Michael Gray, CPA's Tax and Business Insight

July 2, 2012

© 2012 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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Arrrh! Clive Baker's latest passion is Pirates!
Arrrh! Clive Baker's latest passion is Pirates!

Happy July 4!

"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed..."

Our country was founded based on an amazing document, the Declaration of Independence. The Declaration was a political document, full of compromises, including the omission of a statement about slavery that was negotiated away. Despite that, the amazing spirit of Thomas Jefferson, the principal author, and the other founding fathers remains in this document, which remains a foundational statement of our belief and commitment to liberty.

Every July 4, we recommit ourselves to our country's ideals. The ideals of the United States of America are still an inspiration to people struggling for freedom throughout the world. Let's resolve to preserve and promote those ideals in our country and in our lives as an example to others.

Happy Fourth of July!

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Dawn is on maternity leave.

We're expecting a new granddaughter late in July, so Dawn is taking some time to prepare and to care for her new baby girl. Michele Brantley will be handling Dawn's duties in her absence, which is a challenging job! Dawn's plan is to return in October to help process returns for the final extended due date for 2011 individual income tax returns, October 15.

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It's time for tax planning and working on amended, extended and late income tax returns.

It's time to have a second look at income tax returns that were filed for possible amended income tax returns. Taxpayers who filed extensions are also looking for help getting their income tax returns done.

If you would like our help, call Michele Brantley on Wednesdays from 9 a.m. to 5 p.m. Pacific Time to make an appointment. Michele's telephone number is 408-918-3162.

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The year is half over! How's it going?

Remember those New Year's resolutions, personal financial plans and business strategic plans that it seems you made just yesterday? Are they being implemented? Have you had any significant transactions that we should be discussing? Have you made that appointment with an attorney to have your estate plan done? May we be of service in helping you accomplish your goals during the last half of the year?

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July celebrations.

My son, James Gray, is celebrating his 32nd birthday this month. Happy birthday, James!

My daughter, Dawn Siemer, married John Siemer six years ago. Happy wedding anniversary, Dawn and John!

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The Supreme Court upholds Federal Health Care Reform.

June 28, the Supreme Court announced its opinion upholding the individual mandate in the Patient Protection and Affordable Care Act, which was enacted March 23, 2010. The individual mandate means that most individuals will be required to have medical insurance coverage by 2014, or be required to pay a penalty. The mandate was a key provision of the legislation, because broad participation is required in order to make coverage for individuals with pre-existing medical conditions economically feasible.

2.5 million Americans have taken advantage of a provision in the Act extending coverage under parents' medical insurance to their children until they are 26 years old.

This decision is a major victory for President Obama. The legislation is probably the most significant accomplishment of his term in office.

This is a complex piece of legislation, was crafted under the guidance of the health insurance providers. It is not a single government provider plan, as some would have preferred, but the majority opposed who were in favor of a private company system. If the Supreme Court didn't uphold it, it would have been disruptive. California has already implemented many of the provisions. Congress would have had to renegotiate another solution to the problem of the inability of many Americans to get medical insurance.

Mitt Romney, the Republican presidential candidate, has resolved to repeal the legislation immediately if he wins the election. If a Democrat majority remains in the Senate, that is highly unlikely.

There are passionate feelings for and against this legislation that are beyond the scope of this discussion.

Remember, effective next year, the legislation includes a 3.8% "Medicare tax" on unearned income for single taxpayers with modified adjusted gross income in excess of $200,000 and married taxpayers filing joint returns with modified gross income in excess of $250,000. There is also an additional 0.9% Medicare tax that will be imposed on wages for taxpayers with the same thresholds.

Since the Patient Protection Act has been upheld, these tax increases are scheduled to take effect, unless Congress takes action to postpone them. I don't expect any major tax legislation to be enacted until after the election in November.

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California sales tax rates increase in some communities on July 1.

Thanks to some propositions being passed for sales tax increases in some communities, sales tax rates are increasing on July 1. The rate for Santa Clara County is generally increasing from 8.25% to 8.375%. The rate for the City of Campbell in Santa Clara County is increasing from 8.5% to 8.625%. The rate for the City of Fort Bragg in Mendocino County is increasing from 7.875% to 8.375%.

To double check the rates where you do business in California, visit the California State Board of Equalization web site at www.boe.ca.gov.

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Should you make a significant gift during 2012?

You might recall that the exemption equivalent for the federal estate and gift taxes has temporarily been increased for 2011 and 2012. The exemption equivalent for 2012, adjusted for inflation, is $5,120,000. The maximum estate and gift tax rate is 35%.

