Michael Gray, CPA's Tax and Business Insight

March 30, 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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We have moved!

Please make a note that we have moved. Our new address is 2190 Stokes St., Suite 102, San Jose, CA 95128, which is about a three-minute walk from our old address. Our telephone numbers, fax number and email addresses remain the same.

Moving has been an adventure. Our telephone system was out of service from Friday, April 27 to Friday, May 4.

We didn’t have internet access from April 27 to May 9. Donna Jeffries says she has over 3,800 emails to wade through!

A big THANK YOU to my brother-in-law, Lane Johnston, who helped me move our filing cabinets and over 100 boxes to our new office.

Things are finally getting settled, but we still have many boxes to unpack. Whew!

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Welcome baby Kara Siemer!

Kara Norrine Siemer was born on April 25. She was five pounds, ten ounces. She is my first granddaughter and second grandchild.

Mother Dawn (Gray) and father John Siemer are thrilled and doing well.

Kara Siemer
Here is Kara

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April was a big birthday month.

With tax season time pressures, I wasn’t able to acknowledge April birthdays for our Michael Gray, CPA family.

My mother, Eleanor Gray, celebrated her 85th birthday on April 20. We feel very blessed to still have her with us, in reasonably good health.

My daughter, Dawn Siemer, celebrated her 33rd birthday, April 23, and her husband, John, celebrated his 33rd birthday on April 19. (Their daughter, Kara, was born on April 25!)

Our temporary administrative assistant, Donna Jeffries, celebrated her 60th birthday on April 21.

Thi Nguyen’s husband, Allen Le, celebrated his 33rd birthday on April 22.

Congratulations, all! Whew, that’s a lot of birthdays!

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Happy wedding anniversary, Holly and Dan!

My daughter Holly Baker and her husband, Dan are celebrating their eighth wedding anniversary on May 15.

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New York and New Jersey counties receive filing deadline extension.

Six counties in New Jersey and three in New York have been declared to be disaster areas because of severe storms and flooding. The counties are Bergen, Burlington, Essex, Passaic, Sommerset and Union in New Jersey and Orange, Rockland and Westchester in New York. 2007 disaster losses can be claimed on 2006 income tax returns for these counties. The IRS has a disaster hotline, 866-562-5227, for taxpayers who were affected by the storm but have a residence or business outside the covered disaster area.

The IRS will waive fees and expedite processing for Form 4506, Request for Copy of Tax Return or Form 4506-T, Request for Transcript of Tax Return for taxpayers in these counties. Write "April 16 Storm" in red ink at the top of the form.

The filing date for 2006 income tax returns has also been extended to June 25, 2007 for these counties.

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Estate tax deductions only allowed for claims and expenses that have been paid.

The IRS has issued proposed regulations that would only allow deductions for claims and expenses that have been paid. In some cases, contested and contingent liabilities may be settled years after an estate tax return is filed, and tax return preparers have been claiming estimates of the final settlement amounts. Under the proposed regulations, deductions for unsettled claims will be reported on a protective claim for refund to keep the statute of limitations open.

>The regulations will become effective when final regulations are published. (REG-143316-03.)

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Company is liable when payroll service doesn’t deposit payroll taxes.

An employer, Pediatric Affiliates, P.A., used a payroll service, PAL data, to process its payroll. Menachem Hirsch, the founder of PAL data, embezzled client funds and didn’t make required payroll tax deposits.

The IRS issued deficiency notices to Pediatric Affiliates. Pediatric initially responded that the payroll tax payments had been made. After more notices were received, Pediatric learned from Hirsch that the payments were not made. Hirsch was later convicted of wire fraud and tax evasion.

Pediatric Affiliates claimed it wasn’t liable for the unpaid payroll taxes, interest and penalties because the funds were embezzled.

The Third Circuit Court of Appeals affirmed a district court ruling in favor of the IRS. A taxpayer’s reliance on a third party to fulfill its tax obligations does not relieve the taxpayer of responsibility for those obligations.

This is a harsh reality of life in our society. You rely on a third party to take care of these obligations to eliminate a headache, but you are not relieved of the ultimate responsibility. If you use a payroll service, it would be wise to request a transcript of your payroll tax accounts from the IRS and state payroll tax authorities (the Employment Development Department in California). Follow up immediately when you receive a notice of deficiency from the tax authorities.

More companies go out of business from failure to pay payroll taxes and sales taxes than from failure to pay income taxes. Some of these items are "trust fund taxes" for which liabilities are non-cancellable in bankruptcy.

(Pediatric Affiliates v. United States, No. 06-1979 (3rd Circuit 4/16/07).)

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"Check the box" regulations held valid.

Under the "check the box" regulations, certain entities, including limited liability companies, can elect to be taxed as partnerships or proprietorships instead of as corporations. If no election is made, the default is to not be taxed as a corporation.

Frank Littriello had several businesses set up as single-owner LLCs in Kentucky. He reported the income from those businesses on Schedule C on his individual income tax returns.

The IRS assessed Littriello for unpaid payroll taxes of the LLCs. The IRS asserted that he was personally liable as a sole proprietor, since he did not elect for the LLCs to be taxed as corporations.

Littriello challenged the validity of the check-the-box regulations, and claimed he should not be personally liable for the payroll taxes.

The Sixth Circuit Court of Appeals affirmed a district court ruling that the check-the-box regulations are valid, and found that Littriello was personally liable for the payroll taxes.

