Michael Gray, CPA's Tax and Business Insight

January 31, 2007

© 2007 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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(If you find this information valuable, please pass it on to a friend!)

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Tax season is here! Make your appointment now.

Time has a way of escaping us. There are only about two and one-half months left before the tax return due date. Time to get started now!

If we prepared your income tax returns last year, you should have already received instructions in the mail. If you haven't, please call Dawn Siemer at 408-918-3162.

To have us prepare your income tax returns, start with the online Tax Notebook organizer. Call Dawn Siemer at 408-918-3162 for instructions to get started. We also have a paper organizer, if you prefer that. We still need your documents (W-2s, 1099s, and receipts for donations) to prepare your income tax returns.

We can prepare most income tax returns using information provided online and by mail. If you wish a personal meeting, please call Dawn Siemer at 408-918-3162 to schedule an appointment. Our calendar is filling up fast!

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Happy 66th anniversary, Mom and Dad!

My parents, Aubrey and Eleanor Gray of Saratoga, California, are celebrating their 66th anniversary today, January 31. Last Sunday, we had a family celebration at Mama Mia's restaurant in Campbell. My parents' four surviving children with two spouses, seven of their grandchildren with four spouses, four of their great-grandchildren, and three guests were there. One grandson and his wife, who live in San Diego, and five great-grandchildren and an adopted great-grandchild weren't able to make it.

We feel very blessed to continue to have my parents with us, and are very proud of their achieving a long, successful marriage.

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Welcome, Keyuan Cao!

Keyuan Cao has joined our firm as an intern for this tax season. She is an accounting student at San José State University. Keyuan is married and has a 3 1/2 year old son.

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Yes, we do prepare income tax returns!

With our free newsletters and the information we make available at no charge on the web, some people wonder how we make a living. We prepare income tax returns and provide tax and business consulting services. We are accepting selected new clients and are thrilled when our clients and friends refer their friends, associates and family members to us. To inquire about becoming a client of our firm, please call Dawn Gray at 408-918-3162 or send an email to her at mgray@taxtrimmers.com. We must receive your tax information by March 1 to guarantee delivery by April 15.

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Money on sale! Set up an equity line of credit now.

There are some great opportunities for below prime rate home equity lines with no fees. We think this especially worth considering for seniors, and is almost always a superior alternative to reverse mortgages. To discuss this further, call me at 408-918-3161.

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2007 calendar year tax filing date is April 17.

The IRS has announced that the filing date for 2007 calendar year income tax returns and for the initial 2007 calendar year estimated tax payment is April 17. April 15 falls on a Sunday, and Monday, April 16 is Emancipation Day, a legal holiday in the District of Columbia. (IR 2007-15.)

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Securities trader tax benefits lost from improper election.

Stephen and Patricia Knish and their S corporation, SPK, started day trading securities during 2000. They filed elections to use the mark-to-market method of accounting and be treated as securities traders for 2000 for themselves and their corporation with tax returns filed on the extended due dates during October and September, 2001. The IRS disallowed deductions for ordinary security trading losses, leaving the Knishes with over $5 million in capital losses.

The reason the IRS disallowed the losses was the Knishes didn't make a timely election, as specified in Revenue Procedure 99-17. The election must be filed by the due date for the tax year before the year it is effective. In other words, an election for calendar year 2000 should have been filed by April 15, 2000 for the Knishes and March 15, 2000 for SPK. An election for calendar year 2001 should have been filed by April 15, 2001 for the Knishes and March 15, 2001 for SPK. The due dates for both 2000 and 2001 were missed.

The Knishes also asked for administrative relief to make late elections under Internal Revenue Code Section 9100. The IRS denied relief because it was based on hindsight of the tax results.

The Tax Court upheld the IRS's determinations, denying the benefits of security trader status to the taxpayers. (Knish v. Commissioner, T.C. Memo. 2006-268.)

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Guidance issued for retirement plan rollovers by nonspouse beneficiaries.

Rollovers for nonspouse beneficiaries of qualified retirement plans are allowed after 2006 under the Pension Protection Act of 2006. The IRS has issued guidelines implementing these new rules.

Under the guidelines, a plan may, but is not required to, permit rollovers by nonspouse beneficiaries. Required minimum distributions must be made under the rules that would have applied had the distributing plan not made the rollover to the nonspouse beneficiary's IRA. (Make the required minimum distribution for the year before making the rollover.)

