Michael Gray, CPA's Tax and Business Insight

September 6, 2006

© 2006 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

• Some September family celebrations.
• Back to school.
• Third quarter estimated tax payments are due.
• Extended due date for calendar year corporations is coming.
• Not much time left for calendar year non-corporate taxpayer income tax returns.
• Pension Protection Act of 2006 is enacted.
• Kennedy conference concepts.
• Telephone excise tax standard refund amounts announced.
• Medicare refund checks issued in error.
• Final HSA regulations issued.
• SOX deadline extended for small companies and foreign issuers.
• Taxation of award for non-physical injury ruled unconstitutional.
• IRS says medical reimbursement plan is taxable.
• "Spoil sport" IRS says goodie bags are taxable income.
• Questions and Answers
• Sale of principle residence answers.
• Are US mutual funds subject to US estate tax for a nonresident alien?
• Is my inheritance from a Chinese relative taxable in the US?
• How do I claim a mileage deduction for my business driving?
• Do I have to pay taxes on an IRA withdrawl if I give it away?
• Do you have employee stock options?
• Do you have real estate tax issues?
• Read our new article!
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Some September family celebrations.

On September 25, my grandson, Kyan Gray Baker, will be celebrating his second birthday. On September 16, Holly Baker, who is Kyan's mom and my daughter, will be celebrating her 31st birthday.

Kyan Baker will be two years old September 25

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Back to school.

Didn't summer go by quickly? Now Labor Day is over and most kids are back to school. Drive extra carefully.

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Third quarter estimated tax payments are due.

The third quarter estimated tax payment for calendar year entities, including most individuals, is due on September 15. Some taxpayers with irregular income make payments based on their actual information for the year. If this applies to you, get in touch with your tax advisor now. If we can be of service to you in this area, call Dawn Siemer at 408-918-3162 for an appointment.

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Extended due date for calendar year corporations is coming.

The extended due date for calendar year C and S corporations is September 15. That is also the extended due date for making deductible employer payments to qualified corporate retirement plans, including defined benefit plans, profit sharing plans, ESOPS and 401(k) plans. If this due date applies to you, hopefully you have everything well under control by this time.

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Not much time left for calendar year non-corporate taxpayer income tax returns.

The extended due date for calendar year noncorporate taxpayers, including most individuals, partnerships, estates, and trusts is October 15. That is also the extended due date for making deductible employer payments to qualified retirement plans of these entities, including Keoghs, SEPs, defined benefit plans, profit sharing plans, ESOPS and 401(k) plans. The extended due date for 2005 gift tax returns is also October 15. This is a critically important due date, so please be sure your income tax returns are filed on time. In some situations, penalties can even be imposed when there is a tax overpayment. If we can be of service to you in this area, call Dawn Siemer at 408-918-3162 for an appointment.

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Pension Protection Act of 2006 is enacted.

President Bush signed the Pension Protection Act of 2006 on August 17, 2006. This is a big tax act that goes beyond pension provisions. You should consult with your advisors about the impact of the new laws relating to retirement plans, distributions from IRAs and retirement accounts, donations to donor advised funds, charitable contributions, tax exempt organizations and employee benefits. There are many provisions for which state tax laws will need to be updated or state tax penalties could apply. Here are just a few highlights.

• Up to $100,000 per year may be excluded from taxable income as qualified charitable distributions from an IRA for 2006 and 2007. Distributions from a SEP or SIMPLE won't qualify. The payments must be made directly from the IRA trustee to a qualified charity. In order to qualify, the IRA owner must be at least age 70 1/2. (According to Spidell Publishing, California automatically conforms to this provision.)



• Nonspouse beneficiaries of qualified plans, tax sheltered annuities and government plans will be able to roll over a deceased employee's account to an IRA, and then take distributions according to the life expectancy of the nonspouse beneficiary. In the past, only beneficiaries who were surviving spouses could do this. The rollover must be accomplished by a trustee-to-trustee transfer. This new benefit is effective for distributions after 2006.



