Michael Gray, CPA's Tax and Business Insight

July 2, 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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Happy July 4!

Hope you and your family enjoy a great July 4! We get a three-day weekend this year.

Be extra careful with fireworks this year. If you live in California, you know there are many wildfires burning throughout the state. There might not be many firefighters available for emergencies right now.

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Can you believe the year is half over already?

How is your year going? Despite all the "doom and gloom" talk in the press, we hope this has been a good year for you. Let us know if we can be of service for any developments that are happening.

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Aubrey Gray
Aubrey Gray is celebrating his 90th birthday July 16!

Happy 90th birthday, Dad!

My father, Aubrey K. J. Gray, who will be celebrating his 90th birthday on July 16.

Dad has been a resident of Saratoga, California for 50 years.

He grew up in Vancouver, British Columbia, Canada. He was active in sports, including playing fullback in his high school and University of British Columbia football teams, all-star rugby player, competitive tennis player, and British Columbia champion swimmer. A physical fitness practitioner before it became fashionable, he involved his family in water skiing and he continued playing tennis at West Valley College until age 80, when he was forced to stop because he suffered from vertigo.

Dad met my mother, Eleanor, in Glendale, California while attending engineering classes in Southern California. During World War II, he served in the Royal Canadian Air Force. He was stationed in Montreal, Quebec when Mom traveled alone by train at age 18 to meet him there to be married on January 31, 1941. They have been devoted to each other in marriage for 67 years.

Their family includes six children – four are living, a son-in-law, a daughter-in-law, nine grandchildren, and 15 great-grandchildren.

After World War II, Dad worked in management of military aircraft projects at Northrop Aircraft in Southern California and moved in 1958 to Santa Clara County to work on military space photography projects, including Discover Satellite, for Lockheed Missiles and Space Company.

His family and friends are gathering for his birthday celebration at the home of his granddaughter, Michelle Davis, in Folsom on July 12.

We are very glad Dad is still with us, of sound mind and in reasonably good health!

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More July family celebrations.

My son, James is celebrating his 28th birthday on July 28. Dawn (Gray) and John Siemer are celebrating their second wedding anniversary on July 9.

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Have a great vacation, Dawn!

Dawn Siemer will be taking a vacation visiting family in the Northwest from July 14, returning July 28. Dawn manages our internet operations and our office and she will be sorely missed while she’s away.

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Janet Panan
Janet Anne Panan is our new student administrative assistant.

Welcome Janet!

Janet Anne Panen joined us today as our student administrative assistant.

Sadly, Sonia Monroy wasn’t able to continue with us, but we are delighted that Janet Anne was able to join us.

Janet Anne is a proud Trojan from the University of Southern California. She will be starting her sophomore year this coming fall, with a major in Public Relations. At USC she is involved with the Ambassador program, welcoming prospective students. She is involved with the Troy Philippines club on campus, and has pledged with the professional leadership fraternity, Delta Omega Zeta, where she will be the social chairman next year.

She was born in Honolulu, Hawaii and has lived in San Jose since she was five years old.

When she isn’t working or going to school, Janet enjoys spending time with her family, including shopping with her Mom and watching sports on television with her Dad.

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Michael Gray gives a live employee stock options seminar on July 11.

Michael Gray will be giving a live "Secrets of Tax Planning For Employee Stock Options" luncheon seminar on July 11. The seminar will be at Hobee’s Restaurant at the Pruneyard in Campbell, California. For details and to make reservations, call Dawn Siemer weekday afternoons at 408-918-3162, or email mgray@taxtrimmers.com.

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Standard mileage rates increase.

Since fuel prices have increased substantially, the IRS has announced increases in the optional standard mileage rates for the period July 1 through December 31, 2008. The business rate is increasing from 50.5¢ to 58.5¢. The mileage rate for medical and moving is increasing from 19¢ to 27¢. The charitable mileage rate remains unchanged at 14¢. (Announcement 2008-63.)

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Fraud alert.

I went to a fraud conference on June 20.

When economic times get tougher, the temptation for fraud grows. Employees rationalize that they are only "borrowing" money and they "intend to pay it back," until the fraud gets so big that it is overwhelming.

The people who are most likely to embezzle funds are the people you trust the most.

The biggest source of information on frauds is anonymous tips. It’s a good idea for every business to have and publicize a telephone number for employees to leave anonymous tips.

A minimum precaution for fraud avoidance is for the owner /CEO to receive the company bank statement at home and for the owner/CEO to study the cancelled checks that clear the bank account and the transactions in the account for irregularities before taking the statement to the office.

Our tax return preparation procedures are not designed to discover fraud, and shouldn’t be relied on for fraud prevention.

If you would like to discuss internal controls and fraud prevention further, call Mike Gray at 408-918-3161.

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Be alert for identity theft.

One of our clients took his wife’s computer in for repairs. One day later, there was a fraudulent charge against his credit card account. Be alert.

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Do you own property in a Mexican Residential Trust?

U.S. citizens and residents who own property in a trust set up outside the United States are required to report activities for the trust each year using IRS forms 3520 and 3520-A.

When persons who are not citizens of Mexico own residential real estate in certain areas, including Baja California and Cancún, they are not permitted to take the title individually, but must take the title in a Mexican Residential Trust (MRT) or fideicomiso.