The receiving IRA must be identified as an IRA with respect of the deceased individual and name the surviving beneficiary. Example - "James Smith as beneficiary of John Smith". (Notice 2007-7, 2007-5 IRB.)

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IRS explains transfers by taxpayers over age 70 1/2 to charity.

Nontaxable transfers of up to $100,000 by taxpayers over age 70 1/2 from their IRAs to charities are allowed for 2006 and 2007 under the Pension Protection Act of 2006.

The IRS has issued guidance in applying the new rule.

Since the income isn't taxable for the distribution, no deduction is allowed for the related charitable contribution. The required documentation for a charitable contribution must be received by the taxpayer in order to qualify for the exclusion.

Each spouse can make an election to make a transfer of up to $100,000 from their IRAs.

The direct transfer can only be made from an individual retirement plan other than an "ongoing" SEP or SIMPLE IRA. An "ongoing" SEP or SIMPLE IRA is maintained under an employer arrangement under which an employer contribution is made for the plan year ending with or within the IRA owner's tax year in which the charitable contribution would be made.

The transfer is "counted" as part of the required minimum distribution for the taxable year to avoid penalties for failure to make required distributions. (Notice 2007-7, 2007-5 IRB)

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Decision that non-physical damages aren't income is vacated.

A decision by the District of Columbia Circuit, Court of Appeals that damages for emotional distress unrelated to lost wages are not income and therefore not taxable has been vacated. The Court will be rehearing the issue during April, 2007. (Murphy v. IRS (CA DC 12/22/06, 99 AFTR 2d 2006-324.)

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Hybrid car credit not allowed for AMT.

The IRS has issued a fact sheet reminding taxpayers that the alternative motor vehicle income tax credit may be claimed for regular tax reporting, but not for computing the alternative minimum tax. Many taxpayers who are expecting a tax break from the credit will be disappointed when their income tax returns are prepared. (Fact Sheet 2007-09.)

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Claiming extended deductions on 2006 paper tax forms.

The IRS has announced how three of the tax deductions extended through 2006 by the Tax Relief and Health Care Act of 2006 may be deducted on federal income taxes filed using paper forms.

The sales tax deduction, which may be claimed instead of the state income tax deduction, should be reported on Schedule A, line 5, "state and local income taxes" and the letters "ST" should be written in at the left of line 5.

The deduction for up to $4,000 of tuition and fees paid to a post-secondary institution should be deducted on Form 1040, line 35, "domestic production activities deduction", and the letter "T" should be written on the dotted line next to that entry. If both the tuition and domestic production activities are being claimed, the total should be entered on Form 1040, line 35, the letter "B" should be written on the dotted line next to that entry, and a schedule showing the separate amounts being claimed should be attached to the income tax return.

The deduction for up to $250 of an educator's out-of-pocket classroom expenses should be reported on Form 1040, line 23, "Archer MSA deduction" and the letter "E" should be written on the dotted line next to that entry. If both the educator's expense deduction and the Archer MSA deduction are being claimed, the letter "B" should be written on the dotted line next to that entry, and a schedule showing the separate amounts being claimed should be attached to the income tax return.

(IR 2006-195, 12/22/2006.)

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IRS issues final regulations for depreciation changes.

The IRS has issued final regulations that treat most changes in computing depreciation and amortization deductions as accounting method changes. Only changes from an impermissible to permissible depreciation requires a Section 481(a) adjustment, spreading any additional deduction over several years. For example, recomputing depreciation for a corrected life doesn't require a Section 481(a) adjustment, and any "catch up" depreciation can all be deducted for the year of change.

The final regulations are similar to proposed regulations that were previously issued, and are effective for a change in depreciation made by a taxpayer for a depreciable or amortizable asset placed in service in a taxable year ending on or after December 30, 2003.

(T.D. 9307, 12/22/2006.)

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Simplified procedure issued for depreciation changes.

Concurrently with the final regulations for depreciation changes, the IRS has issued an updated procedure for making depreciation changes. The taxpayer should file a Form 3115 under automatic approval procedures. (Revenue Procedure 2007-16, 2007-4 IRB.)

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President Bush proposes taxing employer-provided health insurance.

In his State of the Union speech to Congress, President Bush proposed to eliminate the exclusion from income of employer-provided health insurance. The exclusion would be replaced by a deduction for up to $15,000 of medical insurance payments for families and up to $7,500 of medical insurance payments for individuals.

