Michael Gray, CPA's Tax and Business Insight

November 6, 2019

© 2019 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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Mike Gray, his wife Janet, and Gail and Lane Johnston at the Tillamook Cheese Factory.
Janet, her sister, Gail Johnston, our brother in law, Lane Johnston and me during our visit to the Tillamook Cheese Factory in Tillamook, Oregon

Happy Thanksgiving!

Thanksgiving falls on November 28 this year. I hope you are able to spend the day with your family or friends. This is one holiday people of all faiths or no faith can share. Being thankful and counting your blessings is one of the best things you can do for your emotional health. Even when things aren't working out, you can still be thankful for past good memories. Drive carefully and enjoy the holiday.

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Family celebrations.

My brother, Steve, and I are celebrating our birthdays this month. Thank goodness we are both healthy and enjoying spending time with our family.

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Want help with your promotions, web pages, newsletters, blog posts, emails or books?

Michael Gray is available for promotional and content writing assignments. In addition, some of our publications and articles are available for licensing (use for a fee). Want more information? Call Michael Gray weekdays at 408-918-3161.

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Do you love Disney?

I have created a Facebook group, called Disney Magic, for members to share Disney photos, experiences and tips. I am also posting developments for Disney films, television shows, and amusement parks there. If you are on Facebook, you can use this URL to join: https://www.facebook.com/groups/2006739209578437/, or search "Groups" on Facebook. You have to use the "join" button to join the group. This is a private group, and I will approve your membership.

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Check out my new blog.

I have started a new blog with business improvement ideas. Please check it out and consider subscribing. Here's a link to the blog. http://www.profitadvisors.com/business-building-blog/.

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Distribution from an IRA relating to a divorce was taxable.

A divorce court ordered that a former spouse should pay $10,000 using proceeds from the former spouse's IRA account. The former spouse directed that $10,000 should be transferred to a new IRA owned by the taxpayer. Within seven days after the transfer, the taxpayer withdrew the funds and closed the IRA.

The taxpayer didn't report the proceeds from his IRA as taxable income. He claimed the payment should be treated as simply a payment of cash in satisfaction of the court decree.

The Tax Court upheld the IRS in finding the distribution was taxable and subject to a 10% penalty for early distribution from the IRA.

When planning for divorce settlements, form can give substance, as in this case. If the former spouse had received the cash and it wasn't transferred to an IRA in the taxpayer's name, the former spouse would have been subject to the income tax on the distribution.

(Rosenberg v. Commissioner, TC Memo 2019-124, September 19, 2019.)

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IRS lien limited to one-half interest of taxpayer.

A taxpayer made a lease-to-own arrangement with his parents. Before the conditions of the contract were fulfilled, both parents died with no will. The IRS said the taxpayer should be considered the owner of the entire property under the terms of the lease-to-own arrangement. A federal district court ruled that the terms of the lease-to-own contract weren't fulfilled before the death of the second parent, so the taxpayer inherited one-half of the property and his sister inherited the other half as tenants in common. Therefore, the IRS could only attach a lien to one-half of the property.

(Dase v. Commissioner, DC AL September 23, 20129, 124 AFTR ? 20129-5281.)

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IRS answers questions about virtual currency transactions.

The IRS has issued additional guidance about how to report virtual currency transactions. Virtual currency includes things like BitCoin. The guidance includes new Revenue Ruling 2019-24 and frequently asked questions (FAQs) on its web site.

Taxpayers should be aware that any transaction involving virtual currency can have a tax consequence.

I've written a blog post summarizing these items. Here's a link to that blog post. http://www.michaelgraycpa.com/posts/irs-gives-more-guidance-for-virtual-currency-transactions/.

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Dependency exemptions and tax credits denied.

A married couple, who were pastors of a church, provided housing, clothing and food to three children of a friend, who was homeless. They also supported the wife's father, who received $8,796 during 2012 for Social Security.

At the request of the children's mother, they claimed dependency exemptions and child tax credits for the children. They also claimed a dependency exemption for the wife's father.

The Tax Court upheld the IRS in denying the exemptions and tax credits. The children weren't qualifying relatives of the taxpayers and might have been qualifying children of their mother, and the Social Security income of the wife's father exceeded the annual exemption amount for 2012, so the taxpayers didn't qualify for the exemptions or credits.

(Saunders v. Commissioner, TC Summary Opinion 2019-29, September 30, 2019.)

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S corporation that previously terminated its election couldn't distribute old accumulated adjustment account tax-free.

A federal district court upheld the IRS in holding an S corporation that had previously terminated an S election and re-elected to be an S corporation couldn't distribute its undistributed accumulated adjustment account under the previous election. The taxpayer didn't meet the requirement under Internal Revenue Code Section 1377(b) that the account be distributed within one year after the corporation was an S corporation under the previous election.

