Michael Gray, CPA's Tax and Business Insight

October 15, 2010

© 2010 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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Kyan Baker's birthday
Happy 6th birthday, Panch! Where did my grandson, the gourmet, want to go for his birthday? Chez Panisse in Berkeley!

Happy Halloween!

What is America's second most popular holiday? Halloween! It's time to break out the cauldrons, tombstones and spider webs! Have a fun and SAFE holiday!

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Boo! The year is almost over! Time for year-end planning.

Hot on the heels of Halloween are Thanksgiving and the holiday season. When we traveled to Ireland and Scotland, Christmas displays were erected right after Halloween, because they don't celebrate Thanksgiving when we do.

I hope you're having a good year. We know many are not, so give generously if you are doing well.

With the final extended due date for 2009, October 15, behind us, it's time for year-end planning. This is going to be one of the most difficult years for year-end planning in my 36 years in public accounting, because the Bush tax cuts are expiring at the end of 2010 and we don't know what extension legislation, if any, will be enacted. We don't even know the AMT exemption for this year! Congress might not pass extension legislation until next year! We can only guess what the tax laws are going to be after this year. Despite that, we need to estimate the taxes that may be due in April and otherwise work with our broken crystal balls.

Call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162 to make your year-end planning appointment now.

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October celebrations.

My wife, Janet, celebrated her 59th birthday on October 4. She is a blessing for my family. I'm so glad to have her in my life.

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Missed Michael Gray's webinar? Playback is available.

Entrust Group is providing a playback link for the webinar that Michael Gray gave together with Lamarr Baxter about "When IRAs and Roths Must Pay Income Taxes.” Here is the playback link: http://cc.readytalk.com/play?id=g1mtna. (You have to provide contact information to access the webinar.)

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Client appreciation event – Year End Planning For Employee Stock Options.

Subscribers to this newsletter and Michael Gray, CPA's Option Alert only are invited to "be our guest” for a hosted luncheon seminar at Hobee's Restaurant at the Pruneyard. Registration is required and will be limited to 30 guests. (That's right! No admission charge! Usually we charge $97 to attend!) Michael Gray, CPA will give a presentation about "Year-End Planning For Employee Stock Options.” The luncheon presentation will be from noon to 1:30 p.m. on November 12.

To register, call Dawn Siemer on a Monday, Wednesday or Friday from 9 a.m. to 5 p.m. Pacific Time.

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California is "a little short of cash” for refunds.

The Franchise Tax Board announced on October 14 that refunds on corporate and individual income tax returns will be delayed until there is enough cash in the state treasury to pay the refunds. As an alternative, overpayments can be applied to the next year's estimated tax instead of applying for a refund. Then future estimated tax payments or withholding can be reduced. (Spidell's Flash E-Email.)

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Acceleration is not necessarily required for advance payments.

The IRS has revoked an earlier ruling requiring acceleration of reporting taxable income for advance payments for future services to be provided received by an accrual basis service taxpayer. Accrual basis taxpayers that receive advance payments from customers should re-evaluate their method of accounting. They might be able to defer reporting the income until the services are rendered. (TAM 201039024 revoking in part TAM 200725029.)

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Allocation of sale proceeds not respected by IRS or the Tax Court.

An employee benefits consultant sold his business to a bigger company, and continued to work in the business. Based on the advice of his tax advisor, the taxpayer and the acquiring corporation agreed to allocate 75% of the proceeds as payment for the sale of goodwill, qualifying for the 15% long-term capital gains rate.

The IRS challenged the allocation of the sale price. The agreement also included a covenant not to compete and a sale of assets for a small amount. The IRS said the sales price didn't reflect economic reality.

The Tax Court upheld the IRS in reallocating the sales price to items resulting in ordinary income for the taxpayer.

An error in this case was the lack of documentation to establish a value for goodwill. The allocation was arbitrary, based on the recommendation of the tax advisor. If the taxpayer had a study done by a business valuation specialist as part of the process of establishing the allocation and agreement, the allocation to goodwill might have been upheld.

(Kennedy v. Commissioner, TC Memo 2010-26.)

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IRS issues guidance on series LLCs.

The IRS has issued proposed regulations for series LLCs. Under the proposed regulations, each series unit established by the LLC would be treated as a separate entity for federal tax purposes.

(NPRM REG-119921-09.)

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Small Business Jobs Act is enacted.

President Obama signed the Small Business Jobs Act (the Jobs Act) into law on September 27, 2010. Finally we have some tax laws enacted this year, but many of the Bush tax cuts are still scheduled to expire after this year, the federal estate tax is still repealed for 2010 and we still don't know what the alternative minimum tax exemption is for 2010.

Here are a few tax highlights of the Jobs Act:

  1. 50% first-year bonus depreciation has been extended for acquisitions from January 1, 2010 through December 31, 2010. Bonus depreciation has also been extended for personal property with a recovery period of 10 years or longer, and for transportation property. Unlike the expense election, there is no taxable income limit for bonus depreciation and there is no phase out based on the amount of equipment purchased.

    Under the new law, bonus depreciation is not allocated to cost for long-term contracts when the constructed assets have a depreciable life of seven years or less.

    In order to allow a bigger depreciation deduction when bonus depreciation is claimed for an automobile, the maximum deduction is increased an additional $8,000 when bonus depreciation is claimed. The 2010 maximum deductions will be $11,060 for passenger automobiles and $11,160 for light trucks.


  2. The Internal Revenue Code Section 179 expensing election limit has been increased for tax years beginning in 2010 and 2011 from $250,000 (former limit for 2010) to $500,000. The deduction will be phased out for equipment purchases exceeding $2 million (was $800,000 for 2010).

