Michael Gray, CPA's Tax and Business Insight

September 5, 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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Autumn will soon be here.

Hope you had a safe and happy Labor Day weekend. I’m working on this newsletter on Labor Day because of the short work period before September 15.

Labor Day weekend is a crazy "last hurrah". Yesterday we were stuck in traffic for two hours going to and then two hours returning from the wharf at Santa Cruz for dinner with my parents. I can’t remember seeing bumper to bumper traffic at ten o’clock at night on Highway 17 before. What an adventure!

At dinner, my wife, Janet asked my 89 year-old father, Aubrey, "What is your secret for a long, happy life?"

Dad answered, "Keep moving! You can’t be healthy just sitting around!"

The year is two-thirds over. How’s it going for you?

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So long Katie, and good luck!

Katie Thomas finished her part-time job with us at the end of August, and is preparing to start her studies at Stanford University. We really appreciated her efforts and expect to hear news of her bright future.

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San Jose Mercury News profiles Michael Gray.

Did you see the great interview by Mark Schwanhausser on the front page of the Sunday Business section of the San Jose Mercury News on August 5? Thanks Mark, we really appreciate it. We’ll soon have a copy displayed in our office lobby for our visitors to see. (My parents and their friends and neighbors were especially excited!)

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Kyan Gray Baker with giant calculator.
Kyan Gray Baker practices his skills with the calculator (like Daddy Dan and Grandpa Mike). Kyan will celebrate his third birthday on September 25.

September family celebrations and news.

Thi and Allen Nguyen celebrated their second wedding anniversary on September 2.

My daughter, Holly Baker, will be celebrating her birthday on September 16. Holly and her husband Dan recently announced they are expecting another child early next year.

Holly and Dan’s son, Kyan, will be celebrating his third birthday on September 25.

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Final calendar year corporate return deadline is September 17.

Remember the extended due date for 2006 calendar year corporate income tax returns is September 17. We get a couple of extra days because September 15 falls on a Saturday.

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Third quarter estimated tax payment is due September 17.

Remember the third quarter estimated tax payment for calendar-year taxpayers, including most individuals and trusts, is September 17.

If you have had a change in circumstances, such as a major capital gain, exercising stock options, or an early disposition of stock options during June, July or August, you should contact your tax advisor to determine whether any change in estimated tax is required.

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Disregarded entities to pay their own employment and excise taxes.

The IRS is changing the procedures for tax reporting of certain items by disregarded entities. This most widely applies to single-member limited liability companies and qualified subchapter S subsidiaries (Qsubs). The income and deductions of these entities are reported on the income tax returns of the owner.

Back in 1999, the IRS said that the employment tax obligations of these entities could be reported under the name and identification number of the owner.

Now the IRS has issued final regulations requiring employment and excise tax returns and payments to be made under the name and identification number of the disregarded entity. For employment taxes, the new procedure will apply for wages paid on or after January 1, 2009. For excise taxes, the new procedure will apply for liabilities imposed and actions first required or permitted in periods beginning on or after January 1, 2008. (TD 9356, 8/15/2007.)

These entities might need to apply for identification numbers and set up internal procedures to comply with the new requirements.

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Teacher not allowed to take IRA deduction for the year he retired.

The Tax Court ruled that a retired teacher wasn’t eligible to make a deductible IRA contribution for the year that he retired, because he was an active participant in the school system’s retirement plan up to the date of his retirement. (Hedrick v. Commissioner, T.C. Summary 2007-139 (8/9/07).)

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New regulations allow pass-through of partnership Small Business Stock transactions.

The IRS has issued final regulations about how the election to defer gain for Qualified Small Business Stock (QSB) applies to partnerships and their partners.

The election under Internal Revenue Code Section 1045 only applies to sales of qualified small business stock held by a taxpayer other than a corporation for more than six months. To qualify for the deferral, the taxpayer must acquire replacement QSB stock within a 60-day period beginning on the date of sale of the QSB stock.

Under proposed regulations, a partner couldn’t elect to defer the gain if he sold the stock outside a partnership for which he was an owner and the partnership purchased the replacement stock. Also, a partner of a partnership couldn’t replace QSB stock sold by the partnership with stock purchased outside the partnership.

