Michael Gray, CPA's Tax and Business Insight

July 1, 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

• Happy July 4!
• Have any summer tax or business initiatives?
• First extended due date for individuals will soon be here.
• Frank Bettger book re-released.
• Internet guru meets tragic early death.
• California domestic partners require special planning for community property.
• Prepare now for Roth contributions to 401(k) plans in 2006.
• Borders hit with California sales tax for internet sales.
• Special education can be a medical expense.
• IRS issues guidance for donations of vehicles.
• Questions and Answers
  • Can we deduct an apartment at a second business location?
  • Can I claim an exclusion for a home sale if I lose my job?
  • Am I responsible for taxes if I have a business name?
  • How much can I contribute to a SEP account?
  • Will long-term capital gains be taxed in 2008?
  • Can I borrow against muni bonds tax free?
• Do you have employee stock options?
• Read our new articles!
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Happy July 4!

Summer has really arrived. The weather reporter says we're going to have a hot July 4 weekend. Hope you enjoy a happy July 4 holiday, as Dawn and I will with our family.

My father, Aubrey Gray, will be celebrating his 87th birthday during July. We are thankful he is still with us and in reasonably good health. My son and youngest child, James, will be celebrating his 25th birthday. (Your children's birthdays are an inescapable reminder of your own age, especially when they reach age 25!)

Thi Nguyen is busy planning her September wedding.

Dawn will be taking an Oceanic Society tour of Peru, taking an Amazon cruise and visiting the Incan ruins at Machu Pichu at the end of July. (Dawn has finished serving on the Grand Jury. Hooray!)

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Have any summer tax or business initiatives?

Although many people are thinking about vacations during the summer, others are busy with transactions like buying and selling real estate or starting a new business. We are here to help with tax planning and setting up accounting systems.

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First extended due date for individuals will soon be here.

Remember the initial extended due date for individual income tax returns is August 15. Now is the time to be finishing up income tax returns for which an extension was filed last April.

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Frank Bettger book re-released.

Frank Bettger, author of How I Raised Myself From Failure To Success In Selling also wrote a companion book, How I Multiplied My Income And Success In Selling, which has been out of print for many years. I just discovered that Amazon is selling a paperback edition of How I Multiplied My Income And Success In Selling at a very attractive price. If you are interested in selling (as all of us should be) or you just enjoyed Frank Bettger's first book, you will want to own and read the second book. Order your copy today!

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Internet guru meets tragic early death.

Corey Rudl, who taught many entrepreneurs how to be more successful marketing on the internet, died in a car-racing accident on June 2, 2005. Corey warmed his students and associates with his enthusiastic presentations. He will be sorely missed, but his team at the Internet Marketing Center have vowed to carry on the business in his memory. David Gehl has stepped in as the successor CEO of IMC.

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California domestic partners require special planning for community property.

Attorney Michael Miller recently gave a presentation to the Silicon Valley Bar Association about potential federal income, gift and estate tax consequences for California Domestic Partners. Effective January 1, 2005, California community property rules apply for California domestic partners. Since the federal gift and estate marital exemptions do not apply for domestic partners, community property received from earnings after the domestic partner union can result in taxable gifts. In addition, one-half of community property earnings of a working domestic partner may be reportable on the income tax return of the other domestic partner.

Although the intentions of the California legislature were good - to extend the protection of community property laws to domestic partners - our income, estate and gift tax laws will make applying the laws a major headache.

Therefore, California domestic partners or people considering becoming domestic partners, should seek legal advice. In most cases, they will be better off adopting "pre-marital" and "post-nuptial" agreements to nullify the California community property rules and substituting trusts, wills, and insurance arrangements to protect the interests of the parties. In order for these agreements to be effective, each partner must be represented by a separate attorney.

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Prepare now for Roth contributions to 401(k) plans in 2006.

Beginning in 2006, some employees will be able to elect to make non-deductible "Roth" contributions to their employers' 401(k) plans. In order to be eligible, the plan must have been amended to accept such contributions. The maximum contribution will be $15,000, plus an additional $5,000 for employees who are age 50 or older. The amounts will be adjusted for cost-of-living increases beginning in 2007.

If you are interested in making these contributions, discuss with the person responsible for communications relating to your employer's plan whether the plan is being amended to accept Roth contributions and indicate your interest to participate.

Although you don't get the "up front" tax benefits of regular 401(k) contributions, the distributions attributable to the non-deductible contributions plus the accumulated earnings for the Roth account can be distributed tax-free. This is especially attractive for younger employees.

Remember any distributions attributable to employer matching contributions to the plan and the accumulated earnings for the taxable account will be taxable income.

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Borders Online hit with California sales tax for internet sales.