• After 2007, conversions directly to Roth IRAs from qualified retirement accounts, Section 403(b) annuities and Section 457 government retirement plans will be permitted, provided the taxpayer meets the AGI requirements that currently apply to conversions from regular IRA accounts. Of course, any amounts other than returns of non-deductible employee contributions will be taxable.



• Retirement and IRA provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) are made "permanent". These provisions were previously scheduled to expire after 2010. An example of a provision that was scheduled to expire is the Roth 401(k) account. Another example is increasing the contribution limitation for profit sharing plans from 15% of compensation to 25% of compensation. The maximum contributions for IRA and qualified plans were also increased by EGTRRA. Making these provisions permanent should provide an incentive for the states that impose income taxes to conform with the federal tax laws. Also, long-term planning with qualified retirement plans was impossible before the sunset date was eliminated.



• Effective for plan years beginning after December 31, 2007, 401(k) plans may provide that covered employees are automatically enrolled in the plan at pre-set participation levels (percent of compensation) unless the employee elects not to be covered. (Now employees must elect to make salary reduction contributions; in the future employees of employers whose plans provide for automatic enrollment will have to elect out.)



• Defined benefit plans and money purchase pension plans will be able to make distributions to an employee who has reached age 62 and continues to work for the employer, effective for distributions made in plan years beginning after December 31, 2006.



• The vesting schedule for employer contributions to defined contribution plans (profit sharing, money purchase and ESOPs) will be accelerated. Before the change, employers had a choice of five year vesting or three to seven year vesting (20% vested year 3, 100% vested year 7.) After the change, employers will have a choice of three year vesting or two to six year vesting (20% vested year 2, 100% vested year 6.) The new schedule will generally apply for employer contributions made for plan years beginning after December 31, 2006.



• Employees will be able to get fee-based investment advice for managing the assets in their 401(k) accounts and IRAs. Plan fiduciaries will be able to provide these services without violating the prohibited transaction rules. Plan sponsors who permit this service will not treated as violating ERISA's fiduciary duties. Effective for investment advice rendered after December 31, 2006.



• Effective for donations made in taxable years beginning after August 17, 2006, the documentation rules for charitable contributions have been tightened up. In order to claim a deduction for a monetary charitable contribution of any amount, the donor must have a bank record or a receipt from the donee showing the amount, date and name of the donee organization. These rules favor donations by check or credit card. Remember there are additional documentation requirements for donations of $250 or more.



• The requirements for non-cash donations by individuals, partnerships and S corporations of clothing and used household items to qualified charities are also tightened up. No donation is allowed unless the item is in good used condition or better. The Act specifically says that used socks and underwear won't qualify. The IRS may also specify items of minimal value that won't qualify for a deduction. However, if the taxpayer gets a written appraisal of the items, these limitations won't apply. This new rule applies for donations made after August 17, 2006. (That's NOW!)



• Effective for donations of tangible personal property exceeding $5,000 on or after September 1, 2006, if a donee organization sells a donated item for which an above basis amount is being claimed as a deduction because the item was previously represented to be used by the charity in its exempt function during the year of donation, the deduction is reduced to the tax basis of the item. If the donee organization sells the item after the year of donation but within three years after the donation, the excess of the donation deduction over the tax basis of the item is recaptured as income in the year of sale. The reduction or recapture can be avoided if the charity provides a written certification, under penalties of perjury stating (1) how the property was to be used for its charitable function; and (2) that the charity intended to use the property for such purpose at the time of donation, but the intended use has become impossible or infeasible to implement.

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Kennedy conference concepts.

Dawn and I attended Dan Kennedy's Renegade Millionaire Conference during August. One recurring theme was simultaneous vs. sequential. The Renegade Millionaire takes massive action, implementing many initiatives at once. Two key ways of accomplishing this are time management - accomplishing more in a period of time, and multiplying yourself through employees, outsourcing and joint ventures.

