Michael Gray, CPA's Tax and Business Insight

May 2, 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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Minerva Siemer enjoys riding a boogie board at Rio Del Mar beach. Summer is almost here!

Happy Mothers' Day!

Mothers' Day will be celebrated on Sunday, May 12 this year. Remember to express your appreciation to your mother and other mothers who have contributed to your life.

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Happy Memorial Day!

Memorial Day will be celebrated on Monday, May 27 this year. Memorial Day is the unofficial beginning of summer. Break out the griller and enjoy the day while honoring those who died defending our country.

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Family celebration.

My daughter Holly Baker and her husband Dan are celebrating their wedding anniversary during May. (By the way, springtime is a great time for enjoying a patio dinner at their restaurant, Marché Aux Fleurs in Ross, California!) Happy anniversary!

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It's time for cleanup and extensions.

Maybe you have an issue for which you would like a second look on the income tax returns you just filed. Maybe you have extended income tax returns that you need to have prepared. Or maybe you have some planning issues for which need advice. To make an appointment, call Thi Nguyen, CPA at 408-286-7400, extension 206.

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Attention CPAs.

Do you need help writing content for your web site, books to promote your CPA firm, your CPA firm newsletter or promotional communications? Maybe I can help. Call me, Michael Gray, at 408-918-3161 or email mgray@taxtrimmers.com.

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California changes threshold for reporting California sales and use tax for out of state retailers and for district reporting by California retailers.

See my blog post about it. www.michaelgraycpa.com/posts/california-sales-tax-relief-for-small-online-marketers/

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IRS issues updated guidelines for Qualified Opportunity Funds.

See my blog post about it. www.michaelgraycpa.com/posts/irs-issues-more-proposed-regulations-for-qualified-opportunity-funds/

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Increased standard deduction means a higher net investment income tax for some taxpayers.

See my blog post about it. www.michaelgraycpa.com/posts/increased-standard-deduction-means-increased-net-investment-income-tax/

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Seniors age 70 1/2+! Have you considered giving your required IRA distribution directly to a charity?

With the increased federal standard deduction and reduction or elimination of itemized deductions, many senior taxpayers will find they can no longer get a tax benefit from itemized deductions. Taxpayers aged 70 1/2 or older are required to take distributions from their regular IRA accounts. If taxpayers subject to this requirement have the distribution of up to $100,000 paid directly to a qualified charity, the taxpayer isn't required to report the income and the charity receives the payment tax free. (The taxpayer may deliver the check from the IRA made payable to the charity by the required payment date for the taxable year.) For taxpayers who are charitably inclined, this is one of the better tax-favored transactions in the tax law. See your tax advisor for details.

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Be careful when modifying the terms of an incentive stock option.

Sometimes events happen where an employer wants to extend the term of an incentive stock option, such as an incentive to keep a key employee.

Such an extension can have disastrous consequences.

According to Internal Revenue Code Section 424(h), the modification, including an extension, of an incentive stock option is considered the grant of a new option. If the option price isn't changed to the fair market value on the date of the extension, the option probably won't qualify as an incentive stock option (Internal Revenue Code Section 422(b)(4)). The option will also probably violate the option pricing rules under Internal Revenue Code Section 409A, resulting in severe penalty taxes for the employee!

Look before you leap!

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Accelerated vesting isn't a modification of an ISO.

According to Internal Revenue Code Section 424(h)(3)(C), the accelerated vesting of ISOs isn't a modification.

This is helpful, since many companies accelerate the vesting of ISOs if the company is acquired.

However, if the option price of ISOs that are initially exercisable for the year exceeds $100,000, some of the ISOs will be converted to non-qualified stock options (NQSOs). (Internal Revenue Code Section 422(d).) The exercise of the NQSOs will result in ordinary compensation income, subject to withholding and employment taxes.

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IRS explains the interaction of the itemized deduction for state and local taxes and the tax benefit rule.

