Michael Gray, CPA's Tax and Business Insight

September 14, 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

• September firm and family news.
• Have you made a donation for Katrina hurricane victims?
• The year is two-thirds over. How are things going?
• September 15 estimated tax payment.
• Final individual tax return deadline is October 17.
• Tax relief extended to Katrina victims.
• Remember teachers-save your receipts.
• Standard mileage rates increase.
• Form released for donations of cars, boats and airplanes.
• IRS disallows favorable valuation method for conversion of IRA annuities to Roth IRAs.
• Deadline extended to request change of accounting method.
• IRS shuts down "springing value" life insurance arrangements.
• KPMG makes settlement for tax fraud charges.
• Points for mortgage for home improvements deductible in year paid.
• Energy and Transportation Acts include important tax breaks.
• California passes conformity legislation.
• Questions and Answers
  • Can we qualify as "part year residents" in California?
  • Are there any tax breaks for long commutes?
  • Where can I get more information about tax liens?
  • Can I deduct losses in my Roth account without liquidating?
  • Will I have to report a capital gain for selling my residence?
  • Can stock be transferred to an IRA?
  • Will there be a tax consequence of giving part of my house?
  • How do I report earnings from flower shop deliveries?
• Do you have employee stock options?
• Read our new articles!
• PS Marché Aux Fleurs
• Subscribe to Michael Gray, CPA's Tax & Business Insight

September firm and family news.

Janet and I returned from Scotland on September 2. I share some of the details in An American In Scotland, included with this newsletter.

Thi and Allen were married on September 3 and had a huge, Asian-style reception. She was a gorgeous bride. It was an exciting (and exhausting) day. Congratulations, and good luck!

My grandson, Kyan, will be celebrating his first birthday on September 25 and "Mommy" Holly will be celebrating her 30th birthday on September 16.

Like many other young people, my son James has returned to school. He is working on his master's degree in philosophy at San Jose State University with a goal of eventually becoming a professor of philosophy.

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Have you made a donation for Katrina hurricane victims?

There have been lots of opportunities. Refer to your local newspaper for addresses of legitimate charities, such as the American Red Cross or the Salvation Army. Many "scam" sites have been set up on the internet, so be extra careful when making online donations.

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The year is two-thirds over. How are things going?

As we move into the last third of the year, the picture should be becoming fairly clear about your business or financial situation. Consider meeting with us to work on your tax plan for the balance of the year.

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September 15 estimated tax payment.

The due date for the third estimated tax payment for calendar-year taxpayers (including individuals) is September 15. Hopefully you have already made this payment.

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Final individual tax return deadline is October 17.

October 17 is the final extended due date for non-corporate calendar year taxpayers, including individuals, estates, trusts and partnerships. If you haven't given the information to prepare your returns to your professional tax return preparer yet, do it now. The penalties for late filing are becoming more severe, especially in California, where penalties apply even when there is no balance of tax due. Real hassles can be avoided by simply filing your tax returns and paying your taxes on time.

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Tax relief extended to Katrina victims.

The IRS has extended relief provisions to 64 Louisiana parishes, 52 Mississippi counties, 6 Alabama counties and 3 Florida counties.

Affected taxpayers have until October 31, 2005 to file tax returns that would otherwise be due on or after August 29, 2005. "Hurricane Katrina" should be written in red at the top of the tax return. No interest or penalties will be charged for affected taxpayers who pay the balance of the related tax liabilities by October 31, 2005.

The due date for the third quarter estimated tax payment for affected taxpayers is extended from September 15 to October 31, 2005.

Affected businesses will have until September 23 to make federal tax deposit payments without penalty that would otherwise be due on or after August 29, 2005.

The IRS has said it expects the deadlines may be extended even further for the hardest-hit areas.

If a taxpayer resides outside the disaster areas but its books, records or tax practitioner resides within the disaster area, the IRS may waive penalties under the above conditions.

(IR 2005-91.)

Remember that taxpayers who live within a Presidentially-declared disaster area may elect to claim casualty losses on the tax return for the previous year.