(Littriello v. United States, No. 05-6494 (6th Circuit 4/13/07).)

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Deferred compensation regulations extend to common items.

The IRS has issued final regulations under Internal Revenue Code Section 409A, which relates to non-qualified deferred compensation plans. The regulations apply to items that people might not think of, including severance pay, split-dollar life insurance, non-qualified stock options, stock appreciation rights, and unpaid wages.

My printout of the regulations is 232 pages. Tax advisors should be studying them carefully, and anybody with a business should be consulting with their advisors about how the regulations affect them.

Most "plans" that are covered by the regulations need to be fixed by January 1, 2008. The IRS has not indicated that model documents will be issued, which will create some real headaches for attorneys who help their clients create these documents.

(TD 9321.)

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S corporation shareholder debt benefits limited.

The IRS has issued proposed regulations that would limit the tax basis a shareholder of an S corporation can receive for "open account" debt to $10,000.

The IRS is shutting down the tax benefits of short-term benefits of year-end loans that were upheld by the Tax Court in Brooks v. Commissioner (TC Memo 2005-204).

S corporation shareholders are able to deduct losses for the amount of their tax basis in the corporation, including amounts loaned to the corporation. The proposed regulations would reduce the amount of "open account" loans for which this tax benefit can be claimed.

The regulations would be effective for shareholder advances to an S corporation and repayments on those advances by the S corporation made on or after the date final regulations are issued.

(REG-144859-04 4/12/07.)

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2007 depreciation dollar limits issued for business autos, light trucks and vans.

Here are the annual depreciation dollar limits for "luxury automobiles" placed in service during 2007: $3,060 year 1, $4,900 year 2, $2,850 year 3, $1,775 succeeding years. The limits are reduced for personal use.

Here are the annual depreciation dollar limits for light trucks and vans: $3,260 year 1, $5,200 year 2, $3,050 year 3, $1,875 thereafter. The limits are reduced for personal use.

Heavy SUVs built on a truck chassis rated more than 6,000 pounds gross (loaded) vehicle weight, are exempt from the luxury auto dollar limitations. The maximum Section 179 expense amount for an SUV that is used 100% for business is $25,000.

(Rev. Proc. 2007-30.)

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A marketing legend passes away.

On April 8, Gary Halbert passed away in his sleep. From time to time, I have mentioned him in my "better business idea" articles. Although I never met Gary personally, I was a subscriber to his newsletter for years before he moved it to the web. He had a profound influence in the direct response marketing industry, some of which I have highlighted in a separate article. If you did not receive a copy with this newsletter, call me at 408-918-3161 and I’ll send you one. If you are serious about learning about marketing (and every business is first a marketing business), you must study Gary’s material.

Copywriter Gary Bencivenga has written a beautiful piece about Gary Halbert’s influence at bencivengabullets.com. Internet direct response marketing teacher Ken McCarthy has posted some video clips of Gary Halbert teaching at one of seminars at www.garyhalbertlive.com.

Gary Halbert posted an archive of his newsletters that you can study for free at www.thegaryhalbertletter.com. I especially recommend that you find and study The Boron Letters. Copywriter John Carlton, who is Gary’s likely successor as a teacher of direct response copywriting, has written a letter for the Halbert family about Gary’s passing at the home page of the Gary Halbert Letter web site. John keeps a blog at www.john-carlton.com, and his regular web site is www.MarketingRebel.com.

TWI Press sells Gary’s book, How To Make Maximum Money In Minimum Time at www.twipress.com/productpages/HowToMakeMax.htm.

You might be able to find a set of video tapes of Gary teaching at the Ted Nicholas Self Publishing Seminar on EBay.

These are all worthwhile investments of time and money for the serious businessperson.

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Questions and Answers

Question

I’m an RN raising two grandchildren. Last year, I withdrew my 401(k) to invest it in a home. I didn’t realize that this sum would be added to my yearly income. The combined amount from my wages and the 401(k) put me in a different tax bracket and I had to pay the AMT. I was not financially prepared to pay that amount of taxes.

A 401(k) is accumulated over years, 12 or more in my case. I think it should be taxed separately.

Is the IRS investigating such cases?

Answer

I’m sorry you had this experience. It is a good example why it’s a good idea to consult with a tax advisor and possibly a financial planner when making major financial decisions. If you had done so, the tax consequence could have been calculated in advance, so at least you would have been better informed and known this tax hit was coming. On the other hand, changes were adopted very late during 2006 that might have reduced the amount of AMT you paid compared to if the changes weren’t adopted.

There is a separate tax computation for lump sum distributions from a qualified retirement plan, like a 401(k), if you were born before January 1, 1936 and were a participant in the plan for at least five years before the year of the distribution. The Federal form is Form 4972 and the California form is Schedule G-1. The forms are available at www.irs.gov and www.ftb.ca.gov.

If you qualify, the form can be filed with an amended income tax return.

I hope this helps.

The reason these plans are taxed heavily when you take big distributions is to encourage taking installment payments over a period of years for retirement planning. A five-year averaging computation, available before 2000, was repealed due to government budget bargaining.

If you believe the current scheme is unjust, I suggest that you write to your representatives in Congress.


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. To subscribe and read a sample issue, visit realestatetaxletter.com.

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Visit our new articles!

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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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