It appears a MRT is subject to the reporting requirements for foreign trusts. There are severe penalties for non-compliance, which the IRS says it will waive provided the late return is filed with a reasonable cause explanation.

See your tax advisor about preparing the form.

Call or write your representatives in Congress to ask to have this requirement repealed for MRTs, or to request that the IRS waive this reporting requirement for MRTs.

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IRS now accepts rolling average inventory.

A problem area for QuickBooks and some other packaged accounting software has been the computation of inventory value. QuickBooks computes inventory using a rolling-average method. This has not been an acceptable method for federal income tax accounting.

Now the IRS has announced it will accept inventories computed using a rolling average method. The method will be acceptable for taxable years ending after December 31, 2007 when it is used for financial reporting. See your tax advisor for details, or look up the Revenue Procedure at www.irs.gov. (Revenue Procedure 2008-43, 2008-30 I.R.B.)

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Auditor’s Tax Accrual workpapers protected under work product doctrine.

In Regions Financial Corporation v. United States, a federal district court in Alabama held the IRS was not entitled to access to an auditor’s tax accrual workpapers. The taxpayer did not waive his privilege by disclosing contested documents to its independent auditor.

The workpapers related to two listed transactions that the company was involved in. (Listed transactions are transactions the IRS has identified as tax-motivated, and requiring special disclosure.)

The court agreed with the taxpayer that workpapers prepared in anticipation of litigation with the IRS are privileged and not required to be submitted on request from the IRS.

(Regions Financial Corporation v. United States, No. 2:06-CV-00895-RDP (N.D. Ala. 5/8/08.)

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IRS can garnish Social Security payments.

In addition to ruling on other issues, a federal district court ruled the IRS could garnish Social Security benefits. (Acevedo v. United States, No. 4:08CV248 CDP (E.D. Mo. 5/16/08).)

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SEP contribution disallowed. No contribution made for wife.

The president of an S corporation made a contribution to a Simplified Employee Pension (SEP) for himself, but not for his wife, who also received a salary from the S corporation. SEPs have strict nondiscrimination rules that must be complied with, and this S corporation failed to comply with the rules, so the contribution for the president was disqualified. Moral: Pay Attention To Details. (Brown v. Commissioner, T.C. Summary 2008-56 (5/20/08).)

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California same-sex spouses will share tax complexity.

Now that California’s Supreme Court has ruled that same-sex marriages shall be permitted, those who choose to be married in California will face tax complexity. First, the federal government does not recognize these marriages. These couples may file joint California income tax returns, but must file separate federal income tax returns. The (federal) unlimited marital deduction for gifts will not apply to same-sex spouses. If the couple is required to file income tax returns in states other than California, only a few will recognize their marital status.

Until same-sex marriages are recognized by the federal government and all of the states, preparing income tax returns for these couples will be a big headache for income tax return preparers.

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Richard Hatch appeals conviction.

Richard Hatch, who was the first-season winner of the "Survivor" television series, has appealed his conviction of tax evasion to the U.S. Supreme Court. Hatch’s attorney said there was a procedural error in Hatch’s trial. The main witness against Hatch was the CPA who prepared his income tax return. Hatch’s attorney says she was cooperating with the government to protect herself.

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Spending July 4 weekend in Silicon Valley? See Grease!

If you are going to be spending July 4 weekend in Silicon Valley, consider seeing West Valley Light Opera’s production of Grease. It’s a great show and there are great seats available for Saturday, July 5. You can get details and tickets at www.wvlo.org or call 408-268-3777.

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Questions and Answers

Question

I am a partner (member) in an LLC. The LLC files Form 1065 (U.S. partnership income tax return).

Can I take an owner’s draw, or should I pay myself a guaranteed payment? I understand that an owner’s draw is not taxable on my individual income tax return, gut guaranteed payments are.

If I can collect an owner’s draw, is there a limit of how much?

Answer

A guaranteed payment can be for different purposes. The one you are talking about is for a partner’s salary. A salary is usually arranged when one or more partners are active in the business and others aren’t.

The LLC/partnership takes a tax deduction for the guaranteed payment and the member/partner who receives it reports it as income. The amount is reported by the LLC/partnership to the member/partner at Part III, line 4 of Schedule K-1.

The members/partners share taxable income of the LLC/partnership, after the guaranteed payment deduction, is taxable on their individual income tax returns. The amount for each member/partner is shown at Part III, line 1 of Schedule K-1.

Draws for LLC members may be legally limited because LLCs have limited liability protection. You should discuss this with a business lawyer.

Consider hiring a tax return preparer to prepare your income tax returns and for tax advice. That’s our business!

Question

I am a single part-time teacher in California. Normally I make $15,000/year. I just won $500,000 on a game show. I received a check with no taxes withheld.

Does this mean I don’t owe any taxes? If not, what taxes should I expect to pay? Does FICA or self-employment tax apply?

Answer

Congratulations on winning $500,000!

Prizes are subject to income taxes, but not employment taxes like FICA or self-employment taxes.

A tax advisor can help you estimate your tax liabilities. That’s our business!

Consider prepaying most of your California tax to get a current deduction against your federal income tax.

You also should be getting investment advice to preserve your new nest egg.


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 book review!

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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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