Note that Arnold Schwartzenneger is pushing for requiring most California employees to be covered by employer-provided plans for his health care reform proposal.

It may be President Bush will find the exclusion for employer-provided health insurance is a "sacred cow" that will be difficult to change with the Democrats controlling Congress.

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California enforcing withholding for nonresident S corporation shareholders. (Also, a reminder for partnerships, estates and trusts.)

California S corporations should be withholding 7% California income taxes for most distributions to non-resident shareholders. Similar withholding requirements apply for distributions to nonresident partners of California partnerships and for nonresident beneficiaries of California estates and trusts.

A waiver for a maximum of two years may be requested using Form 588, Nonresident Withholding Waiver Request. A reason for waiving withholding is the shareholder consistently files California returns and makes California estimated tax payments.

The waiver can also be used for nonresident partners and for nonresident beneficiaries of California estates and trusts.

The withholding is reported using California Forms 592, 592-A, and 592-B. You can get the forms at www.ftb.ca.gov.

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California taxes installment sales of former residents.

The Franchise Tax Board has approved a proposed regulation taxing former residents on installment sales made while a California resident of intangibles, such as private company stock. This position violates the principle that income from intangibles is taxable in the state of residence. Anybody want to litigate the issue?

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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

I will be retiring this year with a University of California Retirement Plan. I will not be taking the monthly payout but rather a lump sum that I plan to roll into an IRA. I will be taking monthly payments from the IRA starting January, 2008. I will also be moving to Texas in 2008. Will my retirement income be taxed in California while I am here and what about when I move to Texas?

What is "qualified retirement income" that isn't taxable by former residents of California who move to another state?

Answer

Your retirement income received while a California resident will be taxable in California and retirement income after moving to Texas will no longer be taxable by California.

The taxability of certain retirement benefits of former residents who move is governed by Federal law.

Income from the following retirement plans are "qualified retirement income", exempt from California tax after a former California resident moves to another state:

The exclusion also applies to distributions from nonqualified retirement plans described in IRC Section 3121(v)(2)(c) if payments are made at least annually and spread over the actuarial life expectancy of the beneficiaries or spread over at least a 10-year period.

When a former nonresident of California moves and becomes a California resident, all otherwise taxable retirement income received while a California resident is subject to California tax.

Question

I own my own company and am an independent contractor with no employees. I will earn about $60,000 this year.

I want to contribute to a SEP. I file a joint income tax return with my husband. Does that affect my ability to contribute to a SEP?

Answer

No.

Question

My mother was widowed two years ago. She has lived in her residence for 30 years. If she sells her home for $300,000 in Alabama, will she have to pay any tax for the capital gain?

Answer

Since your mother has lived in the house for more than 30 years, she qualifies for a $250,000 exclusion for the sale of a principal residence.

If her husband owned a portion of the residence, she may be entitled to a basis adjustment for the inherited part of the residence, which could eliminate any additional gain.

I suggest that she consult with a local CPA who is familiar with these rules when preparing her income tax return for the year of sale.

Question

I get $600 per month car allowance. How many cents per dollar does the IRS match? I thought it was around 35¢ per mile.

Answer

The IRS doesn't "match" a car allowance. The standard mileage rate for business miles you can account for is 44.5¢ per mile for 2006 and 48.5¢ per mile for 2007.

Car allowances are non-accountable plans, includable in an employee's income and for which employment taxes are computed. The employee claims a miscellaneous itemized deduction for employee business expenses on Form 2106. Two percent of adjusted gross income is subtracted from most miscellaneous itemized deductions, and they are not deductible when computing the alternative minimum tax.


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/optionalert/.

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We also have a newsletter devoted to real estate tax issues.

Like this newsletter, we 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 realestatetaxletter.com.

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Visit our new article!

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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 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 www.taxtrimmers.com/directions.shtml.

They also have a second restaurant, AVA, at 636 San Anselmo Ave., San Anselmo, California. AVA serves food and drinks produced in California. For reservations, call 415-453-3407. The web site is avamarin.com.

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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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Michael Gray, CPA
2190 Stokes St. Ste. 102
San Jose, CA 95128
(408) 918-3162
FAX: (408) 998-2766
Hours: 8am - 5pm PDT Monday - Friday

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