Qualified disaster relief payments can be excluded from taxable income under Internal Revenue Code Section 139.

In addition, gains from certain casualty-related recoveries can be rolled over to replacement property on a tax-deferred basis under Internal Revenue Code Section 1033.

There have been many other relief announcements that are beyond the scope of this newsletter. Consult with a tax advisor to learn what might apply to your situation. The IRS has a hotline for Katrina victims, 1-886-562-5227. The hotline is available from 7 a.m. to 10 p.m. local time. The IRS is offering Disaster Tax Loss Kits. (IR 2005-88.)

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Remember teachers -- save your receipts.

Teachers will be able to deduct up to $250 of qualified unreimbursed school-related expenses on their 2005 income tax returns. The IRS has issued a reminder that teachers should save their receipts for these expenses now to be prepared for assembling the information required next tax-filing season. (IR-2005-82.)

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Standard mileage rates increase.

The IRS has announced increases for the optional standard mileage rates effective for miles driven from September 1, 2005 through December 31, 2005. The business mileage rate is increased to 48.5¢ from 40.5¢ per mile. The rate for deductible medical and moving expenses is increased to 22¢ from 15¢ per mile. (Announcement 2005-71.) The rate for charitable use of a vehicle was set by Congress at 14¢ per mile.

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Form released for donations of cars, boats and airplanes.

The IRS has released new Form 1098-C, Contributions of Motor Vehicles, Boats and Airplanes. Donee organizations will report donations of cars, boats and airplanes to the IRS using this form. The form can also be used to provide a contemporaneous written acknowledgment to donors who contribute a car, boat or airplane to a charity during 2005 and claiming a value exceeding $500. The form should not be used when the value is at least $250 but not more than $500 - a separate written acknowledgement should be issued for those donations.

Form 1098-C should be issued to the donor no later than 30 days after: (1) the date of the sale (if the vehicle is sold to an unrelated party); or (2) the date of the contribution (if the vehicle won't be sold before the completion of material improvements or significant intervening use or will be transferred to a needy person at a price significantly below fair market value in furtherance of a charitable purpose.)

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IRS disallows favorable valuation method for conversion of IRA annuities to Roth IRAs.

The IRS has issued temporary and proposed regulations clarifying that IRA annuities or annuities held within an IRA should be valued at full fair market value of the annuity contract, not cash surrender value, in determining the amount taxable when the IRA is rolled over or converted to a Roth IRA. The new rules are effective for conversions on or after August 19, 2005. (TDNR JS-2689, T.D. 9220.)

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Deadline extended to request change of accounting method.

The IRS has changed its procedures for requesting a change of accounting method. Previously, the change of method form (Form 3115) was required to be filed within the first 180 days of the tax year. Now the form can be sent any time during the first year that the change would apply. (Rev. Proc. 2005-63.)

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IRS shuts down "springing value" life insurance arrangements.

The IRS has issued final regulations about how transfers of life insurance from employers or from retirement plans are valued. Under the new regulations, the insurance should be valued at fair market value, not cash surrender value. The regulations were adopted to shut down a practice of crediting the cash surrender value of policies after transfer by the employer or retirement plan to the employee. (TD 9223.)

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KPMG makes settlement for tax fraud charges.

Big Four CPA firm KPMG has admitted criminal wrongdoing and agreed to pay $456 million in fines, restitution and penalties in an agreement to defer prosecution by the U.S. Justice Department for a multi-billion dollar criminal tax fraud conspiracy. The fraud generated at least $11 billion in phony tax losses, which may have cost the U.S. at least $2.5 billion in evaded taxes.

The agreement imposes permanent restrictions on KPMG's tax practice, including permanently imposing higher tax practice standards in issuing certain tax opinions and preparing tax returns. KPMG is also banned from being involved with pre-packaged tax products and restricts KPMG's use of fees not based on hourly rates. An independent, government-appointed monitor will be installed to oversee KPMG's compliance with the agreement.

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Taxpayer wins! Points for mortgage for home improvements deductible in year paid.

