax shelter promotion was not protected by tax practitioner privilege. (US v. BDO Seidman, LLP, (DC IL, 3/30/2005, 95 AFTR 2d ¶ 2005-755.))

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Questions and Answers

Question

I have two questions pertaining to Form W-4 (Federal Withholding.)

1. Can you make as many changes as you want to your W-4 form during the year?
   
   
2. Does a W-4 form have to be a perfect copy - no errors or scratched items on it?

Answer

1. You can make changes by submitting new W-4 forms throughout the year. There may be practical issues of having your employer give them effect when computing payroll.
   
   
2. Form W-4 doesn't have to be pristine. However, you can easily get "fresh" copies at the IRS web site, www.irs.gov, so why not do so?

Question

I won a vehicle in an online contest, which I will receive later this year. The amount to reported on Form 1099 MISC will be the invoice price for the vehicle, which is more than I can sell it for. I will also receive some cash, but not enough to pay the taxes.

As I understand it, as an individual, I can't let a loss on the sale offset the gain reported on Form 1099 MISC. Can I create a business for this one transaction?

Answer

No. In order to have a business selling vehicles, you would need to be licensed by the Department of Motor Vehicles.

First, ask if you can receive a cash settlement instead of the car, since you don't want it.

Alternatively, it would be simpler to just challenge the value reported on Form 1099 MISC. Use the Kelly Blue Book to determine the cost for the car and add a profit that you could expect if you negotiated the purchase of the car. You can also pay to have the car appraised. Then disclose why you are reporting a different amount of income from the amount reported on Form 1099 MISC.

Question

Is it true that if you provide more than one-half the support of your grandchildren, you can claim them as dependents?

Answer

Yes. When the grandchildren have living parents, you should coordinate claiming the exemption with them. The IRS can check the social security numbers for the dependents to be sure they aren't being claimed on more than one income tax return.

Question

For a 1031 exchange, do I have to close escrow on the sale of my property before I identify the replacement property? Can I sign a purchase agreement on the replacement property before the first sale is executed? And does the purchase of the replacement property have to be contingent on the sale of the first property?

Answer

I suggest that you retain a qualified intermediary to help you with your exchange, and get a tax advisor to work with. Acquiring the replacement property before the sale of property is a "reverse exchange" requiring specialized help, but it can be done. The purchase of the replacement property does not have to be contingent on the sale of the first property. It might have to be "parked" with the intermediary until it can be determined if the first property is sold.

Question

My parents would like to sell their house to my spouse and me, but they don't want to pay taxes on the sale of the house. Is there a way to just add us to the title and avoid taxes altogether?

Answer

First, do your parents need the cash? In most cases, the $500,000 exclusion for married persons who sell a principal residence will eliminate any tax.

If they don't need the cash, your parents could simply make a gift of the house to you and your spouse, but this should be reported on gift tax Forms 709, and will use part of their lifetime exemption amount.

There are attorneys that can advise you on this. Let me know if you need a referral.

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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 Michael Gray, CPA's Option Alert?

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

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P.S.

My daughter and her husband, Holly and Dan Baker, have 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 and their website address is http://marcheauxfleursrestaurant.com. For the best meal of your life, call 415-925-9200 for a reservation and give them a try! 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.