    The definition of Section 179 property eligible for expensing has temporarily been expanded to include qualified real property, defined as qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. The maximum amount of qualified real estate eligible for expensing is $250,000. Taxpayers may also elect to exclude qualified real estate from the expensing, such as if claiming the property would result in having more than $2 million in additions, phasing out the deduction.

    "Off the shelf” computer software also continues to be eligible for the expense election.


  3. S corporations pay a "built-in gains” tax for appreciated property disposed within 10 years after making the election. Under the American Recovery and Reinvestment Act of 2009, the holding period was reduced to seven years for 2009 and 2010. Under the Jobs Act, the holding period has been reduced to five years for dispositions in a tax year beginning in 2011, provided the fifth year in the recognition period precedes the tax year beginning in 2011.


  4. For qualifying stock acquired during the period from September 27, 2010 through December 31, 2010, the exclusion of gain for certain small business stock has been increased from 75% to 100%. Since this period is so short, I'm not going to explain the details. See your tax advisor.


  5. Effective for the first tax year beginning after December 31, 2009 (2010 for most taxpayers), the deduction for health insurance costs for a self-employed person for the individual and his or her immediate family for income tax reporting will also be deductible when computing the self-employment tax. (Let's hope this one will be extended after 2010.)


  6. Effective for distributions after September 27, 2010, an employee can roll over in-plan distributions from a "regular” 401(k), 403(b) or 457 retirement plan account to a Roth account under the same plan. The plan must permit "in service” distributions, so plans might have to be amended to permit the transfer. In addition, for distributions during 2010, the taxpayer may either report the taxable income resulting from the transfer in equal amounts for 2011 and 2012 or elect to report all of the income for 2010. (Same as for regular to Roth IRA conversions for 2010.)


  7. The information return reporting requirements for payments of $600 or more have been extended to rental property expenses, effective for payments made after December 31, 2010.

For more details about how the new rules affect you, see your tax advisor, or call Michael Gray at 408-918-3161.

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Financial Insider Weekly broadcast schedule for September and October.

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 7:00 p.m., Pacific Time on Comcast channel 15. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for the rest of October and for November:

October 20: Richard Lambie, Professional Fiduciary, "The Role of the Professional Fiduciary”
October 27: Mark Erickson, Attorney, "Divorce, California Style – Child Custody”
November 3: Mark Erickson, Attorney, "Divorce, California Style – Spousal Support”
November 10: Jeffrey Hare, Attorney, "Using a Checkbook LLC with a Self-Directed IRA”
November 17: Jann Besson, Attorney, Besson & Yarbrough, "Medi-Cal Benefits for Long-Term Disability”
November 24:, John Hopkins, Attorney, Hopkins & Carley, "Promoting Community Giving as a Family Value”M

Financial Insider Weekly is also broadcast as follows:

Past episodes of Financial Insider Weekly are posted on YouTube. One way to watch them is to go to our web site, www.financialinsiderweekly.com, and click on "Past Episodes."

Let me know any ideas that you have for topics or guests. Guests will usually have to be located in or near the Silicon Valley in California.

Hope you can watch or record the show. Please tell your friends about it!

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Questions and answers

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

For your questions about dependent exemptions, see IRS Publication 501 at www.irs.gov.

Question

I am dealing with converting a Dentistry practice from an LLC to a corporation. The sole proprietor of the LLC also became the president of the corporation and the sole shareholder. As a result, the corporation is a personal holding corporation with a flat income tax rate of 35% instead of graduated tax rates for ordinary corporations. One solution to this problem would be to reduce the sole stockholder's ownership of stock to 95% or less. Is there any other solution to this problem?

Answer

The corporation is not a personal holding corporation, but a personal service corporation, defined at Internal Revenue Code Section 448(d)(2). The ownership requirement that you mention is defined at Treasury Regulations Section 1.448-1T(e)(5).

I am wondering why this decision to convert was made.

One alternative is to elect to be an S corporation, which actually has very similar results as being an LLC. An advantage of being an S corporation compared to being an LLC is computing retirement contributions is much simpler, since it's based on W-2 income for an S corporation instead of self-employment income for an LLC.

The main way most personal service corporations deal with the problem is by paying out most of the income as wages by the end of the year. Retirement contributions can be made up to the extended due date of the corporate income tax returns.

Personal service corporations require careful monitoring and year-end tax planning.

(Note – Businesses of licensed professionals, such as health professionals, lawyers, CPAs, and architects aren't permitted to be conducted as LLCs in California. Be sure to consult with an attorney about the rules in your state.)

Question

My 19 year old son, a full-time college student, claimed a $2,500 American Opportunity Credit on his 2009 federal income tax return. No person claimed him as a dependent. The IRS disallowed the credit. They said if my son did not claim a personal exemption for himself, which is not allowed, then he does not get the credit. Is this correct?

Answer

According to Internal Revenue Code Section 25A(d)(2)(g)(3), "If a deduction under section 151 (personal exemption) with respect to an individual is allowed to another taxpayer for a taxable year … (A) no (American Opportunity) credit shall be allowed … to such individual for such individual's taxable year, and (B) qualified tuition and related expenses paid by such individual during such individual's taxable year shall be treated … as paid by such other taxpayer.”

The IRS appears to be taking the position that since your son isn't entitled to the personal exemption deduction for himself, it is allowable to someone else, so he can't claim it.

If you were entitled to the exemption deduction for your son and elected not to claim it so he would qualify for the credit, you could try fighting this determination. I doubt it's worth the time, expense and hassle to go beyond writing a letter arguing the point.


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 articles!

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Follow me on Twitter!

If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.

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I'm also on Facebook and LinkedIn.

you can also follow me on other social media sites, Facebook and LinkedIn.

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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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Check out my blog.

I have also started a blog at www.michaelgraycpa.com. Check it out!

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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.

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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.


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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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