Michael Gray, CPA's Tax and Business Insight

July 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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Granddaughter Picture.
My granddaughter, Minerva Siemer, who is almost seven years old, lost two teeth in two days!

Happy Fourth of July!

The Fourth of July is a great holiday to enjoy with our families and friends. Please do it safely! It's also a good time to reflect on the blessings of liberty and what they mean to us and to be grateful to those who defend our country.

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The year is half over!

Time is sneaking by us again! How is 2019 going for you? Is there any way we can help you reach your goals? How is your tax picture shaping up this year? Call Thi Nguyen, CPA at 408-286-7400, extension 206.

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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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It's time to think about California real estate property tax appeals.

For most of us in California, real estate values have more than recovered from any declines that we previously experienced. Victims of the fires that ravaged some areas of our state might need to file claims for reduced assessed values. Your family might have received a supplemental assessment notice relating to a change of ownership that you don't agree with. Santa Clara County sends its notices of assessed value during June.

The deadlines for appeals are 60 days after the date of a supplemental assessment notice and either September 16 or December 2 for regular assessments, depending on the county the property is located in. Here is a link for a list. http://www.boe.ca.gov/proptaxes/pdf/filingperiods.pdf

If you want help preparing your California real estate property tax appeal, call Ms. Thi Nguyen, CPA at 408-286-7400, extension 206.

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California enacts its own health care mandate.

The California legislature has passed SB 78, which would require most California residents and their dependents to have minimum health care coverage by January 1, 2020, or pay a penalty similar to the one previously imposed under the federal Affordable Care Act. Governor Newsom is expected to approve the legislation.

Employers will be required to annually provide health care coverage information to the Franchise Tax Board by March 31, and will be subject for penalties for failure to comply.

The legislation includes California subsidies to help residents to get health insurance if their income is below 600% of the federal poverty level.

(Spidell's Flash E-mail, Legislature passes individual health care mandate penalty and subsidies, June 27, 2019.)

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U.S. Supreme Court says states can't tax trust income based on beneficiary's residency.

The U.S. Supreme Court has ruled that a state can't tax trust income based on the residency of a beneficiary. In the case submitted to the Court, a trust was created by a resident of New York with a trustee located in New York. The trustee had discretion in making trust distributions and didn't make any. A beneficiary of the trust was a resident of North Carolina. North Carolina said the trust was subject to taxation by North Carolina, despite the fact that no distributions were received by the beneficiary.

The Supreme Court ruled that the North Carolina tax law violated the Due Process clause of the U.S. Constitution.

California also taxes, allocates and apportions income of trusts to California based on the residency of the trustee and the beneficiaries of the trust.

Out of state trusts with California beneficiaries should consult with their tax advisors about this new ruling, including whether amended income tax returns should be filed to recover income taxes paid under the beneficiary residency rule.

(North Carolina Department of Revenue v. Kimberley Rice Kastner 1992 Family Trust, U.S. Supreme Court Case No. 18-457, June 21, 2019.)

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California partial tax conformity legislation sent to Governor.

The California legislature has passed AB 91, which conforms California tax law to several provision in the federal Tax Cuts and Jobs Act of 2017, effective beginning in 2019. Taxpayers may elect to apply the provisions retroactively for 2018.

Governor Newsom is expected to approve the legislation.

Some of the provisions adopted include:

The legislation does NOT include tax incentives for Qualified Opportunity Zones.

(Spidell's Flash E-Mail, Partial TCJA conformity legislation sent to Governor, June 24, 2019.)

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Losses from horse breeding operation disallowed.

The Tax Court upheld the IRS in disallowing losses from a horse breeding operation as not conducted for profit. The taxpayers had the horse breeding business from 1985 through 2012. They only had $35,691 of gross receipts and $1,008,303 of expenses during that time. During the years at issue: 2010, 2011 and 2012, the taxpayers didn't breed, race or sell any horses. The breadwinning taxpayer earned his principal income as a computer programmer.

(Donohue v. Commissioner, TC Memo 2019-71, June 11, 2019.)