Another recurring theme was the importance of working with a Mastermind Group of peers to create accountability and feedback for accomplishing goals.

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Telephone excise tax standard refund amounts announced.

The IRS has announced standard amounts of refunds for the telephone excise tax on long distance service. Individuals will be able to claim the standard amounts without digging out old telephone bills. The standard amounts are $30 on a tax return claiming one exemption, $40 for two exemptions, $50 for three exemptions and $60 for four or more exemptions.

The refund will be claimed on a line of the 2006 individual income tax return.

Standard amounts haven't been determined for business and nonprofit returns. The IRS is working on how these taxpayers can estimate the refund amount without having to dig through their telephone bills. (Imagine putting together a claim for IBM or General Motors!)

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Medicare refund checks issued in error.

The federal government has issued refund checks to about 230,000 Medicare recipients for monthly premiums paid during 2006 for prescription drug coverage. A letter was included with the checks that says their monthly premiums will no longer be deducted from their Social Security checks.

Some of the refunds were directly deposited to the bank accounts of Social Security recipients.

Both the refund check and the letter are in error. The refund has to be returned, and the premiums will continue to be deducted from Social Security checks.

A second letter was sent about August 22 notifying refund recipients about the problem.

It will take months to straighten out this mess. Meanwhile, the government has assured Medicare participants that their benefits will continue, uninterrupted.

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Final HSA regulations issued.

The IRS has issued final regulations for employer contributions to employee Health Savings Accounts (HSAs). A 35% excise tax is imposed on an employer that fails to make comparable contributions to the HSAs of its employees. Since HSAs are so new, employers and their tax advisors should study these regulations. The final regulations will apply to employer contributions to HSAs made on or after January 1, 2007. (T.D. 9277.)

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SOX deadline extended for small companies and foreign issuers.

The SEC has issued two releases that give smaller U.S. companies and many foreign private issuers more time to comply with Section 404 of the Sarbanes-Oxley Act.

Under the first draft proposal release, the initial reporting date for assessing the effectiveness of internal controls for smaller public companies would be extended from fiscal years ending on or after July 15, 2007 to December 15, 2007. The reporting date on the auditor's attestation on internal controls would also be extended from the first annual report for a fiscal year ending on or after December 15, 2007 to December 15, 2008.

Under the second final release, the due date for the auditor's attestation report on internal controls for foreign private issuers is extended to July 15, 2007.

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Taxation of award for non-physical injury ruled unconstitutional.

The Court of Appeals for the District of Columbia Circuit reversed a district court ruling and found that the federal income tax on an award to an employee for a non-physical injury was unconstitutional. Since the award was unrelated to lost wages or earnings, taxing the award is unconstitutional. The award is not "income". The compensation was expressly awarded only for mental pain and anguish and injury to professional reputation. This ruling will probably be appealed to the Supreme Court. (Murphy v. IRS (CA DC 8/22/2006), 98 AFTR 2d 2006-5357.)

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IRS says medical reimbursement plan is taxable.

An employer provided a medical reimbursement plan to its employees and retired employees from which medical expenses of the employee, the employee's spouse and dependents of the employee and employee's spouse were reimbursed. In the event the employee and employee's spouse and their dependents were all deceased, any unpaid reimbursements were to be paid to a beneficiary designated by the employee. The IRS ruled that, since benefits can be paid to someone other than the employee, employee's spouse or a dependent after death, the medical reimbursement plan is disqualified from exclusion from income, so reimbursements will be taxable income to the employee.

For reimbursement plans containing a provision on or before August 14, 2006, stating that on the death of a deceased employee's surviving spouse and last dependent, or on the death of the employee leaving no surviving spouse or dependents, any unused reimbursement amounts will be paid to a beneficiary designated by the employee, the revenue ruling is effective for plan years beginning after December 31, 2008.

Employers with uninsured medical reimbursement plans should have them reviewed relating to this provision. Presumably, payments to the estate of the employee, surviving spouse or dependent should be OK. This may not be the last word on this subject. (Rev. Rul. 2006-36.)

