Michael Gray, CPA's Tax and Business Insight

June 7, 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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Sorry, our internet connection was out of service.

Everything seemed to be working fine with our DSL internet service until it suddenly switched off on May 18! The service was finally restored on June 4. Sorry for the inconvenience of not being able to receive emails for over two weeks. Donna Jeffries is wading through the backlog.

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Thank you Donna, and welcome back Dawn.

Donna Jeffries is finishing her "tour of duty" as our temporary administrative assistant on June 8, and Dawn is returning from maternity leave on June 18. The plan is for Dawn to work afternoons while Grandma Janet babysits Kara. Dawn is looking forward to taking a break from being a 24/7 mom, and Janet is very excited about spending more time with her granddaughter.

We really appreciated Donna stepping in and stepping up for tax season and for helping us clear out old files from storage. This has also been a challenging period dealing with moving to our new location.

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Second 2007 estimated tax payment is due June 15.

Remember the second estimated tax payments for calendar year taxpayers are due on June 15. If you have a change in your situation or your estimated taxes are based on your 2007 income and deductions, you should contact your tax advisor now.

If we can be of service with this, call Mike Gray at 408-918-3161.

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Now is a good time to finish those extended 2006 income tax returns.

If you filed for an extension of time to file your 2006 individual income tax returns, the extended due date is October 15, 2007. It’s easy to put this project "on the back burner" and wait until the due date to finish the returns.

There is a possibility that waiting until the extended due date could result in missing the deadline and filing late income tax returns. Sometimes an election is made on the return that must be made on a timely-filed return.

Also, penalties and interest may be charged for any unpaid tax finally determined.

Finally, your friendly neighborhood tax return preparer would appreciate having work for their team members to do and to avoid the stress of having a last-minute "crunch" of tax returns during October, requiring working overtime.

So do yourself and your tax return preparer a favor and finish your 2006 income tax returns during June this year.

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Michael Gray speaks on non-qualified deferred compensation plans.

Michael Gray, CPA and attorney Michael Brayton will discuss the final regulations under Internal Revenue Code Section 409A, Non-Qualified Deferred Compensation Plans, at two presentations. One will be a breakfast meeting for the Silicon Valley San Jose Chapter, California Society of CPAs from 8:30 a.m. to 11:30 a.m. at the Los Gatos Lodge. For details, call Stephanie Stewart at 408-983-1122. The second will be a lunch meeting for the Santa Clara County Bar Association from noon to 2 p.m. at the Bar office 31 N 2nd Street, 4th floor in San Jose. For details, call Cindy Gartner at 408-975-2113.

These regulations have a surprisingly broad application, and the penalties for violating these rules are severe. Some items we’ll be talking about include pricing employee stock options, waiver of salary for small business owners, split dollar life insurance and expense reimbursement arrangements, in addition to structuring traditional non-qualified deferred compensation arrangements.

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Do you have a summer remodeling project to finance?

Remember that we can help with setting up equity lines of credit or refinancing a first mortgage to get the cash you need to finance your new kitchen, bathroom or workshop. Call Mike Gray at 408-918-3161 for details.

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Is your interest-only mortgage going to start amortizing?

Yes, mortgage interest rates have increased from a few years ago. But you can have often have a lower mortgage payment by refinancing with a new interest-only mortgage. We can help. Call Mike Gray at 408-918-3161 for details.

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Small Business and Work Opportunity Tax Act enacted.

President Bush approved H.R. 2206, the Iraq emergency supplemental appropriations bill, on May 25, 2007. The legislation includes a minimum tax increase, the Small Business and Work Opportunity Tax Act of 2007, and some technical corrections of pension rules. Here are a few highlights:

As a tax return preparer, I am concerned about the chilling effect the new preparer penalties will have on the ability of tax return preparers to effectively serve their clients. Also, the "excessive claim" penalty is very severe considering the uncertainty of our tax laws. There currently is no "reasonable cause" exception to the penalty. Hopefully, these provisions will be revisited and softened in the future.

Write your representatives in Congress.

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Exchange intermediary goes bankrupt.

An exchange qualified intermediary holds funds for taxpayers who are in the process of completing tax-deferred real estate exchanges. This is an unregulated industry, so there is little protection for the taxpayer. 1031 Tax Group of Richmond, Virginia was doing business as 1031 advance. The company filed for bankruptcy during May, 2007. The company was holding millions of dollars for its clients. If the funds aren’t made available for completing the tax-deferred exchanges within 180 days of the initial transaction, the taxpayers may have big tax bills with no cash to pay them.

This situation is hard to protect oneself against, because this intermediary had an excellent record of providing intermediary services in the past.

Banks can serve as intermediaries and are regulated. I have even seen a client suffer when his exchange funds were embezzled at the bank that was holding the funds.

Beware that you could suffer a loss from improper actions of an intermediary. Consider whether you should request that the intermediary be bonded. If you are considering using an intermediary in an exchange, discuss how you will be protected from a loss in case of the intermediary’s financial difficulty.

Our sympathies to the investors whose funds are in limbo with 1031 Tax Group.

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Questions and Answers

Question

My neighbor is currently trying to sell her house, which was purchased during August 1995.

She was divorced from her husband in September 2004 and she and her children have been living in the house. Her ex-husband moved into an apartment.

When the house is sold, both should receive about $127,000.

Does her ex-husband have to pay taxes on his portion of the sale since he has not resided in the house for about 3 years?

Does the two years principal residence requirement apply to him as one-half owner of the house?

Answer

Congress anticipated this issue, which was a source of litigation under the old sale of residence rules.

Under Internal Revenue Code Section 121(d)(3)(B), an individual is treated as using a residence as that person’s principal residence during any period of ownership when that person’s spouse or former spouse is granted use of the property under a divorce or separation instrument and uses the home as his or her principal residence. (But no double dipping for exclusions for two homes for the same period.)

Therefore, each of the spouses should be entitled to claim a $250,000 exclusion for the gain on their shares of the residence.

Remember, the gain isn’t determined based on what you "receive" from the sale, because a mortgage may be paid off with a portion of the sale proceeds.

Question

A friend of mine sent me your book review on Rich Dad, Poor Dad.

We had a discussion about assets. I have a home with no mortgage.

I believe it is an asset, even though I live in and don’t have to pay anything except taxes and utilities.

My friend says it’s a liability, not an asset, because I live in it.

Can you enlighten us on this issue?

Answer

Kiyosaki doesn’t use terms according to their "standard" meaning in his book.

In accounting literature, an asset is something that exists, that you can own, and that has value. According to that definition, your residence is an asset. The accounting definition of liability is an amount you owe somebody, or a debt.

Kiyosaki is trying to educate us about how to build wealth. According to his definition, an asset is an item that generates income or builds wealth. A liability is an item that consumes wealth. He believes that personal items, such as a residence or a car, are nice to own, but they consume your wealth to maintain them.

Kiyosaki’s concepts are helpful for getting out of the mindset of simply making a livelihood by being an employee earning a salary, and into the mindset of building wealth by accumulating assets that work for you.

Sometimes we can get into word games because a word can mean different things in different contexts. When we do this, we’re creating confusion.

Instead of playing word games, focus on concepts. A personal residence continues to have the same advantages and disadvantages it always has had. It can be a "money pit" and also an inflation hedge. The same residence converted to rental property can be part of a wealth building plan.

I’m sure glad I bought my home back in 1978 and have a much smaller monthly mortgage payment and property tax bill than people who are buying now.


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 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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