After 2012, the exemption equivalent is scheduled to be $1 million and the maximum estate and gift tax rate is scheduled to be 55%.

Married couples with more than $10 million in net worth should be seriously considering an aggressive gift plan for 2012. The benefits of the exemption can be leveraged using a family limited partnership or life insurance.

There is a risk of a "clawback" in an estate tax return for decedents dying after 2012, but it still seems worthwhile to seriously consider making a significant gift during 2012. (See the blog post below for an explanation.)

You should only go ahead with the gift plan after consulting with your estate planning attorney and tax advisor.

See my blog post on this subject. http://tinyurl.com/big2012gift (Call Michele on Wednesdays at 408-918-3162 if you want us to mail you a copy.)

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Should you consider making a charitable remainder trust?

If you have a significantly appreciated asset, such as publicly traded stock, that would qualify for a long-term capital gain if sold, you might consider setting up a charitable remainder trust. Current low interest rates result in a bigger tax deduction for gifts to such trusts. When you make a gift to a charitable remainder trust, the trust can sell the appreciated asset tax free. You get a current tax deduction for the remainder interest, subject to a 30% of adjusted gross income limit, with a carryover for the donation over the limit. Then the trust can make diversified investments and pay you income during your lifetime. The balance of the trust is distributed to a qualified charity at your death.

These trusts are usually made by individuals who are interested in benefiting a charity they like, because the principal of the trust is not going to their families. The principal is often replaced using life insurance, possibly in an irrevocable life insurance trust.

There is an annual cost for maintaining these trusts for tax return preparation, asset management and possibly trustee fees, so they should only be used for significant gifts.

If you are interested in finding out more, consult with your estate planning attorney and tax advisor, or call 408-918-3162 on Wednesdays from 9 a.m. to 5 p.m. for an appointment to meet with Michael Gray.

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IRS issues guidance on medical FSAs.

Under Federal Health Care Reform, the amount that can be contributed to a flexible spending arrangement or cafeteria plan for medical expenses is limited to $2,500, effective for plan years beginning after December 31, 2012. (Previously there was no limit.) The amount is indexed for inflation effective for plan years beginning after December 31, 2013.

The IRS has issued guidance about the effective date of the new requirement, and to remind employers that their FSA or cafeteria plan documents must be amended to conform with the new limit or employees won't be eligible to make pre-tax contributions to the plan.

In addition, the IRS has asked for comments about eliminating the "use-or-lose" it rule for these plans. The reduced limit has reduced the potential for abuse of these plans.

(Notice 2012-40, May 31, 2012.)

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IRS issues proposed regulation about shareholder loans to S corporations.

Shareholder loans to S corporations are an IRS audit target, and the subject of a lot of litigation. The reason is legitimate loans by a shareholder are included in the shareholder's investment when computing the limitations for deducting losses passed through from an S corporation. The IRS has issued proposed regulations explaining when a shareholder loan is bona fide, qualifying to be included as an investment for the loss limitation.

The IRS makes it clear that shareholder guarantees of loans from third parties don't qualify until the shareholder makes a payment to the third party under the guarantee.

A "back to back" loan where a shareholder borrows money from a related entity and then loans the funds to the S corporation will also be questioned as not a bona fide direct shareholder loan.

The proposed regulations apply to loan transactions entered into on or after the date the regulations become final.

(NPRM REG -134042-07.)

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Tax Court disallows business arrangement using Roth IRAs.

A husband and wife set up two separate "C" corporations, which were owned by their Roth IRA accounts. The couple had another constructions business, which paid for services by the corporations owned by the Roth accounts.

The Court ruled that the payments were disguised contributions to the Roth accounts exceeding the annual limits.

The first lesson of this ruling is the IRS is looking at what is going on in retirement accounts, and is particularly interested in finding abusive transactions.

The second lesson is to be very careful when doing business under a retirement account. Transactions with related parties are usually prohibited transactions, which can disqualify the account and subject the account owner to serious penalties.

Owning a business owned by a retirement account should be done very carefully under the guidance of a skilled tax advisor.

(T.C. Repetto, TC Memo 2012-168, June 15, 2012.)

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Attention restaurant owners: IRS distinguishes tips from service charges.

The IRS has issued a Revenue Ruling and an Announcement explaining how to distinguish tips from service charges. The Revenue Ruling is in question and answer format. The new ruling is actually based on guidelines previously given in Revenue Ruling 59-252.

Both service charges and tips are subject to income taxes and payroll taxes. Service charges should be included in wages and tips are separately reported on Form W-2. The employee has more responsibility for reporting tips received to the employer. Employer FICA taxes paid for employee tips are eligible for a tax credit on the employer's income tax return.

