Michael Gray, CPA's Tax and Business Insight

August 5, 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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Aloha!

Janet and I (Michael Gray) will be vacationing at Waikiki starting August 23. I'll return to the office on September 1. If you need help with a tax issue in my absence, call Thi Nguyen, CPA at 408-918-3163. For help with an administrative issue or to make an appointment for when I return, call Dawn Siemer weekday afternoons at 408-918-3162.

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Thank you Janet Panen!

Our student administrative assistant, Janet Panen, is leaving to return to the University of Southern California on August 15. Janet was a great help getting us caught up with administrative chores and covering for Dawn during her vacation.

Thanks, Janet, and good luck at USC!

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August family celebrations.

Janet and I will be celebrating our 37th wedding anniversary on August 7. My sister and her husband, Virginia and Wade Allison will be celebrating their 46th wedding anniversary on August 4. We were all teenagers when we got married. "They tried to tell us we're too young..." Maybe we'll make it after all!

My father in law, Wally Bowers, will be celebrating his 82nd birthday on August 23. My sister-in-law, Gail Johnston, will be celebrating her 59th birthday on August 19.

That's a lot of celebrating!

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Do you need help preparing extended income tax returns?

Time marches on! The extended due date for 2007 calendar year corporate income tax returns is September 15, 2008. The extended due date for 2007 calendar year individual, partnership, estate and trust income tax returns is October 15, 2008.

If your 2007 income tax returns aren't done yet and you are seeking help from a tax return preparer, call Dawn Siemer on a weekday afternoon for an appointment at 408-918-3162.

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Do you have an estate plan?

Although having a will and/or living trust is critically important, there is more to an estate plan than documents. What will the estimated cash requirements be for estate taxes, paying off debts and final expenses? How will your final expenses be paid? How should your retirement accounts be handled? Will your family be left in financial distress? Is there a succession plan for your business? Do you have a charity that you would like to provide for? If you would like our help in exploring these issues, please call Dawn Siemer for an appointment on a weekday afternoon at 408-918-3162.

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Michael Gray gives a telephone employee stock options seminar on August 21.

Michael Gray will be giving a telephone "Secrets of Tax Planning For Employee Stock Options" seminar at 1 p.m. Pacific Time on August 21. For details and to make reservations, call Dawn Siemer on a weekday afternoon at 408-918-3162, or email mgray@taxtrimmers.com.

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Housing Act includes a tax surprise.

President Bush signed The Housing Assistance Act of 2008 (H.R. 3221) on July 30, 2008. The tax part of this legislation is The Housing Assistance Tax Act of 2008.

The big surprise in the tax act that isn't being widely discussed is a cutback in the home sale exclusion. The reduction applies for home sales in tax years after 2008. Gain eligible for the $250,000 exclusion for single persons, $500,000 for married, filing joint returns, is reduced for periods of non-qualifying use after 2008. For example, if you convert a principal residence to a vacation home or a rental, the gain eligible for exclusion is reduced for the period of non-qualified use. (Temporary absences, such as for a vacation or for medical treatment, still count as qualified use.) This is a major change that many people won't understand, and is especially important for real estate investors who convert a principal residence either to or from rental or vacation property.

For example, John Taxpayer, a single person, bought a residence on January 1, 2007. It was his principal residence until December 31, 2008. He used it as a vacation home starting January 1, 2009. John sells the house on December 31, 2010 and has a $200,000 gain. Before the change in the tax law, the entire gain would be eligible for the $250,000 exclusion, resulting in no tax. After the change in the tax law, only one-half of the gain is eligible for the exclusion, the other $100,000 is taxable as a long-term capital gain.

The Act also includes a tax credit for first-time home buyers. The credit is 10% of the purchase price of a home, up to $7,500 ($3,750 for married taxpayers filing a separate income tax return. The credit is phased out for married persons filing a joint income tax return with modified adjusted gross income from $150,000 to $170,000, and for single taxpayers with modified gross income from $75,000 to $95,000. The credit is effective for homes purchased from April 9, 2008 through June 30, 2009. The credit is actually an interest-free loan that is repaid over a 15-year period. The balance must be repaid if the home is sold before the repayment period is over. A "first-time homebuyer" is defined as a person who had no ownership interest in a principal residence during the three-year period before the new home is purchased.

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Extension period reduced for pass-through entities.

