Michael Gray, CPA's Tax and Business Insight
February 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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Table of Contents
- Happy Valentine's Day!
- Happy Lunar New Year!
- February celebrations.
- Remember federal income tax returns for calendar-year S corporations and partnerships are due March 15.
- The election to be an S corporation for calendar-year corporations is also due March 15.
- Have you received your tax preparation materials?
- Attention CPAs located in the Silicon Valley area.
- Make your tax return preparation interview appointment now.
- File your tax return early, if you can.
- Failure to file or pay taxes can lead to denial of a U.S. passport.
- Final Section 199A regulations released by IRS.
- IRS tax season begins January 28.
- Remember Congress needs to pass a technical correction for bonus depreciation of Qualified Improvement Property.
- Spouses of military service members can elect to be residents of the military service member's state.
- IRS issues final regulations for tax on offshore income.
- Form issued for Qualified Opportunity Funds.
- Partnerships will have to consider new audit rules for 2018 income tax returns.
- IRS will waive some underpayment of estimated tax penalties for 2018.
- If you sell mutual fund shares, remember to account for reinvested dividends.
- Don't report taxable income twice!
- Remember to report the sale of option stock.
- Watch reporting qualified sales of ISO stock.
- Pay withheld federal payroll taxes first.
- Please share your good experiences with Michael Gray, CPA.
- Financial Insider Weekly past episodes.
- Visit our new book review: Factfulness
- Follow me on social media!
- Check out my blog.
- PS Marché Aux Fleurs
- Subscribe/Remove from Michael Gray, CPA's Tax & Business Insight
Gail and Lane Johnston with Janet and myself at The Beach House Restaurant in Pacific Grove. Gail and Lane are celebrating their 50th wedding anniversary during February 2019. Happy Valentine's Day!
Remember to show your love and appreciation for your loved ones on Thursday, February 14. (Marché Aux Fleurs restaurant, located in Ross, California, is owned by my daughter, Holly Baker, and her husband, Dan. They are fully booked for Valentine's Day. Book your reservation at your favorite restaurant now!)
Happy Lunar New Year!
Lunar New Year is celebrated this year from February 5 - 19. This year is the Year of the Pig (or Boar). Happy Lunar New Year!
February celebrations.
My grandson, Clive Baker, and Thi Nguyen, CPA, who is now serving my former clients, are celebrating birthdays this month. Happy birthday Clive and Thi! My wife's sister, Gail Johnston, and her husband Lane are celebrating their 50th wedding anniversary this month. Congratulations!
Remember federal income tax returns for calendar-year S corporations and partnerships are due March 15.
(Federal income tax returns for calendar-year C corporations are due April 15.)
The election to be an S corporation for calendar-year corporations is also due March 15.
Have you received your tax preparation materials?
If you haven't received a tax data organizer or instructions to submit information online and want tax return preparation service by my successor, Ms. Thi Nguyen, CPA, please call her at 408-286-7400, extension 206.
Attention CPAs located in the Silicon Valley area.
Are you overloaded for review of income tax returns this tax season? Do you need a second opinion or research relating to a complex tax issue? Maybe I can help on a project basis. Call me, Michael Gray, at 408-918-3161 or email mgray@taxtrimmers.com.
Make your tax return preparation interview appointment now.
Most personal interview appointments for preparing 2018 individual income tax returns will be scheduled in February. Many clients send their information without having an interview, but if you need that personal attention, you should schedule your interview appointment now. Call Ms. Thi Nguyen, CPA at 408-286-7400, extension 206.
File your tax return early, if you can.
Identity theft has become a rampant problem. Scammers are filing bogus income tax returns and claiming refunds for withholding and estimated tax payments of innocent taxpayers. It can take months to straighten out a duplicate filing situation. Your easiest defense is to be the first one to file an income tax return under your social security number. Individuals who have suffered from identity theft in the past can get a special identification number for electronic filing from the IRS. Meanwhile, many taxpayers must wait to receive documents like Schedule K-1 as late as September, and have to file for extension of time to file their tax returns.
Failure to file or pay taxes can lead to denial of a U.S. passport.
The Federal State Department can deny or revoke U.S. passports of individuals who have federal tax debts exceeding $51,000 or if a levy has been issued. This doesn't include individuals paying their taxes under an installment agreement, individuals in bankruptcy, people who live in a federally declared disaster area, or people with a tax debt the IRS has determined is uncollectible because of hardship.
(Notice 2018-7, January 16, 2018.)
Final Section 199A regulations released by IRS.
