Michael Gray, CPA's Tax and Business Insight

September 4, 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's wife, Janet, at the Getty Villa
Here's Janet at the Getty Villa in Malibu, California

Happy autumn!

Summer ends and autumn begins on September 23. The year is 2/3 over! Are you ready for the year end?

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Family celebrations.

My daughter, Holly Baker and her son, Kyan, are both celebrating birthdays during September. Happy birthdays! Thi Nguyen and her husband, Allen Le, are celebrating their wedding anniversary during September. Happy Anniversary!

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September 16 due dates.

The due date for extended income tax returns for calendar-year partnerships and S corporations is September 16.

Federal estimated tax payments for individuals are also due September 16. There is no California estimated tax payment due September 16 because estimated payments for April and June are "front loaded."

The federal estimated tax payment can be based on the income tax reported on the 2018 federal income tax return. If the 2018 federal adjusted gross income was more than $150,000 (or $75,000 if married filing separately), the payment can be based on 110% of the income tax on the 2018 federal income tax return. Alternatively, the payment can be based on 90% of the actual tax for 2019. Although the tax payment is 25% of the annual tax liability, the computations can be made using income and deductions through August 31. (The computations have become so complex that I recommend using the "protected estimate" based on 2018 tax approach.)

If you aren't making your payments based on your 2018 income tax, you might want to get professional help with your estimated tax payments this year.

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Trusts and estate tax returns due October 1.

The due date for 2018 calendar-year trusts and estates for which timely extensions were filed is September 30, 2019.

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Individual and C corporation tax returns due October 15.

The due date for 2017 individuals and calendar year corporations for which timely extensions were filed is October 15, 2018.

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Business owners can still set up a SEP-IRA for 2018.

Certain businesses that don't have other qualified plans and have extended the filing date for the income tax returns can still set up and fund a SEP-IRA plan and make a retirement plan contribution for 2018 up to October 15, 2019. See your tax advisor.

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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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Check your 2019 withholding.

The IRS didn't change its withholding form, Form W-4, for changes in the Tax Cuts and Jobs Act of 2017. Last year, many taxpayers were surprised that they owed a balance due with their income tax returns, despite a decrease in their federal income tax. Their withholding wasn't enough to cover the tax. I recommend that you review your withholding with your tax advisor now to consider whether you should increase your federal tax withholding. The current interest rate for computing the penalty for underpayment of estimated tax is 5%. Also, since personal exemptions have been repealed for federal tax reporting but not for state tax reporting, you should probably give your employer separate state income tax withholding instructions. The California form is DE-4.

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IRS adds Tax Withholding Estimator to its web site.

Here is a link to the IRS's new Tax Withholding Estimator. https://www.irs.gov/individuals/tax-withholding-estimator

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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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New business building blog.

I have started a new business building blog. The posts will mostly relate to advertising and marketing, but I will also talk about other business issues. Check it out at http://www.profitadvisors.com/business-building-blog/.

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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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How to protect your credit from identity thieves.

I recently went to a seminar that included simple and free ways to defend your credit from identity theft. Here is a blog post that I wrote about it. http://www.michaelgraycpa.com/posts/here-are-simple-free-ways-to-help-defend-your-credit-from-identity-theft/

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Dan Kennedy is in hospice.

One of my mentors, marketing guru Dan Kennedy, is seriously ill and in hospice. His condition has been improving, and his family is asking for continued prayers. No BS Marketing, which publishes Dan's No BS Marketing Newsletter, has set up a tribute web site. https://dankennedytribute.com/ No BS Marketing will also have a Growth Summit in Denver, Colorado on October 23 - 26, featuring some long time Magnetic Marketing Legends paying tribute to Dan. Here is a link for details about the Growth Summit. https://growthsummit19.com/

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Roth conversions can increase income tax rates.

With relatively low current income tax rates under tax reform, many taxpayers are thinking about converting their regular IRA account to Roth IRA accounts. Such a conversion subjects the converted amount to current federal income tax. Taxpayers should be aware that, if they have long-term capital gains or qualified dividends, an increase in taxable income can result in higher income tax rates for the long-term gains. For example, a married couple filing a joint income tax return with taxable income up to $78,750 has a long-term capital gains rate of $0.

Before going ahead with a Roth conversion, prepare tax projections to find out whether you will be paying higher income taxes on your long-term capital gains and qualified dividends.

Remember, you can no longer "undo" a Roth conversion.

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IRS issues procedures for making and revoking certain bonus depreciation elections.

The bonus depreciation changes in the Tax Cuts and Jobs Act of 2017 were effective for property acquired by a taxpayer after September 27, 2017 and placed in services by the taxpayer during its tax year that includes September 27, 2017.

