Michael Gray, CPA's Tax and Business Insight

April 30, 2008

© 2008 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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Kara Siemer on her first birthday.
Here's Kara Siemer on her first birthday.

Tax filing season is over. Tax planning season is here. How can we be of service to you?

With April 15 behind us, we have been focusing on finishing extended income tax returns. Now we have time to think about tax planning issues. How about discussing putting your estate plan in place, or updating an old plan? Do you have a stock option exercise to prepare for? I have been talking to several people who are arranging their affairs to get the refundable minimum tax credit. Thinking of starting a business or making changes to your existing business? Looking for profit improvement ideas? To make an appointment, please call Dawn Siemer weekday afternoons at 408-918-3162.

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May vacations.

Thi Nguyen and her husband, Allen Le are leaving May 1 for Waikiki, and she will return to the office on May 6. Aloha!

Mike and Janet Gray are leaving May 3 for Edisto and Charleston, South Carolina and he will return on May 12.

Dawn Siemer will be minding the firm and making appointment reservations weekday afternoons at 408-918-3162 in our absence.

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May family celebrations.

Holly (Gray) and Dan Baker will be celebrating their ninth anniversary in May. It doesn’t seem so long ago we were scrambling to make wedding arrangements in Sonoma. Since that time, they have opened two restaurants and had two boys – Kyan and Clive. Their union has certainly enriched our family, and we get along great with Dan’s family too.

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Some rebates are in the mail.

The IRS has started mailing rebate checks. There is a sequence they are following that favors efiled tax returns. Most of our clients won’t qualify for a rebate because their income is too high. Remember you have to file an income tax return to receive an "advance" rebate check during 2008.

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Current deduction, depreciable improvement or non-deductible capital expense? The IRS issues guidelines.

The IRS withdrew proposed regulations issued on August 21, 2006 and issued new proposed regulations about capitalization and expenditures relating to tangible property on March 10, 2008. The proposed regulations won’t be effective until they are finalized, but they are still important as guidelines of the current thinking at the IRS on these issues.

My printout of the proposed regulations and the preamble (IRS summary) is about 51 pages. I can’t cover them in detail.

There are new conformity rules when a taxpayer has applicable financial statements, such as financial statements required to be filed with the SEC or a governmental agency, or other audited financial statements.

Materials and supplies are eligible to be currently deducted. They are tangible property used or consumed in the taxpayer’s operations that meet one of four tests –

  1. Not a "unit of property" (such as spare parts, other than rotable or temporary spare parts, for repairs);
  2. A unit of property that has an economic useful life of 12 months or less;
  3. A unit of property that has an acquisition or production cost of $100 or less; or
  4. Is identified by the IRS in an announcement as materials and supplies.

Rotable or temporary spare parts may only be deducted when they are ultimately disposed of or scrapped.

Another example in the proposed regulations of an item that is "not a unit of property" is a broken window in a building that is replaced. The replacement qualifies for a current deduction as materials and supplies.

When materials and supplies are used to improve a property, such as for rehabilitating a "fix up" property in preparation for sale, they must be capitalized.

The IRS has stated the "plan of rehabilitation" doctrine that disallows a current deduction for repairs made as part of a general plan of renovation or rehabilitation will be obsolete when the proposed regulations become effective. Repairs that do not improve the property will be currently deductible even when performed at the same time as other repairs that must be capitalized as an "improvement".

There is a special rule for amounts paid by a taxpayer in the process of investigating or otherwise pursuing the acquisition of real property permitting the current deduction of expenses relating to the process of determining whether to acquire real property and which real property to acquire. However, "inherently facilitative costs", such as getting an appraisal of a property, must be capitalized and may be deducted when the acquisition is abandoned or added to the purchase price of the property when it is acquired.

I recommend that advisors study these proposed regulations and that taxpayers consult with their advisors about how the new proposed regulations would affect them.

(REG-168745-03.)

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State agency payments for in-home care of elderly are tax exempt.

The IRS has privately ruled that payments made directly to caregivers to help the elderly live at home as an alternative to care in a nursing home are tax-free to the person being cared for and for the caregivers. The payments are to offset the costs of support and maintenance for elderly individuals living in the home of a capable adult caregiver, usually a spouse or other relative. The payments are exempt under the general welfare exclusion. To qualify for the exclusion, the payments must (1) be made from a governmental fund, (2) be for the promotion of the general welfare, and (3) not represent compensation of services by the caregivers or the elderly individuals being cared for. Since the payments are tax exempt, no information returns (Forms 1099) are required to be submitted for the payments. (Letter Ruling 200810005.)

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Transfers to LLC not included in estate.

Anna Mirowski transferred substantial assets to a limited liability company and then made gifts of interests in the company to trusts established for her daughters. She said the primary reasons for forming the LLC were (1) joint management of the family’s assets by her daughters and eventually her grandchildren; (2) maintenance of the family’s assets in a single entity so that investment opportunities could be better exploited; (3) providing for each of her daughters and eventually her grandchildren on an equal basis.

Anna died unexpectedly two weeks after setting up the LLC.

An estate tax return was filed, excluding the shares of the LLC transferred to the trusts. The source for paying the estate taxes was the LLC.

The IRS claimed the transfers to the trust should be disregarded. The IRS said there was no non-tax reason for the transfers, and that the "bona fide sale" exception didn’t apply because (1) Anna didn’t keep enough assets outside the LLC for her expected financial obligations; (2) the LLC didn’t have any valid business operation; (3) the transfer happened shortly before Anna’s death; (4) Anna sat on both sides of her transfers to the LLC; and (5) after Anna’s death, the LLC made $36.4 million of distributions that were used by the estate to pay federal and state transfer taxes, legal fees and other estate obligations.

The Tax Court ruled in favor of the estate. The Court found there was no agreement that Anna retain the possession or enjoyment of, or the right to the income from, the interests given to her daughters’ trusts.

The Court found there were significant, legitimate non-tax reasons for forming the LLC, as specified in the first paragraph, above.

The Court found that Anna had sufficient other assets to pay her other obligations, most significantly the gift tax for the transfers to the trusts.

The Court also found that Anna didn’t believe her death was imminent when the LLC was formed and the gifts were made.

The Court also said that the estate tax liability wasn’t expected at the time of Anna’s death, which happened unexpectedly after the transfers were made.

(Estate of Mirowski v. Commissioner, T.C. Memo. 2008-74 (3/26/008).)

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IRS issues bonus depreciation form for fiscal year businesses.

The IRS has issued new Form 4562-FY for 2007. The form is to be used by fiscal year businesses with tax years beginning in 2007 and ending in 2008 that want to claim 50% bonus depreciation under the Economic Stimulus Act of 2008 for qualified property placed in service after December 31, 2007. The bonus depreciation will be claimed at Line 14.

(Remember California and many other states have not adopted bonus depreciation in conformity with the federal tax law change.)

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Questions and Answers

Question

My husband normally works five days a week, but very often he has to work extra on Saturday. He gets paid for it, but his employer will not pay for the mileage. Can he claim this mileage as a business expense?

Answer

Assuming the mileage is for commuting from your home to his job and back, it’s a non-deductible personal expense.


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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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.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

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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 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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