The IRS has issued final regulations for Section 199A, the 20% deduction for qualified business income. Due to the government shutdown, the regulations haven't yet been published in the federal register, which delays the effective date for many provisions. The final regulations include several changes from proposed regulations that were published during August 2018.
The IRS has also issued Notice 2019-07, a proposed revenue procedure providing a safe harbor under which a rental real estate enterprise will be treated as a trade or business under Section 199A, proposed regulations providing guidance on the treatment of previously suspended losses and determining the deduction relating to regulated investment companies (mutual funds), charitable remainder trusts and split interest trusts, and Revenue Procedure 2019-11, providing methods for calculating W-2 wages for the limitations on the Section 199A deduction.
The rental real estate safe harbor is based on hours of rental services provided in a taxable year. For taxable years beginning after December 31, 2017 and before January 1, 2023, the activity will be considered a trade or business if 250 or more hours of rental services are provided. For taxable years beginning after December 31, 2022, the 250 hour test must have been met in any three of five consecutive taxable years ending with the current taxable year. Rental services may be performed by owners or by employees and independent contractors. Rental services include advertising to rent or lease the real estate, negotiating and executing leases, verifying information from prospective tenant applications, collection of rent, daily operation, maintenance and repair of the property, management of the real estate, purchase of materials, and supervision of employees and independent contractors. Rental services do not include financial or investment management or hours spent traveling to and from the real estate. Contemporaneous records must be maintained to document the hours spent, effective for tax years beginning after December 31, 2018. Taxpayers may still assert other arguments that their real estate operations are a trade or business if they don't meet the safe harbor.
(REG-107892-18, Notice 2019-07, REG-134652-18, and Revenue Procedure 2019-11.)
IRS tax season begins January 28.
The IRS has confirmed that it will begin processing 2018 income tax returns on January 28, 2019. The IRS has also said that there will be no delay in issuing refunds due to the government shutdown (which has since ended).
Remember Congress needs to pass a technical correction for bonus depreciation of Qualified Improvement Property.
Congress passed a tax simplification provision in the Tax Cuts and Jobs Act of 2017 to consolidate the eligibility of certain real estate improvements for tax favored treatment. Specifically, Qualified Improvement Property is defined as an improvement to an interior portion of a building that is nonresidential real property provided the improvement is placed in service after the date that the building was first placed in service. Improvements related to the enlargement of the building, an elevator or escalator, or the internal structural framework of the building are not qualified improvement property.
Congress intended to a assign a 15-year depreciable life to Qualified Improvement Property, which would have qualified it for 100% bonus depreciation. (Effective for property acquired and placed in service after September 27, 2017 and before January 1, 2023. The rate phases down thereafter.) In its hurry to pass the legislation, the 15-year life provision was missed. That means, unless Congress passes a technical correction, Qualified Improvement Property has a 39-year depreciable life and doesn't qualify for bonus depreciation.
Taxpayers who plan to use bonus depreciation for Qualified Improvement Property for 2018 should consider extending the due date for their income tax returns. Consult with a tax professional about alternative ways to deal with the situation. It's likely, but not certain, that Congress will eventually pass a technical correction and permit amended income tax returns to claim bonus depreciation on tax returns where it should have been available.
Alternatively, taxpayers can claim the Section 179 expense election for Qualified Improvement Property. The maximum amount that a taxpayer may elect to expense for 2018 is $1 million. The maximum deduction is reduced when the taxpayer places more than $2.5 million of property qualifying for the Section 179 election in service during 2018. The thresholds are indexed for inflation after 2018. The Section 179 deduction also can't reduce taxable income below zero. Any excess is carried forward.
Spouses of military service members can elect to be residents of the military service member's state.
Effective 2018, the spouse of a member of the U.S. military service may elect to be a resident of the state for which their military member spouse is a resident, even if the non-military spouse was never previously a resident of that state.
For example, John, who was previously a resident of California, married Jane during 2017. Jane is serving in the U.S. Navy. She is stationed in San Diego, California. Jane is a resident of Washington state. John may elect under the federal Veteran's Benefits and Transaction Act of 2018 (VBTA; P.L 115-407) to also be a resident of Washington state for 2018. Since Washington state has no state income tax for its residents, any wages earned by John and Jane during 2018 would be free of state income taxes!
(Under the prior Military Spouses Residency Relief Act of 2009, the non-service member spouse could only share the residency of the service member spouse if the spouse previously had the same domicile as the service member and moved to California to be with the service member.)
(Spidell's Flash E-mail February 1, 2019, "Military spouses may elect spouse's state of residency with no limits.)
IRS issues final regulations for tax on offshore income.
The IRS has issued final regulations on the "transition tax" under Internal Revenue Code Section 965 on untaxed foreign earnings of certain specified corporations. If this applies to you, I suggest that you consult with your tax advisor.