According to Revenue Ruling 59-252, the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge: 1) the payment must be made free from compulsion; 2) the customer must have the unrestricted right to determine the amount; 3) the payment should not be the subject of negotiation or dictated by employer policy; and 4) generally, the customer has the right to determine who receives the payment.

For example, a restaurant has a policy of charging an 18% standard gratuity for parties of six or more customers. This gratuity is a service charge, not a tip, because it is made according to an employer policy.

Another example is when the employer receives all employee tips and divides them among the employees. Since the customer doesn't have the right to determine who receives the payment, the gratuity is a treated service charge and is included in wages, not separately reported as a tip.

In the Announcement, IRS agents are directed to not recharacterize amounts reported by employers as tips before January 1, 2013 as service charges.

(Reminder: The California State Board of Equalization has previously announced that "standard gratuities" are subject to California sales tax, while discretionary tips are not.)

(Revenue Ruling 2012-18, June 21, 2012, Announcement 2012-25, June 21, 2012.)

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IRS issues guidance on estate exemption portability.

The IRS has issued temporary regulations and proposed regulations relating to the election to make the unused exclusion amount for a deceased spouse available for a surviving spouse. At this time, the election is only available for individuals who were deceased during 2011 and 2012 for the unused exclusion to be used by surviving spouses who are deceased during 2011 and 2012.

The current federal estate tax rules, mostly enacted as part of the Bush Tax Cuts, are currently scheduled to expire after 2012.

As a precaution in case this portability election is extended, many elections are being filed for deceased individuals for whom federal estate tax returns otherwise wouldn't be required.

Under the temporary regulations, the portability election is made by timely filing a complete federal estate tax return.

In response to complaints about the expense of preparing a complete federal estate tax return, including documenting the value of all assets, the IRS has relaxed the valuation and documentation requirements somewhat for property that qualifies for the marital deduction or a charitable deduction. No federal estate tax would result from the transfer of such property.

Since the federal estate tax return is due nine months after death and the due date can be automatically extended an additional six months, it probably makes sense to file for an extension for any no-tax estate when there is a surviving spouse and an individual subject to U.S. estate tax is deceased during 2011 or 2012. Then you can buy a little time to decide whether it's worth the effort to prepare the federal estate tax return and make the election.

(T.D. 9593, June 18, 2012,NPRM REG-141832-11, June 18, 2012.)

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Community public access television needs our help.

Public access television is a vital part of our educational outreach to various communities. These are usually nonprofit, charitable organizations, like public television stations. Unlike those stations, most of the programming for the public access stations comes from local producers.

This programming includes the local arts, productions by students at local schools, community outreach by churches, independent local producers discussing current social issues, educational programming by local providers like ourselves and much more. In other words, public access television makes a unique, important contribution to the communities it serves.

With the difficult times we are experiencing, many public access stations are facing severe financial challenges, and might not survive without more community financial support. I urge you to consider making a donation to your local public access television station. Here is a link for a list of public access television stations in California: http://www.communitymedia.se/cat/linksca.htm.

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Financial Insider Weekly broadcast schedule for June and July.

Financial Insider Weekly is broadcast in San Jose and Campbell on Fridays at 8:00 p.m., Pacific Time. You can watch it on Comcast channel 15 for San Jose and Campbell. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for June and July:

June 8, 2012, Michael Desmarais, attorney, “Your rights as a beneficiary”
June 15, 2012, Janis Carney, attorney, Carney, Sugai & Sudweeks, LLP, “Life care planning”
June 22, 2012, Janis Carney, attorney, Carney, Sugai & Sudweeks, LLP, “Veteran’s Administration benefits for long-term care”
June 29, 2012, Peggy Martin, CLU, ChFC, MSFS, The Family Wealth Consulting Group, “Long-term care insurance”
July 6, 2012, David Howard, attorney, Hoge, Fenton Jones & Appel, “Information reporting requirements for foreign bank accounts and foreign trusts”
July 13, 2012, James Brown, ASA, CFP®, Perisho, Tombor, Ramirez, Filler & Brown, PC, “The role of the business valuation specialist”
July 20, 2012, Dean Fabro, Bank of the West, “Small Business Financing”
July 27, 2012, Francis Doyle, attorney, WealthPLAN, “Preserving family assets using a family limited partnership or LLC”

Financial Insider Weekly is also broadcast as follows:

Past episodes are available at https://www.youtube.com/user/financialinsiderweek.

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!

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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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.

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 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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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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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
Hours: 8am - 5pm PDT Monday - Friday

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