The Tax Court has ruled in favor of a taxpayer who deducted points for refinancing a mortgage in the year paid when the money saved from reduced mortgage payments as a result of paying the points was used for home improvements. The Tax Court said that since the taxpayer's refinancing was in connection with home improvements, the points were deductible in the year paid. (Hurley v. Commissioner, T.C. Summary 2005-125 (8/16/05).)

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Energy and Transportation Acts include important tax breaks.

With rising energy costs after Katrina, taxpayers should consider the breaks for energy conservation included in the Energy Tax Incentives Act of 2005 and Safe, Accountable, Flexible, Efficient Transportation Equity Act of 2005. Most of the provisions will be effective in 2006.

• A tax credit of up to $500 is available to individuals for nonbusiness energy property. The credit is equal to (1) residential energy property expenditures plus (2) 10% of the cost of qualified energy efficiency improvements installed during the year at the taxpayers principal residence in the United States. No more than $200 of the credit can be based on expenditures for windows. The credit relates to improvements placed in service during 2006 and 2007.
  
  
• A tax credit is available to help taxpayers pay for residential alternative energy equipment. The residential alternative energy credit is 30% of the cost of eligible solar water heaters, solar electricity equipment and fuel cell plans. The maximum credit is $2,000 per tax year for each category of solar equipment and $500 for each half kilowatt of capacity of fuel cells installed per tax year. Cooperative and condominium dwellers can split the cost of installing equipment with other unit owners. To qualify, the equipment must be placed in service after December 31, 2005 and before 2008.
  
  
• A tax deduction is available for energy-efficient commercial building property placed in service after December 31, 2005 and before January 1, 2008. The maximum deduction is $1.80 per square foot of the building, less the total amount of deductions previously claimed with respect to the building in previous tax years. The improvements must reduce energy costs by 50% or more in comparison to a reference building that meets the minimum requirements of Standard 90.1-2001. In order to qualify for the full deduction, the overall cost reduction plan must target all of the systems identified in Internal Revenue Code Section 179D(c)(1)(D), including interior lighting, heating, cooling, ventilation and hot water supply systems.
  
  
• The non-refundable business credit for solar energy property is increased from 10% to 30%. The credit applies to (1) solar equipment for generating electricity or to heat or cool or provide hot water for use in a structure, or to provide solar process heat, or (2) equipment which uses solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight. Property using solar energy to heat swimming pools isn't eligible for the credit. The credit applies for solar energy property placed in service after December 31, 2005 and before January 1, 2008. The credit is a component of the general business credit, which may not exceed the excess of the taxpayer's net income tax over the greater of (1) 25% of the net regular tax liability exceeding $25,000 or (2) the tentative minimum tax. Unused general business credits may be carried back one year and forward 20 years.
  
  
• The research credit relating to qualified energy research is modified so the taxpayer may claim a credit equal to 20% of amounts paid or incurred by the taxpayer during the tax year to an energy research consortium. 100% of amounts paid or incurred by the taxpayer to an eligible small business, a university or a Federal laboratory for qualified energy research constitute contract research expenses. This provision is effective for amounts paid or incurred after August 8, 2005. (Note the credit for increasing research activities will expire on December 31, 2005, unless Congress takes further action.)
  
  
• A series of credits have been enacted to encourage the use of alternative fuel motor vehicles. The taxpayer will be able to claim the credits when the original use of the vehicle begins with the taxpayer and the vehicle is acquired for use or lease by the taxpayer and not for resale. The most widely-used credit will initially be for hybrid motor vehicles and advanced lean burn technology motor vehicles. The credit will vary based on the fuel economy of the vehicle from $400 to $2,500. The credit may be increased by a conservation credit, based on estimated lifetime fuel savings for advanced lean burn technology motor vehicles, from $250 to $1,000. The credit is also being limited to a total of 60,000 vehicles sold after December 31, 2005 per manufacturer.

These are a few highlights of the new provisions, and there are many more. You should consult with your tax advisor to learn more details about these provisions and others that may apply to you.

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California passes conformity legislation.