The regulations haven't been published in the federal register yet, due to the federal government shutdown.
Form issued for Qualified Opportunity Funds.
Certain partnerships and corporations that operated in designated areas can be Qualified Opportunity Funds that qualify for special tax benefits under the Tax Cuts and Jobs Act of 2017. The benefits include the federal income tax deferral of capital gains reinvested in the funds until the earlier of the date the Qualified Opportunity Fund property is sold or December 31, 2026 and potentially avoiding federal income tax on appreciation of the fund itself. The IRS has issued Form 8996 that funds must file annually with their federal income tax returns.
Partnerships will have to consider new audit rules for 2018 income tax returns.
The IRS has issued new audit rules for partnerships. Generally, increases in the tax liability as a result of audit adjustments will be paid by the partnership instead of the partners. Partnerships with 100 or fewer partners can opt out of the new rules, but partnerships that issue K-1s to a partnership, disregarded entity (such as a single member LLC), or trust aren't allowed to opt out. Partnerships must select a representative to deal with the IRS and list the representative on their federal income tax returns. Partnerships might need to update their partnership agreements to consider the new rules.
IRS will waive some underpayment of estimated tax penalties for 2018.
The IRS has announced that it will expand the threshold to avoid penalties of underpayment of estimated tax for 2018.
If you sell mutual fund shares, remember to account for reinvested dividends.
Mutual fund shares purchased using reinvested dividends have a cost and acquisition date for the reinvestments. Mutual funds and brokers don't always provide the cost and acquisition dates when the shares were purchased before 2012. They are required to provide the information when the shares were purchased after 2011. You can't rely on the information provided being complete when preparing your income tax returns.
Don't report taxable income twice!
A common error for employees who exercise employee stock options is to report their income twice. Ordinary income from exercising a non-qualified stock option or from the disqualified disposition of stock received from exercising an incentive stock option should be reported by the employer on Form W-2. The ordinary income amount is added to the tax basis (cost for computing gain and loss on your income tax return), reducing or eliminating the gain reported for the sale of the stock. Brokerage companies can also miss this adjustment on the information return for the sale. This is especially a common error for employees who skip the "interview mode" when preparing their own income tax returns using software like TurboTax.
Remember to report the sale of option stock.
Employees who exercise their stock options and immediately sell the stock sometimes omit reporting the sale of the stock. They figure the income is already reported on their W-2 form. They are essentially right, but the IRS "matches" the income reported on income tax returns with information returns for the sale of securities issued by brokerage companies. See the above information, "Don't report taxable income twice!" If you add the option price to the ordinary income reported for the nonqualified stock option exercise or disqualified disposition of ISO stock resulting from an exercise and immediate sale, the cost should be equal to or slightly more (because of selling expenses) than the sales price of the stock.
Watch reporting qualified sales of ISO stock.
A common error for employees who make a qualified disposition of ISO stock is to add the AMT income reported for the year of exercise to the cost of the stock. (A qualified sale is made more than two years after the grant of the ISO and more than one year after the exercise of the ISO.) Employees rationalize they have already paid income taxes for that income. The tax they paid was on the alternative minimum tax schedule, not the regular tax schedule, so there is no regular tax basis adjustment for the exercise. This is an error. The tax basis of the shares for regular tax reporting is generally the option price paid for the shares. (Note special rules apply when the option price is paid using other shares of employer stock. Those rules are beyond the scope of this explanation.)
The mechanism for recouping some of the AMT paid when the ISO was exercised is the minimum tax credit, reported on Form 8801. A second AMT Schedule D is prepared for the year of sale with the basis adjustment for the AMT income reported relating to the exercise of the ISO added to the tax basis on the AMT Schedule D for the sale of the ISO stock.
Does this make your head spin? Maybe you should hire someone who understands this to prepare your income tax returns. Call Thi Nguyen, CPA at 408-286-7400, extension 206 to make an appointment.
Pay withheld federal payroll taxes first.
A federal district court granted summary judgment to the IRS, and said the chief financial officer of a corporation was personally liable for unpaid withheld payroll taxes when he signed checks to pay creditors other than the IRS for several years and he was aware of the company's unpaid tax debt.
(Robert McClendon v. U.S., U.S. District Court, Southern District, State of Texas, January 22, 2019.)
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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.
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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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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Michael Gray, CPA2482 Wooding Ct.San Jose, CA 95128(408) 918-3162FAX: (408) 938-0610email: mgray@taxtrimmers.comHours: 8am - 5pm PDT Monday - FridayFind us on Facebook
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