Since the Act was enacted December 22, 2017, some taxpayers might not have reported their bonus depreciation correctly or might not have made a desired election out of bonus depreciation, which would otherwise be mandatory.

The IRS has issued guidance allowing a taxpayer to make or revoke bonus depreciation elections affected by the Tax Cuts and Jobs Act of 2017. The guidance only applies for a tax year that includes September 27, 2017.

(Revenue Procedure 2019-33.)

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Partnership interest expense for a donee-beneficiary wasn't investment interest.

The Tax Court ruled against the IRS on an important issue. A taxpayer received shares in a real estate partnership from his father as a gift and a bequest. The taxpayer deducted the interest as a business expense relating to real estate held by the partnership. The IRS claimed the taxpayer should have "stepped into the shoes" of his father, who previously reported the interest expenses as investment interest expense. Since the taxpayer had no investment income, he would have lost the current deduction for the interest expense.

The Tax Court said it found no support for the IRS's theory in the statute. Since the nonrecourse debt existed at the time the taxpayer acquired the partnership shares from his father, it was acquisition indebtedness and should be allocated to the assets acquired within the partnership. The partnership assets were used in an active trade or business, so the interest was currently deductible against the partnership income.

This is an item I have puzzled about myself, and it's good to see this positive result for the taxpayer.

(Lipnick v. Commissioner, 153 T.C. No. 1, August 28, 2019.)

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Accounting documents protected under tax practitioner privilege.

An accountant prepared documents to help an attorney to give tax advice, and not merely to prepare a tax return. The attorney hired the accountant to review and, if necessary and/or possible to amend the income tax returns of a taxpayer who was being audited by the IRS.

According to the accountant, he performed services necessary for the attorney to provide appropriate and accurate legal and tax advice to the taxpayer, including reviewing and interpreting tax and financial information and documents.

The IRS asked the taxpayer to produce the documents that accountant had prepared.

A federal district court upheld the taxpayer's position that the documents were protected under tax practitioner privilege and the Kovel case.

(Burga v. Commissioner, DC CA August 16, 2019, 124 AFTR 2d 2019-5153.)

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Part of cost of genetic testing qualified for medical deduction.

The IRS privately ruled that part of the cost of ancestry genetic testing, consisting of a DNA collection kit and health services, qualified for a tax deduction as a medical test. The service included reports on an individual's ancestry and health. The health report included genetic health risks, carrier status, wellness and traits.

The IRS said the taxpayer should allocate the cost between medical and non-medical items, but didn't explain how to make the allocation.

(PLR 201933005, August 16, 2019.)

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Spousal rollover approved when no beneficiary was designated.

Usually a tax-free spousal rollover of an inherited IRA is only allowed when the spouse is the named beneficiary of the IRA. The IRS allowed a spousal rollover when no beneficiary was named and the surviving spouse was the administrator of the deceased spouse's estate and was the sole heir.

It was expensive for the surviving spouse to apply for this ruling. Be sure to designate beneficiaries for your IRA.

(PLR 201931006, released August 2, 2019.)

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Tax Court opens the door to tax-affecting for pass-through entity valuation.

The IRS suffered a stunning defeat relating to the valuation of S corporation stock. According to the Tax Court, this case was different from past ones because the appraisers justified their amount using a tax-affecting adjustment for the valuation.

The Tax Court upheld the valuation of the stock as an operating company, with an income-based approach. In this case, the interests being valued were minority interests that couldn't direct a liquidation of company assets. This ruling was significant because the S corporation owned valuable timberlands.

The taxpayer's expert applied a 38% tax rate to company pretax earnings in computing net cash flow. The expert also added a "pass through entity" premium to reflect the benefit to a shareholder from owning an interest in the entity due to avoiding double taxation.

The total value determined by the taxpayer's expert was $21 million. The value asserted by the government was $141 million.

(Estate of Aaron Jones, TCM 2019-101.)

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Outstanding balance of a defaulted plan loan was a deemed distribution.

An individual defaulted on a plan loan from his government employer's retirement plan and later resumed the loan payments.

The Tax Court upheld the IRS in finding the default was a deemed distribution. The grace period had expired, and the taxpayer failed to cure the default when he resumed making payments.

This case illustrates the danger of taking loans from retirement plans. A default results in taxable income and might result in early distribution penalties. Since the taxpayer probably spent the money, this results in a financial hardship. There is no avoidance of tax for insolvency in this situation.

It's usually better to get a loan from another source.

(McEnroe v. Commissioner, TC Summary Opinion 2019-21, August 20, 2019.)

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Proposed regulations issued for personal use of employer-provided vehicles.

The IRS has issued proposed reliance regulations relating to special valuation rules for employers and employees to use in determining the amount to use for reporting the value of personal use of employer-provided vehicles.

