Michael Gray, CPA's Tax and Business Insight
February 5, 2020
© 2020 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
- Valentine's Day!
- February celebrations.
- Remember federal income tax returns for calendar-year S corporations and partnerships are due March 16.
- The election to be an S corporation for calendar-year corporations is also due March 16.
- Have you received your tax preparation materials?
- File your tax return early, if you can.
- If you have these credits, wait to efile.
- California doesn't conform to SECURE Act change for IRA contributions.
- IRS issues new proposed regulations for IRC Section 382.
- Form W-4 for 2020 still valid with medical expense limit error.
- IRS issues draft of GILTI form.
- You can lose a refund for a late-filed return.
- ESOP wasn't a qualified plan.
- Investment credit form issued.
- IRS gives debt relief for certain student loan borrowers.
- Attorney's declaration of timely filing a petition was accepted.
- IRS takes a hard look at micro-captive insurance arrangements.
- W-4 instructions for nonresident aliens issued.
- Out-of-state limited partnership was required to file a California income tax return.
- Don't report taxable income twice!
- Remember to report the sale of option stock.
- Watch reporting qualified sales of ISO stock.
- Please share your good experiences with Michael Gray, CPA.
- Financial Insider Weekly past episodes.
- Visit our new book review: Magnetic Marketing
- Follow me on social media!
- Check out my blog.
- PS Marché Aux Fleurs
- Subscribe/Remove from Michael Gray, CPA's Tax & Business Insight
Janet, her sister, Gail Johnston and brother in law Lane, and me at The Beach House Restaurant at Lover's Point at Pacific Grove, California Valentine's Day!
Remember to show your love and appreciation for your loved ones on Friday, 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!)
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 wedding anniversary this month. Congratulations!
Remember federal income tax returns for calendar-year S corporations and partnerships are due March 16.
(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 16.
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.
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.
If you have these credits, wait to efile.
Several tax credits that previously expired were extended in the Taxpayer Certainty and Disaster Tax Relief Act of 2019, enacted on December 20, 2019. The IRS hasn't updated its electronic filing system to accept Form 8835 - Renewable Electricity, Refined Coal and Indian Coal Production Credit yet, so it is asking taxpayers to wait to file their tax return with these credits until its systems are updated.
California doesn't conform to SECURE Act change for IRA contributions.
Although California conforms to most of the changes in the SECURE Act enacted on December 20, 2019, it does NOT conform to the federal change allowing making a deductible IRA contribution after age 70 ½. The federal change is effective for taxable years beginning after December 31, 2019. Any contributions after age 70 ½ will be nondeductible on the California income tax return and taxpayers will have to track the nondeductible contributions as additional tax basis in the account when accounting for distributions. Hopefully California will conform to this rule to eliminate this accounting headache.
(Spidell's California Taxletter, February 2020, p. 3, "Secure Act not so secure for California taxpayers.")
IRS issues new proposed regulations for IRC Section 382.
The IRS has issued new proposed regulations for IRC Section 382, the rules limiting losses and credits when there is a change of ownership for a corporation. The new proposed regulations make changes to other proposed regulations issued on September 10, 2019. One of the changes is the effective date for the regulations is 30 days after the proposed regulations are issued as final regulations. Previously, the effective date was the date the proposed regulations were issued as final regulations.
(REG-125710-18, Prop. Reg. § 1.382-2, Prop. Reg. § 1.382-7.)
Form W-4 for 2020 still valid with medical expense limit error.
The IRS issued a corrected Form W-4, Employee's Withholding Certificate, on December 31, 2019. A correction on the updated form is to reduce the AGI floor for medical expenses from 10% to 7.5% because of a change in the tax law adopted on December 20, 2019. The IRS says on its website 2020 Forms W-4 previously submitted by employees are still valid and employers can use them for computing payroll tax withholding.
IRS issues draft of GILTI form.
The IRS has issued an updated draft of Form 8992, U.S. Shareholder Calculation of Global Intangible Low-Taxed Income (GILTI), and updated draft instructions for the form. The form has been updated to reflect final regulations issued by the IRS on June 21, 2019 with guidance on how U.S. shareholders of controlled foreign corporations should determine the amount of GILTI to include in their gross income.
You can lose a refund for a late-filed return.
The amount of a refund can't exceed the portion of the tax paid within the period, immediately preceding the filing of the claim equal to three years plus the period of any extension of time for filing the return.