The $10,000 limit for the itemized deduction of state and local taxes that was enacted in the Tax Cuts and Jobs Act of 2017 has created some confusion relating to state tax refunds. If a refund is received, does it relate to the deducted state tax or the disallowed state tax?

The IRS has responded to this question. According to the IRS, taxpayers should follow the tax benefit rule. If a taxpayer receives no tax benefit from including the refunded amount in the tax deduction, then the refund amount isn't taxable.

For example, a taxpayer paid $20,000 of state and local taxes for 2018, and receives a $5,000 state income tax refund. Since the deduction, $10,000, wouldn't change if the $5,000 amount wasn't included ($15,000 of "potential" deduction is still limited to $10,000), the refund amount isn't taxable under the tax benefit rule.

(Revenue Ruling 2019-11, March 29, 2019.)

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California makes some late corrections to forms.

The original version of Schedule CA didn't include adjustments to medical expense deductions. California doesn't recognize Health Savings Accounts (HSAs). That means income earned by an HSA is taxable in California and medical expenses paid by an HSA are added to the federal amount. California has corrected this problem on an updated form.

The federal itemized deduction for foreign property taxes was suspended by the Tax Cuts and Jobs Act of 2017. California still allows the deduction. The adjustment should be entered at Form 540, Schedule CA, Part II, Line 6, Column C. That box was blacked out on the original version of Schedule CA. California has corrected this problem on an updated form.

(Spidell's California Taxletter®, May, 2019, p. 2, "Post-tax season catch-up.")

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Arizona sues California about business taxes.

Arizona is suing California, claiming California is imposing an unconstitutional tax on Arizona businesses and individuals that don't actually conduct any business in California. The California Franchise Tax Board continues to aggressively claim out of state taxpayers are subject to California tax, despite rulings against the FTB by the California court of appeal and the Office of Tax Appeals in the Swart and Satview Broadband cases.

The venue for legal disputes between the states is the U.S. Supreme Court.

(Spidell's California Taxletter®, May, 2019, p. 1, "Arizona suing California over the FTB's doing business interpretation.")

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IRA rollover was exempt in bankruptcy.

A taxpayer rolled over $20,000 of a $50,000 IRA distribution in a qualified rollover. After the rollover, the taxpayer filed a Chapter 7 bankruptcy petition. The trustee in bankruptcy said the $20,000 rollover was subject to the claims of creditors. An Illinois bankruptcy court ruled that, since the rollover was completed before the bankruptcy filing, the funds were in an account exempt from the claims of creditors. (Note — as I understand it, the rules of exemption vary from state to state.)

(In re: Jones, Bankruptcy Court Illinois, April 15, 2019, 123 AFTR 2d ¶ 2019-620.)

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Unused employee commuter benefits were lost at termination.

An employee elected to contribute pre-tax wages to a qualified commuter benefits plan at her employer. When the employee terminated employment, the employer asked the IRS if she could be reimbursed for about $380 of unused commuter benefits. The IRS responded that the amounts contributed could not be refunded and, since the person was no longer an employee, she could no longer use the funds for continued transportation expenses.

(Information Letter 2019-0002.)

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No SSN - No child credit.

The IRS allows taxpayers with religious or conscience-based objections to obtaining Social Security Numbers to claim a personal exemption deduction without providing a taxpayer identification number.

The personal exemption deduction was repealed for tax years 2018 through 2025 by the Tax Cuts and Jobs Act of 2017.

Parents can claim a child tax credit for a qualifying child. The credit was increased by the Tax Cuts and Jobs Act of 2017 from $1,000 to $2,000 for a qualifying child. The Act also added the requirement that the child must have a valid Social Security Number to qualify for the credit.

The IRS says that, since the requirement is now in the Internal Revenue Code, it applies regardless of whether the parents have a religious or conscience-based objection. The Religious Freedom Restoration Act of 1993 doesn't provide an exception to the rule because the IRS has a compelling governmental interest to ensure uniform and orderly tax administration and to prevent improper claim of the child tax credit.