(Tomseth v. Commissioner, DC OR September 27, 2019, 124 AFTR 2d ? 2019-5304.)

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IRS explains why religious objectors can't claim a child tax credit.

The IRS has issued an information letter explaining why taxpayers with a religious objection to Social Security may no longer claim the child tax credit for a child without a Social Security number.

Under new rules governing the administration of the child tax credit under the Tax Cuts and Jobs Act of 2017 that are effective for tax years 2018 through 2025, a taxpayer can't claim a child tax credit unless the child's Social Security number is included on the income tax return.

(Information Letter 2019-0017.)

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2020 FICA thresholds for domestic employees and election workers announced.

The Social Security Administration has announced the FICA coverage thresholds for domestic employees will be $2,200 and for election workers will be $1,900. When compensation for these workers reach these amounts, it will be subject to FICA tax.

(SSA Website: Employment Coverage Thresholds.)

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Taxpayer couldn't deduct expenses he couldn't substantiate after a fire.

Brent Katusha was a professional racing mechanic. Brent agreed with the IRS that he failed report $10,000 of additional business income for 2014. He claimed that he was entitled to deduct $7,355 of additional business expenses for that year. His business records were destroyed in a fire at his tax return preparer's office.

The Tax Court upheld the IRS in finding that Brent wasn't able to adequately substantiate the additional deductions.

If there is a moral, it's to be sure to claim the deductions you're entitled to in the first place.

The IRS is now saying that it expects taxpayers to maintain their records "in the cloud." Time will tell if the courts uphold that requirement.

(Katusha v. Commissioner, TC Summary Opinion 2019-31, October 10, 2019.)

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Seller's payment of buyer's finder's fee wasn't tax deductible.

A seller paid a $1.5 million finder's fee charged to the buyer relating to the purchase of a business. The Tax Court upheld the IRS in finding the seller couldn't deduct the fee, because it wasn't an ordinary and necessary business expense of the seller.

(Plano Holding LLC v. Commissioner, TC Memo 2019-140, October 16, 2019.)

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California Court of Appeal says new employee classification rules apply retroactively.

A California Court of Appeal recently ruled that the California Supreme Court's adoption of an "ABC test" in its Dynamex decision of whether a worker should be classified as an employee or an independent contractor should be applied retroactively. The Court also ruled that the status as an employee under Dynamex applies not only to the California Industrial Welfare Commission's wage order claims but to Labor Code claims that enforce wage order requirements, including wage and hour laws, minimum wage, meal and break times, etc.

The California legislature adopted the Dynamex employee classification rules in AB-5.

If you use independent contractors in your business, consult with your tax advisor and labor lawyer about these rules.

(Gonzales v. San Gabriel Transit, Inc., Cal. Ct. App., 2nd App. Dist., Case No. B282377, October 8, 2019; Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903, April 30, 2018.)

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California excess business losses will be different from federal.

Effective 2019, California has conformed to the federal limitation on excess business losses for non-corporate taxpayers, with some important differences.

An excess business loss for a taxable year is the excess of the aggregate of all of the taxpayer's trade or business deductions or losses over aggregate gross revenues or gain, plus a threshold amount. For 2019, the threshold amount is $255,000, or $510,000 for a joint return.

Here are California differences.

  1. The limitation applies indefinitely. The federal limitation only applies for tax years 2018 through 2025.
  2. The California excess business loss deduction is computed after applying California's passive activity loss limitations. California doesn't reclassify losses as nonpassive for real estate professionals.
  3. Any unused losses will be treated as "carryover excess business losses", not as a net operating loss as under the federal rule. The carryover is included in subsequent years to determine the amount of excess business losses that may be deducted in that year.

In addition, California business income can be quite different from federal business income because of items like federal bonus depreciation and expense election differences.

Tax return preparers and taxpayers should look for adjustments on California income tax returns relating to these differences.

(AB 91, Revenue and Taxation Code Section 17560.5, Spidell's California Taxletter, November, 2019, p. 3, "California's excess business loss deduction may be different from federal.")

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Noncorporate cannabis businesses may now deduct their business expenses.

California has enacted legislation that will allow noncorporate businesses engaged in commercial cannabis activities to deduct their ordinary and necessary business expenses on their California, but not their federal, income tax returns for taxable years beginning on or after January 1, 2020 and before January 1, 2025. They will also be able to claim California credits related to their cannabis business activities.

Previously, only corporate taxpayers could deduct these expenses on their California tax returns, provided they were not convicted of specified illegal activities, including drug trafficking, in a criminal proceeding or other proceeding when a governmental agency was involved.

(AB 37, Revenue and Taxation Code Section 17209, Spidell's California Taxletter, November 2019, page 13, "Noncorporate cannabis businesses may deduct expenses.")

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New employer FSA notification requirements enacted.

