Michael Gray, CPA's Tax and Business Insight

February 28, 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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48 days to April 17. Have you made your tax appointment yet?

Tax season is here!

In order for us to prepare your income tax returns and avoid an extension, we should have most of your information by March 15. If you haven't received partnership information or some 1099 forms, send us the information you have to get in the system. When we receive tax information after that date, there is a good chance that an extension of time to file will be required.

To make an appointment, call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Thirty years a CPA.

From my desk, I can see the date on my CPA certificate is March 18, 1977. On March 18, I will have been a CPA for 30 years. We'll have some kind of celebration after tax season is over.

I have had a rewarding career as a CPA and enjoy being of service to clients dealing with life's challenges. I have also enjoyed contributing to my profession by helping other CPAs and attorneys keep up with tax law changes and participating in the California Society of CPAs, including a term as president of the Silicon Valley San Jose chapter.

Since I left the "big firm" scene in 1986, I have had more control of my time to spend more of it with my family, most recently with my grandson, Kyan, on Saturday evenings.

You, our clients, make all of this possible. Thanks!

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First calendar year corporation filing date is March 15.

The initial due date for corporations that have a December 31 year end is March 15. File Federal Form 7004 to apply for an automatic six-month extension of time to file. Remember, the deadline to pay the income taxes is not extended. If you expect an overpayment for your corporation, you can request a "quick refund" of estimated tax using Form 4466. Many corporations decide to file for an extension of time to file simply to extend the due date for making deductible payments to their qualified retirement plans. See your tax advisor for details.

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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 Siemer at 408-918-3162. We must receive your tax information by March 15 to guarantee delivery by April 17.

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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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Is your interest-only mortgage converting to amortized payments?

Some home buyers chose to have interest-only payments for an initial period to keep their monthly payments to a minimum. Usually after three, five or seven years, the mortgage payments increase to reflect current interest rates and to amortize the principal. In many cases, we can help refinance the mortgage to continue an interest-only payment. For details, call Mike Gray at 408-918-3161.

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"Small business tax relief" legislation passes House.

The U.S. House of Representatives passed the "Small Business Tax Relief Act of 2007" (H.R. 976) on February 16. A conference will convene to resolve differences between legislation passed in the House and the Senate. Under the House bill, the expense election for depreciable equipment would be increased from $112,000 to $125,000, and would be extended for one year through 2010. The work opportunity credit would also be extended for one year and would be expanded. A married couple that lives in a non-community property state and jointly owns a small business would be able to elect to file on Schedule C with Form 1040 instead of on a partnership income tax return, and each spouse would pay his or her share of social security tax and medicare tax with Form 1040. The tax breaks would be paid for with offsetting revenue increases, including denying the lowest capital gains rate (5% for 2007, 0% for 2008) to dependent children to prevent wealthy taxpayers from shifting income to their children to avoid taxation on capital gains and dividend income.

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IRS complains of inflated telephone excise tax refund claims.

The IRS has identified inflated telephone excise claims as an abuse item on 2006 income tax returns, and has already raided several tax return preparation companies for originating the claims. The amount of the refund for most taxpayers should be small - less than a couple of hundred dollars. I think people might be confused about how to compute the credit.

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Special school tuition can qualify as a medical expense.

The IRS has privately ruled that the cost of attending a special school for a mentally or physically handicapped individual is a medical expense where alleviation of an individual's handicap is a principal reason for attending the school. (PLR 200704001.)

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Partnership's self-funded health plan is approved by IRS.

A partnership set up a self-funded health plan. The plan is administered by an independent administrator. Premium amounts are set up according to expected claims. Any amounts not used for claims are carried over to the next year to pay future claims. The IRS privately ruled the plan was "an arrangement having the effect of accident or health insurance." Employees may exclude the amounts paid for premiums by the partnership on their behalf. Partners may deduct the premiums paid on their behalf on their individual income tax returns. Amounts paid for claims are excluded from income for partners and for employees. (PLR 200704017.)

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Rollover allowed for settlement award for bad IRA investment advice.