The deferred election for these transactions is permitted under the final regulations.

However, the sale of an interest in a partnership that owns QSB stock is not treated as a sale of the underlying stock, and so isn’t eligible for deferral.

The new regulations are effective for sales of QSB stock on or after August 14, 2007.

These rules are complex. If you believe they apply to you, discuss them with your tax advisor.

(T.D. 9353, 8/13/07.)

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IRS explains rules for cafeteria plans.

Some employers let their employees choose to receive cash compensation or to receive alternative benefits, such as family medical insurance coverage, child care, life insurance, or disability insurance. The value of nontaxable qualified benefits is not includable in income. These plans are called cafeteria plans or Section 125 plans.

The IRS has issued proposed regulations explaining the requirements for these plans, including flexible spending arrangements (FSAs).

The proposed regulations are generally effective after 2008, but taxpayers may rely on them until final regulations are issued.

If you are responsible for maintaining a cafeteria plan or are considering one, you should discuss these proposed regulations with your tax advisor.

(REG-142695-05 72 FR 43937 (8/6/07).)

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IRS denied access to tax accrual workpapers based on work product privilege.

Textron, Inc. and Subsidiaries successfully persuaded a U.S. District Court to deny an IRS summons for tax accrual workpapers. The IRS was seeking information about "listed (tax avoidance) transactions" that it believed Textron had participated in.

The court found that Textron had waived the attorney-client privilege and (tax) practitioner-client privilege by submitting the workpapers to its external auditors.

Textron said its tax accrual workpapers should be protected under the work product privilege because it was preparing for the possibility of litigation with the IRS about items on its income tax returns. Hazards of litigation percentages were part of the workpapers, indicating that the possibility of litigation was the reason for preparing the workpapers.

The IRS said the workpapers were documents prepared in the ordinary course of business or that would have been created in essentially similar form, irrespective of the litigation.

The court found that the opinions of Textron’s counsel and accountants regarding items that might be challenged by the IRS would not have been prepared at all "but for" the fact that Textron anticipated the possibility of litigation with the IRS. Therefore, the IRS was required to demonstrate there was a substantial need for providing the workpapers, which wasn’t satisfied.

The protection of tax accrual workpapers is becoming even more critical under new requirements for documenting uncertain tax positions under FASB FIN 48. So far, the IRS’s stated policy is to not request these workpapers, but the fact this case exists indicates an interest in getting access to them. We will certainly see more litigation about this issue in the future.

(U.S. v. Textron, Inc. and Subsidiaries, (DC RI 8/28/07).)

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Watch out for IRS email scams.

The IRS has issued a consumer alert warning taxpayers about an email scam. An unsolicited message appears to come from the IRS. The email promises the recipient $80 for participating in an online survey. The survey displays the IRS agency logo and asks for information including the participant’s name, telephone number and credit cards. References to the IRS are included in the "from" and "subject" lines.

The IRS says that recipients of the emails shouldn’t open the attachments or click on any links in the email. Forward the email to the IRS at phishing@irs.gov.

We recently received email messages stating the recipient was owed a refund. Don’t fall for it! If the IRS owes you a refund, you’ll know about it and they’ll send it to you. They have all the information they need to do so on your tax return.

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Are you shopping for a new home?

Yes, some people are actually buying homes! Remember that we can help the mortgage financing to buy a new home. 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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Questions and Answers

Question

What is the "after-tax rate of return"? Is there a formula to compute it?

Answer

The "after-tax rate of return" is the rate of return after income taxes are paid.

A rough formula would be (r – t)/(y X i) or the return (income from the investment) – taxes paid with respect to the return divided by the years or period of investment and the amount of the initial investment.


Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

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Visit our new article!

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If you have employee stock options, have you subscribed to Michael Gray, CPA's Option Alert at no charge or obligation?

To learn more, visit stockoptionadvisors.com/subscribe.shtml.

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Real estate investors, have you subscribed to Michael Gray, CPA’s Real Estate Tax Letter at no charge or obligation?

For details, visit www.realestatetaxletter.com.

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P.S. Still a few months left of great weather to enjoy outdoor patio dining at Marché Aux Fleurs and AVA!

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
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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