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"Spoil sport" IRS says goodie bags are taxable income.

The IRS has reached an agreement with the Academy of Motion Picture Arts and Sciences that recipients of gift baskets at this year's Academy Awards will receive information returns notifying them of the taxable value of the baskets to be included in taxable income. The IRS has issued a reminder to celebrities to report the value of gift items received at award shows and other gatherings. (IR-2006-128 (8/17/06).)

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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?" (realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.

Question

1. Are US mutual funds (invested in US stocks) or cash savings in a US bank account subject to US estate tax for a non-resident alien?
2. What are the gift tax rules for a non-resident alien? Is a gift of US mutual funds subject to US tax? Is a gift of international mutual funds subject to US tax? Is a cash transfer between non-resident aliens subject to US gift tax?

Answer

1. Stock of US domestic corporations are subject to US estate tax. Funds deposited by or for a nonresident alien in a US bank (including a domestic banking branch of a foreign corporation) are not subject to US estate tax unless they are effectively connected with the conduct of a trade or business within the US by the decedent.
2. Gifts of intangible property by non-resident aliens are generally exempt from US gift tax. (Internal Revenue Code Section 2501(a)(2).) There is an exception for former citizens or long-term residents of the US who expatriate after June 3, 2004 for transfers made during the 10-year period following relinquishment of citizenship or long-term residency.

You should also consult with a tax advisor about any tax treaty between your country and the US, which can supercede US tax law.

Question

I am receiving a large inheritance from a Chinese relative who has recently passed away. The funds will be transferred to my bank account in America. What taxes will I have to pay to the American government? I was told by a lawyer in China that the taxes could be paid in China as opposed to paying to the US.

Answer

U.S. transfer taxes are generally imposed on the transferor (the decedent's estate). Unless your relative had stock of a US company, US bonds, real estate or a business in the US, US estate tax shouldn't apply. An inheritance is not subject to US income tax, except for income received after the decedent's death.

Check with a local tax advisor about state tax consequences of your inheritance.

Question

I use my own vehicle on my job as a commercial building maintenance person. I anticipate driving about 20,000 miles this year. I want to claim the mileage deduction. I am not getting reimbursed. What kind of documentation (mileage records) do I have to keep?

Answer

I recommend that you keep a mileage log showing the date, beginning and ending odometer readings and the customers visited during the day. If you stop at the home office at the beginning and the end of the day, the mileage to and from the home office is non-deductible commuting expense. If you don't stop at the home office and assuming your customers are local, the mileage to your first customer and from your last customer is non-deductible commuting expense. Note your odometer readings at the beginning and the end of the year.

You might have bigger deductions by actually keeping track of your vehicle expenses, including insurance, interest expense, fuel and repairs.

Remember that employee business expenses are miscellaneous itemized deductions. You have to have enough deductions to itemize, and two percent of your adjusted gross income is subtracted from your miscellaneous itemized deductions. Also, employee business deductions are not allowed when computing the alternative minimum tax. These are high hurdles to qualify for the tax deduction. You are much better off if your employer reimburses you for these expenses.

Question

If I make a withdrawal from a traditional IRA account and give the money to my mother as a gift, do I have to report taxable income from the withdrawal? Would I responsible for paying income taxes on it?

Answer

Giving the money to your mother doesn't shift the income tax burden to her. The IRA is personal to you. Any amounts that you withdraw from it will be taxable to you. Remember penalty taxes can apply if you withdraw funds from an IRA before reaching age 59 1/2.

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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 www.stockoptionadvisors.com/subscribe.shtml.

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We are starting a newsletter devoted to real estate tax issues.

Like this newsletter, we will talk about new developments, have reports on special tax concerns, and answer questions and answers. The subscription rate is $19.95 per month. For a sample issue, visit www.realestatetaxletter.com.

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Visit our new article!

• How to Sell at Margins Higher Than Your Competitors book review

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.

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.