The IRS allowed an individual who received a payment from an IRA brokerage company as an arm's length settlement of a good faith claim of liability to roll the payment into another IRA. The payment was a restorative payment that should be eligible for a rollover. (PLR 200705031.)

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New disclosure forms released for large partnerships.

Certain large partnerships are required to include certain disclosure forms with their 2006 federal partnership income tax returns including:

The forms are Schedule M-3 (Net Income (Loss) Reconciliation for Certain Partnerships), Form 8916-A (Reconciliation of Cost of Goods Sold Reported on Schedule M-3), and Form 8916 (Reconciliation of Schedule M-3 Taxable Income with Tax Return Taxable Income for Mixed Groups).

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Marché aux Fleurs mentioned in Wall Street Journal.

Marché Aux Fleurs restaurant in Ross, California (owned by Dan Baker and Holly (Gray) Baker) was listed as one of the most romantic restaurants in the country for a Valentine's Day dinner in the February 8 issue of the Wall Street Journal. Of course, all of the reservations were already taken when the article was printed! Congratulations, Dan and Holly!

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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.


My primary home is in Northern Virginia and I have a second home in North Carolina. If I sell the North Carolina home, which I've had less than two years, what are the state tax implications?

Also, can I accumulate days to meet the use test for a principal residence?


State tax issues are some of the most complex. Please consult with a local tax return preparer/advisor for help. The sale of the second residence will be taxable in both states. The maximum rate of tax in North Carolina is 8.25%; the maximum rate in Virginia is 5.75%. You will be entitled to a state tax credit on your Virginia income tax return for the North Carolina tax, but the credit will be limited to the Virginia tax with respect to the sale.

You can not accumulate days for the "use test" to determine if a sale is of a principal residence. The residence is tested each year. Generally, in order to qualify for the exclusion the residence must be a principal residence for two of the five years before the sale.

Be careful, because there are side effects of this situation, including possibly being taxed as a resident in more than one state.


I was in the process of buying a home when I changed jobs to a new city. I forfeited my down payment and paid a settlement to the sellers and lawyer's fees. Are any of these expenses tax deductible?


No. These are non-deductible personal expenses.


A client, who is not a CPA, is savvy with accounting, taxes and finance. He believes he is able to prepare his own return, and that the return would likely be prepared identically or similarly if prepared by a CPA. He has business deductions claimed on a Schedule C that would likely attract attention for an IRS audit. Are tax returns prepared by CPAs less likely to be audited than those prepared by the taxpayer? I haven't found any research on this issue.


Some people believe the IRS gives more credibility to professionally-prepared income tax returns because a second set of eyes has reviewed the information. My clients have told me they believe they are getting some audit insurance by having me prepare their returns. I don't have any statistics one way or the other. We have had very few tax audits of our clients over the years. (Knock on wood!)

Occasionally, a tax return preparer who isn't being conscientious gets busted by the IRS. Then the IRS subpoenas the client list and all of the clients get audited. These individuals didn't get the protection they expected.

Also remember the Consumer Reports articles about the wide variation of results for income tax returns prepared by different tax return preparation companies.

So, I don't have a solid answer or even reassurance for those who use a professional tax return preparer.

I still believe that we tax advisors contribute something with our experience and education about the tax laws, at least for a sanity check for our clients.


My wife and I were married on December 31, 2006. She lived with her parents all year because I am in the military. If they claim her exemption, can I also claim her as my wife and file a joint income tax return? What is the best thing to do from a tax point of view?


The general rule is parents can't claim a dependent exemption for a married child who files a joint income tax return unless neither spouse would have a tax liability if they filed separately. If they claim her exemption, you and she will probably have to file separate returns as married, filing separately.

The best thing to do from a tax point of view depends on the detailed circumstances for your individual case. This might be something to discuss with her parents, because they need your cooperation to claim her dependency exemption.


Do resident aliens qualify for the home capital gains exclusion?



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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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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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
Hours: 8am - 5pm PDT Monday - Friday

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