Under the proposed regulations, the cents-per-mile and the fleet-average valuation rate can be used when the fair market value of the vehicle doesn't exceed $50,000.

(REG-101378-19, Prop. Reg. § 1.61-21.)

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IRS change for donor reporting ruled invalid.

A federal district court ruled in a summary judgment that IRS Revenue Procedure 2018-38, eliminating the requirement that tax exempt organizations identify to the government contributors who donate $5,000 or more, was invalid. The IRS failed to follow the required notice and comment procedures under the Administrative Procedure Act.

(Bullock v. Internal Revenue Service, District Court, Montana, July 30, 2019.)

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California can tax some otherwise tax exempt income in mutual funds.

A California court of appeal reversed a lower court ruling and found California can tax income from California tax exempt bonds or U.S. government obligations held by a mutual fund if the fund invests less than 50% in these obligations. In the case at hand, the mutual fund had 12.41% of its interest income from California municipal bonds.

(Mass et al v. California Franchise Tax Board, California Court of Appeal, Second District, Case No. B286857, August 15, 2019.)

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California Office of Tax Appeals issues conflicting rulings on California income tax for nonresident service income.

The California Office of Tax Appeals (OTA) recently ruled in the Bindley case that fees for services provided outside California by an individual nonresident of California to a California customer, who never performed services in California, were taxable income apportioned to California and subject to California income tax. The OTA upheld the Franchise Tax Board, who said the taxpayer was engaged in a unitary business within and without California.

The OTA previously ruled in the Larsen case that, since the taxpayer never performed services within California, there wasn't sufficient nexus for the taxpayer to be subject to California tax.

This issue comes up because under Proposition 39, which was passed in 2012 and effective for tax years beginning January 1, 2013, multiple-state businesses apportion their income based only on the ratio of sales in California to total sales. The Franchise Tax Board also changed the sourcing rules to "market sourcing," so the income from services are sourced to California if the purchaser received the benefit of the services in California.

The Bindley and Larsen cases are not certified to be precedents, so the tax preparation community is confused about whether this income is subject to California tax.

The Franchise Tax Board is aggressively requesting income tax returns from out of state businesses who receive a Form 1099 from California businesses.

The Supreme Court ruled in Wayfair that state sales tax applies for sales of tangible property by nonresident businesses in a state where they have no physical presence. It seems to me this reasoning could be extended to state income taxes.

California has created a threshold of $500,000 of sales to California customers by nonresident companies before it will impose the California sales and use tax. It would be great if the California Franchise Tax Board would adopt a similar threshold for income tax reporting. There are many small out of state service providers who are connecting with California customers through internet services like Upwork and Elance.

(Bindley, O.T.A. Case No. 18032402, May 30, 2019, Larsen, O.T.A. Case No. 18011113, July 25, 2018, Spidell's California Taxletter®, September, 2019, p. 1. "Nonresident sole proprietor's income sourced to California."

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LLC can eliminate exclusion for California property tax reassessment.

Parents are able to transfer a principal residence located in California plus up to $1 million (per parent) of assessed value of other California real estate to their children without reassessment.

If rental properties are placed in an LLC, the ability to transfer the property tax base is lost.

If you have transferred rental properties to an LLC, you should consult with an estate planning attorney who is familiar with these rules.

(Spidell's California Taxletter®, September, 2019, p. 5, "Maximizing the parent-child property tax exclusion.")

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California non-wage withholding reporting.

The Franchise Tax Board has issued a list of common reporting errors for non-wage withholding. A notable item on the list is if the payee is a grantor (generally revocable) trust, the form should have the name and Social Security number or tax identification number of the grantor who is required to file an income tax return and report the income.

(State of California, Franchise Tax Board Taxnews, September, 2019, page 3.)

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Section 83(b) election doesn't work for regular tax for ISOs.

A Section 83(b) election can be made when you exercise a nonvested incentive stock option. (Some ISO plans have an early exercise privilege.) The election doesn't work for regular tax reporting but does work for alternative minimum tax reporting.

The election can result in some havoc when there is a disqualified disposition of the stock. I had a situation where clients made an installment sale of their stock. For regular tax, they had ordinary income for the disqualified disposition for the year of the sale. The ordinary income isn't eligible for installment sale reporting. For the alternative minimum tax, the tax basis of the stock (fair market value at exercise) is zero. All of the principal payments are short-term capital gain. This can result in an alternative minimum tax liability for future years.

A solution may be to elect out of installment sale reporting. (Remember installment sale reporting is a default election; you have to elect out of installment sale reporting for it to not apply.) In that case, the short-term capital gain may be reported in the same year as the ordinary income, eliminating some or all of the alternative minimum tax.

If you are facing a similar dilemma, consult with your tax advisor about possibly electing out of installment sale reporting as a possible solution.

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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
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