Effective January 1, 2020, AB 1554 requires employers to notify employees who participate in flexible spending accounts of any deadline to withdraw funds before the end of the plan year. The notice must be provided in two different forms, one of which may be electronic. The requirement applies to dependent care flexible spending accounts; health flexible spending accounts; and adoption assistance flexible spending accounts.

(Spidell's California Taxletter, November 2019, page 14, "Legislation of Interest.")

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Family leave benefits expanded.

Effective July 1, 2020, SB 83 extends the duration of California's paid family leave benefits from six weeks to eight weeks and requires the Governor to develop a proposal to increase paid family leave duration to a full six months by 2021-22.

See your labor lawyer about how these requirements might apply to your business.

(Spidell's California Taxletter, November 2019, page 14, "Legislation of Interest.")

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FTB says power shutdown is reasonable cause for late filing or payment.

The Franchise Tax Board has announced that taxpayers who filed a tax return late or made a late payment because of the October 2019 safety power shutoffs are eligible for penalty relief with a reasonable cause. For more information, go to http://www.ftb.ca.gov/help/disagree-or-resolve-an-issue/claim-for-refund.html#Reasonable-cause.

(Spidell's California Taxletter, November 2019, page 14, "Legislation of Interest.")

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If you exercised ISOs during 2019, should you use the "escape hatch"?

Remember if you exercised ISOs during 2019 and didn't sell the stock, your AMT adjustment will be based on the fair market value of the stock on the date of exercise. However, if you sell the stock before the end of the year of exercise, the AMT adjustment is eliminated. Ordinary income is reported for the excess of the selling price over the option price. I call this strategy "the escape hatch."

For example, Jean Employee exercised an ISO for 1,000 shares of XYZ stock on March 1, 2019. The fair market value of the shares on March 1, 2019 was $55 per share and the option price was $5 per share. If Jean didn't sell the stock, she would report additional AMT income of $55 - $5 = $50 X 1,000 shares = $50,000. On December 15, 2019, Jean sells the stock for $15 per share. The AMT adjustment is eliminated and Jean reports $15 - $5 = $10 X 1,000 shares = $10,000 of ordinary income for regular tax and AMT.

There is an important requirement to get this tax benefit. A loss would have to be "allowable" if the stock was sold at a loss. A common transaction that would disqualify an escape hatch is a wash sale. A wash sale happens when replacement shares or an option to acquire replacement shares are acquired during the period 30 days before or 30 days after the sale.

For example, if Jean purchased 1,000 shares of XYZ Software for $16 per share on December 10, 2019, she would still have a disqualifying disposition of the ISO shares, but she would have $50,000 of ordinary income because the escape hatch wouldn't apply. Her short-term capital loss of $15 - $55 = $40 X 1,000 shares = $40,000 would be disallowed as a current deduction. The disallowed loss would be added to the tax basis of the replacement shares. Therefore, the tax basis of the replacement shares would be $16 + $40 = $56 X 1,000 shares = $56,000.

If you are going to use this "escape hatch" strategy, I suggest not waiting until the last minute. One of my clients was thinking of doing this, and an employee unexpectedly sued the company for an employment-related matter. The company's stock was locked up for employees because of the lawsuit. My client wasn't able to use the "escape hatch" strategy.

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Year end planning - should you "harvest" losses before the year end?

The stock market has been very active this year. If you have sold securities (or other assets) for capital gains, review the securities (or other assets) you are holding for potential capital losses. If you sell the loss shares before the end of the year, you can offset the losses against your gains. This is even more important if you could be subject to the 3.8% federal net investment income tax. You could bring your adjusted gross income below the $250,000 threshold for married persons filing joint returns or $200,000 for singles.

Remember the wash sale rules. If you purchase shares of the same security during the period 30 days before and 30 days after a sale at a loss, the loss is disallowed for the same number of shares.

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Please share your good experiences with Michael Gray, CPA.

As you know, more and more people are going to the internet to find information about service providers. We hope you will share some good words about experiences that you have had with our firm<. Some of the sites where you can share your experiences include yelp.com and siliconvalley.citysearch.com.

We use Angie's List to assess whether we're doing a good job keeping valued customers like you happy. Please visit AngiesList.com/Review/4258970 in order to grade our quality of work and customer service.

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Financial Insider Weekly past episodes

After eight years of production, I have discontinued producing new interviews for Financial Insider Weekly. Doing the show has been a rewarding experience and I consider back episodes to be my legacy of financial literacy education to our community. Back episodes available at https://www.youtube.com/user/financialinsiderweek.

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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.

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Visit our new article!

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Follow me on Social Media!

Want to see new episodes of Financial Insider Weekly as soon as they're posted on Youtube? Want to see Michael Gray's blog posts as soon as they're live? We post them (and more) on social media!

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.

I'm also on Facebook, LinkedIn, and Google+.

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

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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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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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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
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