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Naturalized citizen was a non-citizen for estate, gift and generation-skipping tax purposes.

The IRS ruled a taxpayer who was born outside the U.S and its possessions, whose parents weren't U.S. citizens at the time of his birth, and became a U.S. citizen after residing in a U.S. possession was not considered to be a citizen of the U.S. for the estate, gift and generation-skipping tax.

According to Internal Revenue Code Sections 2209 and 2501(c), a decedent who was a citizen of the U.S. and a resident of a possession of the U.S. at the time of his death is considered, for the estate tax, a "nonresident not a citizen of the U.S.", but only if that person acquired his U.S. citizenship solely by reason of 1) His being a citizen of the U.S. possession, or 2) His birth or residence within that possession of the U.S.

(PLR 201924009, released June 14, 2019.)

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Income received from author's personal brand was self-employment income.

The Tax Court upheld the IRS in subjecting income received by an author for her personal brand to self-employment tax. The taxpayer's CPA had advised her that income should be reported as investment income, not subject to self-employment tax. The Tax Court said that the author's brand was part of her trade or business.

(Slaughter v. Commissioner, TC Memo 2019-65, June 4, 2019.)

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IRS issues proposed regulations for qualified business income deduction for cooperatives and their patrons.

There are special rules for cooperatives and their patrons for the deduction for qualified business income. The IRS has issued proposed reliance regulation providing guidance to cooperatives and their patrons and guidance to specified agricultural or horticultural cooperatives and their patrons about how to compute and report the deduction. These taxpayers should consult with their tax advisors about these new rules.

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IRS issues final regulations for electing small business trusts.

Generally, S corporations aren't allowed to have nonresident aliens as shareholders. One of the provisions of the Tax Cuts and Jobs Act of 2017, enacted on December 20, 2017, is to permit electing small business trusts (ESBT) to have a nonresident alien as a deemed owner, effective for tax years beginning after December 31, 2017.

When an ESBT has a nonresident alien as a deemed owner, it will be taxable in two parts. The part that relates to S corporation stock will be taxed at the maximum federal income tax rates that apply to trusts. The part that relates to other assets will be taxed according to the other tax rules for trusts. (If a nonresident alien is the deemed owner of the trust, some or all of the other income might not be subject to U.S. tax.)

The IRS has issued final regulations, effective for tax years beginning after December 31, 2017, to enable the new rule permitting nonresident aliens as deemed owners of trusts owning S corporation stock.

ESBTs are not a "do it yourself" project. You should only use them under the guidance of a qualified tax expert. If the stock of an S corporation is distributed to a beneficiary who is a nonresident alien, the S corporation election will be terminated.

(TD 9868, June 18, 2019.)

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Final regulations issued relating to donation in lieu of a state income tax.

The IRS has issued final regulations that require taxpayers to reduce their charitable contribution deductions by the amount of any state or local tax credits they receive or expect to receive in return. The IRS has also issued a safe harbor that allows individuals, in certain circumstances, to deduct disallowed charitable contributions as state or local taxes.

(TD 9864, Treasury Notice 2019-12.)

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Cost-sharing regulation for stock-based compensation upheld.

The 9th Circuit Court of Appeals has reversed a Tax Court decision and upheld regulations requiring that controlled entities that enter into qualified cost-sharing agreements to share stock based compensation amounts. The ruling is significant for related businesses that have offshore operations, and can result in more income being subject to U.S. tax.

Businesses that have offshore operations and have stock compensation plans should consult with their tax advisors about how this ruling affects them.

(Altera Corporation and Subsidiaries v. Commissioner, CA-9 Nos. 16-70496, 1670497, June 7, 2019.)

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Tax Court determines amount realized on foreclosure.

The Tax Court found that a mortgaged debt was not extinguished by the foreclosure on the property. The IRS argued the bid price of the bank for the property, which was the only bid, didn't meet the definition of fair market value, because the taxpayers were compelled to sell the property. The Tax Court said that, in the case of mortgaged property sold at a foreclosure sale, it presumes the fair market value to be the bid price, absent clear and convincing evidence to the contrary. (Treasury Regulations Section 1.16-6(b)(2).) There was no appraisal for the property.