The California Court of Appeals ruled that Borders Online must collect California sales tax for internet sales merchandise sales - mostly books. Although the internet operation was set up as a separate corporation, customers were allowed to return merchandise bought online to stores located in California. In addition, there were signs and promotional material for the web site displayed in the California stores. The court ruled this established a sufficient California connection to subject sales by the internet company to California sales tax. (Borders Online, California Court of Appeal.)

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Special education can be a medical expense.

The IRS has ruled that special education for children diagnosed with learning disabilities qualifies as a medical deduction, eligible to be claimed as an itemized deduction on Schedule A. (Letter Ruling 200521003)

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IRS issues guidance for donations of vehicles.

A new tax law passed last year tightens up the documentation requirements for donations of vehicles and limits the deduction to the sale price when the charity sells the vehicle for less than the "Blue Book" value, starting with 2005 donations. The IRS has issued guidance about how the new rules will work. If the charity establishes the vehicle was sold to a needy person for less than fair market value, a deduction will still be allowable based on the fair market value of the vehicle. Charities are generally required to issue a written acknowledgement within 30 days after the date the vehicle is donated. For the beginning of 2005, an acknowledgement issued on or before July 3, 2005 will be accepted. For donations made on or before September 1, 2005 where the car was sold by the charity to a needy person, the acknowledgment may be issued up to October 1, 2005. The IRS has issued Form 1098-C for charities to use to provide the acknowledgement to the donor. (Notice 2005-44.)

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Questions and Answers

Question

Can we deduct an apartment at a second business location?

We have a service and installation business that operates in northern and southern Nevada. We have rented an apartment in southern Nevada, because our home is in northern Nevada.

We have started driving and flying back and forth every other week in order to accommodate our customers in a timely fashion.

The southern location apartment rental will probably be temporary (less than a year) in order to decide where the majority of our business is and where we actually need to reside.

I assume we can deduct the travel expenses, but since we are not paying for a hotel at the Las Vegas location, can we write off the rent, utilities, etc. and can we write off or depreciate the furnishings we bought for the apartment.

Answer

Based on the facts you have provided, I think you should be able to deduct your travel costs and the cost of the apartment. The expense of the apartment is actually a replacement for costs you would otherwise incur if you stayed at hotels.

The danger is you could be found to have two personal residences, neither of which is deductible and for which the travel isn't deductible if this arrangement isn't temporary.

Also for income tax purposes, your residence isn't determined based on your personal living address, but your principal business location.

I recommend that you work closely with a tax advisor to nurse you through this transitional period. Can you afford to separately staff the two locations, instead of doing the work yourself? That would be a better situation.

Question

I have lived in my home for 17 months. I was just told my division of my employer company will be closing December 31, 2005, and I will be unemployed. I want to sell my home now, during the booming summer market. Will I be eligible to claim the exclusion of gain from the sale of my residence?

Answer

This should qualify as an "unforeseen circumstance." Remember the exclusion is reduced when you haven't lived in the home for more than two years.

Question

I recently registered a small business name. Am I initially responsible for any taxation? If I conduct no business, am I accruing tax debt?

Answer

The only tax debts I can think of that you might be "accruing" are for your business license and any personal property taxes. If your business is organized as a corporation, limited partnership or limited liability company, you could also be liable for minimum franchise taxes. You either need to hire a tax consultant or invest the time to study how a small business works and how a small business is taxed.

Question

Can I contribute more to my SEP than the $40,000 deductible amount?

Answer

The maximum contribution was increased to $41,000 for 2004 and $42,000 for 2005. Remember the maximum contribution is 25% of qualifying compensation.

Non-deductible contributions are not allowed in addition to the deductible contributions.

Question

I heard that long-term capital gains won't be subject to federal income taxes in 2008. Is that correct?

Answer

There is a very limited exclusion for long-term capital gains in 2008. It was adopted in the Jobs and Growth Tax Relief Reconciliation Act of 2003.

The zero percent rate applies for individuals in the 10% or 15% brackets. If the law applied in 2004, the maximum taxable income for a single person would be $29,050 or $58,100 for married, filing jointly.

The zero percent rate will provide a special opportunity where tax can be avoided by shifting long-term capital gains by making gifts to children over age 13. The other major beneficiaries of this provision will be retired persons with low income.

Question

I have a muni bond portfolio generating tax-exempt interest income. I'd like to borrow against the portfolio and use the proceeds to start a business. My financial advisor says the interest expense would be non-deductible. I feel that under the tracing rules it should be deductible.

What do you think?

Answer

There is a separate internal revenue code section that applies to "indebteness incurred to purchase or carry tax-exempt obligations". (Section 265(a)(2).) Interest paid relating to such debt isn't deductible.

The courts have ruled that the use of tax-exempt interest obligations as collateral for debt is direct evidence of a purpose to carry the obligations. The reason is the taxpayer could have simply sold the securities to raise the cash.

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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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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.