The IRS has issued temporary and proposed regulations that will reduce the maximum extension of time to file for partnerships, estates and trusts from six months (to October 15 for calendar-year returns) to five months (to September 15 for calendar-year returns). This change should eliminate the problem that many partners and beneficiaries are currently experiencing of receiving their Schedule K-1 form with the items to reported on their income tax return close to October 15. The new maximum extension period will be effective for income tax returns due on or after January 1, 2009. (IR-2008-84, T.D. 9407, NPRM REG-115457-08.)

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Rolling-average inventory now accepted by IRS.

The IRS has long resisted accepting an average inventory method, although such methods have been acceptable for financial statement reporting. Some accounting software, notably QuickBooks, will only process inventory using a rolling-average method. Finally, the IRS has indicated it will accept a rolling-average inventory. The procedure for adopting the rolling-average method is explained in IRS Revenue Procedure 2008-43.

The IRS has indicated that, if the new procedure is adopted, the taxpayer's use of a rolling-average method on a tax return filed before June 25, 2008 will not be challenged in a tax audit. The new procedure is effective for tax years ending on or after December 31, 2007. (Rev. Proc. 2008-43, 2008-30 IRB.)

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Leaving the United States could be very expensive.

As part of the Heroes Earnings Assistance Tax Act of 2008, enacted on May 22, 2008, renouncing your U.S. citizenship or leaving the U.S. after a long period of "permanent residency" may be a taxable event. The taxpayer is treated as selling their property for fair market value on the day before their expatriation date.

The "deemed sale" applies to a "covered expatriate" if the individual (1) has an average annual net income tax liability for the five preceding years ending before the date of the loss of U.S. citizenship or lawful permanent residency that exceeds $124,000 adjusted for inflation, or $139,000 for 2008; (2) has a net worth of $2 million or more on that date; or (3) fails to certify under penalties of perjury that he or she has complied with all U.S. tax obligations for the preceding five years or fails to submit evidence of compliance as required by the IRS.

A "covered expatriate" includes a U.S. citizen who gives up his or her citizenship and any long-term U.S. resident who ceases to be a lawful permanent resident of the United States. A long-term U.S. resident is defined as an individual who was a lawful permanent resident (green card holder) for at least eight of the last 15 tax years ending with the year the individual ceases to be a lawful permanent resident.

There are limited exceptions to the rules for certain dual citizens and for minors.

Since there are so many resident aliens working in the United States, including many high-paid professionals, this new law could have a widespread impact. Since they aren't able to vote, you could say this was a form of taxation without representation.

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No tax for dividing charitable trust for divorce.

A husband and wife formed a charitable remainder trust. Later, they divorced and wanted to divide the trust relating to their property settlement. They asked the IRS if they could do this tax-free. The IRS said they could. (Rev Rul 2008-41, 2008-30 I.R.B.)

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IRS explains amount included in taxable estate for a charitable trust.

The IRS has issued final regulations that explain the amount of a charitable trust for which the decedent retained the use of property or the right to an annuity, unitrust or other payment from the property for life. Only the portion required to fund the retained benefits as of the date of death is included. That portion is computed using a present value formula based on an IRS published interest rate. (T.D. 9414, 73 Fed. Reg. 40,173 (7/14/08).)

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Requirement for formal election eliminated for start-up and organization expenses.

The IRS has issued temporary, final and proposed regulations that provide a deemed election to deduct start-up and organizational expenses. The requirement for a formal, written election to deduct these costs has been eliminated.

The amount of the deduction is still limited to the lesser of $5,000 or the actual costs, reduced for each dollar the costs exceed $50,000. Amounts that aren't currently deductible may be amortized over 15 years.

The temporary regulations apply to expenses paid or incurred after September 8, 2008. Taxpayers may choose to apply the regulations to expenses paid or incurred after October 22, 2004. (T.D. 9411, NPRM REG-164965-04.)

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Questions and Answers

Question

Which section of the Internal Revenue Code defines "exempt income"?

Answer

I haven't found one. There are many exclusions and exemptions for different types of exempt income. For example, Section 103 provides an exclusion from gross income from state and municipal bond interest.

Section 265 provides that expenses and interest relating to tax exempt income are not tax deductible.

Treasury (IRS) Regulations Section 1.265-1(b) provides that a "class of exempt income" means any class of income wholly exempt from the taxes imposed by subtitle A of the Code. For purposes of this section, a class of income which is considered as wholly exempt from the taxes imposed by subtitle A includes any class of income which is -

  1. (i) Wholly excluded from gross income under any provision of subtitle A, or
  2. (ii) Wholly exempt from the taxes imposed by subtitle A under the provisions of any other law.

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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