The California legislature has passed legislation that would change the date that the California Revenue and Taxation Code conforms to the federal Internal Revenue Code from January 1, 2001 to January 1, 2005. Governor Schwarzenegger hasn't signed the legislation yet. Under the new legislation, California will conform to the federal uniform definition of a child, which will disqualify many individuals filing as heads of household. Corporations will be able to expense up to $25,000 of equipment under Internal Revenue Code Section 179. California still has not adopted the passive activity loss exemption for real estate professionals or Health Savings Accounts. (AB 115)

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Questions and Answers

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" where you should be able to find the answers to most of your questions.

Question

We used to live in New Jersey, but are looking for a new home with a better climate. We like California, but also have family in Canada/BC.

If we live in Canada for six months and in California for six months, can we qualify to file as "part year residents"?

Answer

The "part year resident" status is mostly designed for people moving to California or out of California, and for people who are temporarily working in California.

It will really complicate your tax status to live in two different countries, let alone two different states/provinces.

If you still think you would like to pursue this idea, I suggest that you have a paid consultation with a tax advisor familiar with the issues. Also, consider states that don't have income taxes like Washington, Nevada, Texas or Florida.

Question

I was recently forced to make a change in my employment. My new employer is located 130 miles from my home, compared to 16 miles from my former employer. Are there any tax breaks for long commutes?

Answer

Commuting expenses aren't tax deductible. There are some breaks for bus passes, but I don't think that will solve your problem.

Consider moving closer to your new employer (moving expenses are a deduction as an adjustment to gross income), or look for other employment located closer to your home.

Good luck!

Question

Today I received The 16% Solution. Are the principles and techniques in the book relevant today? Any update?

Answer

I'm not an expert on Tax Lien Certificates. The book includes telephone numbers you can call for updates in the various states where tax lien certificates are offered. Call them.

Question

I list $2,000 on an investment held in a Roth account. The investment represents about 14% of the account. Can I deduct the loss without totally liquidating the account?

Answer

No. You must totally liquidate ALL of your Roth accounts to report a loss. Not only that, losses from totally liquidated Roth accounts are miscellaneous itemized deductions, and are reduced by 2% of adjusted gross income. See IRS Publication 590.

Question

Will I have to report a capital gain for selling my co-op residence? I lived there just under two years and bought a bigger house. The gain would be under $200,000.

Answer

Unless you qualify for one of the exceptions for a partial exclusion, such as selling the home relating to being employed in another location or relating to a divorce, you have not met the requirements for the exclusion and the gain is taxable.

Question

My husband transferred some shares of stock received in a class action suit as an IRA contribution.

My broker tells me that stock can't be transferred to an IRA. Is there an exception to this rule? I have a few shares of stock that I also would like to contribute to my IRA.

Answer

IRA contributions must be made in cash. (Internal Revenue Code Section 219(e)(1).)

The only exception is that when property is received as a distribution from an IRA that is later rolled over to another IRA, the property must be rolled over intact. (Section 408(d)(3)(A)(ii).)

Question

I own a house in my name only and want to quitclaim 50% to my significant other. Will there be a tax consequence?

Answer

Quitclaiming the interest is a taxable gift. There is no marital deduction for interests given to a significant other. If the transfer is for services rendered, it's taxable income. I recommend that you consult with an estate planning attorney to find alternative ways to provide security for your significant other.

Question

I retired 14 months ago and took a part time job as a delivery person for a small flower shop. The owner pays me in cash and it's my responsibility to report the income on my tax return.

I use my own car for the deliveries, and I'm not reimbursed for the mileage.

How should I report the income on my income tax returns? Can I deduct a mileage allowance for using my car?

Answer

Why get yourself involved in an arrangement that creates tax issues? Isn't there another flower shop in the area that is willing to report the arrangement properly?

Under your current arrangement, you can try reporting the income on Schedule C and claim a business expense for your mileage of 40.5¢ per mile to August 31, 2005 and 48.5¢ per mile for the rest of 2005.

Thanks to information sharing after September 11, 2001, your city may contact you and request that you apply for a business license.

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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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Visit our new articles!

• How to Position Yourself As The Obvious Expert book review
• An American in Scotland

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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.