Since the mortgage wasn't a nonrecourse debt, it wasn't extinguished by the foreclosure of the property. If the bank later canceled the debt, there would be taxable income at that time. The Tax Court said the fact that the bank filed a proof of claim in the taxpayers' bankruptcy proceeding supported that conclusion.

An additional issue was the taxpayers were unable to substantiate carryover basis in a property from a tax-deferred exchange. The Tax Court upheld the IRS in disallowing the carryover basis. The only evidence the taxpayers could produce was a depreciation schedule on their income tax returns. This ruling highlights the importance of keeping records of continuing tax significance, like the acquisition documents for properties exchanged.

(Breland v. Commissioner, TC Memo 2019-59, May 29, 2019.)

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Interest rates for tax overpayments and underpayments reduced.

The IRS has announced that the interest rates for tax overpayments and underpayments for the calendar quarter beginning July 1, 2019 are being decreased.

For noncorporate taxpayers, the rates for both underpayments and overpayments is decreasing from 6% to 5%. This rate is also used to compute the penalty for underpayment of estimated tax.

For corporations, the overpayment rate for the third quarter 2019 will be 4%. Corporations will receive 2.5% for overpayments exceeding $10,000. The underpayment rate for corporations will generally be 5%, but will be 7% for large corporations.

(Revenue Ruling 2019-15.)

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IRS discontinues faxing and third-party mailing of tax transcripts.

The IRS stopped its tax transcript faxing service on June 28, 2019 and will end third-party mailing of tax returns and transcripts on July 1, 2019. The IRS says it is ending these services to protect taxpayers from identity theft.

Taxpayers can still have transcripts mailed to their personal address and authorized tax professionals can get them online.

(IR 2019-11, June 4, 2019.)

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Should you consider using a Grantor Retained Annuity Trust to shift appreciation to other family members?

With today's estate tax rules, a married couple can leave close to $22 million to their heirs without being subject to the federal estate tax. Remember that, unless Congress takes further action, the exemption will be reduced about in half for decedents who die after 2026.

Some public offerings result in stock for which the owners made a minimal investment becoming enormously valuable, far surpassing $22 million, and contingency plans should be in place for a potential estate tax increase. Employees and shareholders holding stock with that potential should consider estate planning strategies to shift the increase in value to other beneficiaries.

One strategy where the stock holder doesn't have to give the total investment away is a "grantor retained annuity trust" or GRAT.

A form of this strategy is called a "zero-out" GRAT, often for a short term, like two years.

In this case, an "annuity" just means a regular payment, and can be thought of as a note with equal payments made at least annually. Stock is transferred to an irrevocable (can't be changed) trust in exchange for an annuity with an equivalent value to the stock transferred. Since an equivalent value is received in the exchange, the amount of the gift is zero.

This exchange should still be reported on a gift tax return in order to have the statute of limitations run on the transaction.

The remainder of the trust after the annuity is paid is distributed to other named beneficiaries, with the grantor's tax basis and holding period.

When the stock isn't publicly traded, it must be appraised. If cash isn't generated to make the annuity payments, they can be made in property, such as a return of the stock. Another appraisal will have to be done when the payments are made when they are made with stock.

For income tax purposes, the person who created the trust, called the "grantor," is treated as the owner of the trust. Any income or deductions of the trust will be reported on the grantor's income tax return.

If the grantor dies before the annuity is paid, the present value of any unpaid annuity payments is included in the grantor's taxable estate.

To avoid estate inclusion, GRATs are often made for short terms, and multiple GRATs may be set up with different maturity dates, or "rolling GRATs."

Short-term GRATs are a target for tax reform. A minimum of a 10-year term for GRATs has been proposed. This would increase the risk the grantor could become subject to income tax if the company is acquired before the term of the trust expires, and that some or all of the GRAT could be included in the grantor's taxable estate.

This is a greatly simplified explanation. There are many alternative structures for GRATs. Be sure to get good professional advice when creating and operating a GRAT.

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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.

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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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