(Program Manager Technical Advice 2019-002.)

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Concierge CFO denied travel expenses.

A taxpayer who had a business providing CFO services as an independent contractor to various corporate clients was denied a tax deduction for his traveling expenses. The taxpayer had a three-year contract to work four days a week for a client located in Pennsauken, New Jersey. His residence was in Atlanta, Georgia. His sole source of business income from the time his contract started on October 2, 2012 until at least August 4, 2014 was with his client in Pennsauken, New Jersey.

The Tax Court upheld the IRS in denying traveling expenses between Atlanta and Pennsauken during 2012 and 2013. The Tax Court agreed with the IRS that, since the agreement was for three years, the taxpayer couldn't have expected his work in Pennsauken would be temporary. For the purpose of deducting travel expenses, his tax home was his principal place of business, which was Pennsauken during the term of the contract.

(Brown v. Commissioner, TC Memo 2019-30, April 8, 2019.)

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Employee family members of S corporation 2% shareholders get self-employed health insurance deduction.

S corporations don't deduct the health insurance premiums as a medical insurance benefit for employees who own 2% or more the corporation's stock. Instead, the premiums are included on the shareholder-employee's Form W-2, included in the S corporation's deduction for employee wages, and deducted by shareholder-employees separately as self-employed health insurance on line 29, Schedule 1, Form 1040.

The IRS has held that medical insurance premiums for family members of S corporation 2% shareholders should be reported according to the same procedure.

This is a tax-favored treatment for family member employees. Medical insurance premiums paid personally are subject to the 10% floor for medical expenses and might not provide a tax benefit if the employee claims the standard deduction.

(Chief Counsel Advice 201912001.)

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Taxpayer who was awarded S corporation shares in a divorce must report income.

A taxpayer who was awarded S corporation shares in a divorce property settlement claimed she didn't have to report the taxable income with respect to the shares because she didn't have legal title to the shares. A federal district court granted the IRS summary judgment, finding the taxpayer was the beneficial owner of the shares because of the divorce court order.

(Bonilla v. U.S., District Court, Connecticut, March 22, 2019, 121 AFTR 2d 2019-547.)

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Settlement payment relating to the death of an S corporation owner's girlfriend is'nt tax deductible.

Claire Robinson, who was the girlfriend of James Cavanaugh, died at Cavanaugh's residence, probably from a cocaine overdose. Cavanaugh is the CEO and sole shareholder of Jani-King International, Inc., an S corporation.

Linda Robinson, who is Claire Robinson's mother, sued Cavanaugh and Jani-King for wrongful death.

Jani-King and Linda Robinson settled the lawsuit for $2.3 million. Cavanaugh paid $250,000 and Jani-King paid the remainder. Jani-King reimbursed Cavanaugh for his $250,000 payment.

Jani-King deducted its payment and reimbursement to Cavanaugh as ordinary and necessary business expenses.

The Fifth Circuit Court of Appeals upheld the Tax Court ruling disallowing the deductions. The Tax Court found the lawsuit didn't relate to Jani-King's profit-seeking activities and the payments were not deductible. Employees of Jani-King who interacted with Claire Robinson relating to her ingesting cocaine weren't involved in corporate activities at the time she did so.

Since the reimbursement of $250,000 to Cavanaugh wasn't made to protect or promote the business, that payment wasn't tax deductible.

(Cavanaugh v. Commissioner, U.S. Court of Appeals for the Fifth Circuit, No. 18-60299, Mar. 29, 2019.)

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Pro Sports Teams get a break for contract trades.

Section 1031, Tax Deferred Exchanges, was repealed except for real estate exchanges by the Tax Cuts and Jobs Act of 2017. This created a dilemma for pro sports teams. Were exchanges of player contracts taxable? The IRS has resolved the issue by issuing a safe harbor for professional sports teams to treat player contracts has having a zero value for the purposes of determining gain or loss to be recognized on the trade of a personnel contract or a draft pick.

(Revenue Procedure 2019-18.)

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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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