Taxes withheld during the year are deemed to have been paid on the 15th day of the fourth month following the close of the tax years. (IRC Section 6513(b)(1).)
Under the postmark rule, a tax return is deemed to have been filed on the date of mailing but only if the postmark date is before the due date for the return. (IRC Section 7502(a)(2).)
Mr. and Mrs. Harrison were granted an extension to file their 2012 income tax return to October 13, 2013. They didn't mail the return until October 11, 2016, and it wasn't received by the IRS until October 17, 2016. They paid their 2012 income taxes through withholding and they had an overpayment of their income taxes.
Since the tax return wasn't filed by the due date (October 13, 2013), October 17, 2016 was the date the tax return was deemed to be filed. Marking back three years plus the extension period, the marking date for payments received was April 17, 2013. The withholding was deemed to be paid on April 5, 2013.
The tax return was filed too late, so the refund was denied.
Moral of the story: File your income tax return by the extended due date to avoid all kinds of problems.
(Harrison, DC WI January 9, 2020, 125 AFTR 2d ¶ 2020-337.)
ESOP wasn't a qualified plan.
The Tax Court upheld the IRS in finding an Employee Stock Ownership Plan (ESOP) failed to meet the requirements for its plan document and in its operations, so it wasn't a qualified plan. One of the deficiencies was there was no qualified appraisal of the stock. The employer/sponsor didn't get its tax deduction and the participant didn't get his tax deferral.
Moral of the story - hire a good professional retirement plan administration company to be sure your plan documents are correct and that it's administered properly, including getting a professional appraisal of the stock contributed to or purchased by the plan when the stock isn't publicly traded.
Investment credit form issued.
The IRS has finalized 2019 Form 3468, Investment Credit and instructions. The form is used to claim these credits: rehabilitation credit (IRC Section 47), energy credit (IRC Section 48), qualifying advanced coal project credit (IRC Section 48A), qualifying coal gasification project credit (IRC Section 48B), and qualifying advanced energy project credit (IRC Section 48C).
(Ed Thielking, Inc., TC Memorandum Decision 2020-5, January 9, 2020.)
IRS gives debt relief for certain student loan borrowers.
The IRS has issued a safe harbor giving tax relief to certain taxpayers who took out federal or private student loans to finance attendance at a nonprofit or for-profit school. The IRS will not assert that a taxpayer who meets the requirements recognizes gross income as a result of the discharge of a student loan under the Department of Education's Closed School or Defense to Repayment discharge process, or where the private loans are discharged based on a settlement of a legal cause of action against nonprofit or other for-profit schools and certain private lenders.
The Revenue Procedure is effective for discharges on or after January 1, 2016.
(Revenue Procedure 2020-11.)
Attorney's declaration of timely filing a petition was accepted.
The Tax Court accepted an attorney's declaration that he mailed a petition on time. In order to go to Tax Court, a petition must be filed within 90 days after receiving a Notice of Deficiency. Generally, the postmark on the envelope is considered to be the date of delivery.
In this case, the envelope didn't have a postmark and the envelope was received by the Tax Court more than 90 days after the IRS mailed the notice of deficiency. The postage on the envelope was paid using U.S. Postal Service postage stamps, but there was no postmark.
The attorney made a sworn declaration that he mailed the petition on time.
The Tax Court accepted the declaration as evidence the filing date requirement was met.
Moral of the story - the argument would have been avoided if the petition was mailed certified mail, return receipt requested.
(Seely v. Commissioner, Tax Court Memorandum Decision 2020-6, January 13, 2020.)
IRS takes a hard look at micro-captive insurance arrangements.
The IRS has announced that it will be deploying 12 new teams to audit micro-captive insurance and similar abusive transactions. The IRS also reminded taxpayers and advisors that Notice 2016-66 requires disclosure of participation in micro-captive insurance transactions with the IRS Office of Tax Shelter Analysis.
(IR 2020-26, January 31, 2020.)
W-4 instructions for nonresident aliens issued.
The IRS has updated Notice 1392, Supplemental Form W-4 Instructions for Nonresident Aliens.
Out-of-state limited partnership was required to file a California income tax return.
An out-of-state limited partnership claimed it wasn't required to file a California partnership income tax return and pay the $800 minimum tax because it was only a limited partner in passthrough entities and exercised no management control over them, citing Swart Enterprises v. FTB 7 Cal. App. 5th 497, 2017.
However, Swart didn't address another situation that can subject a business to tax in California. If an entity is considered to be doing business in California, it will still be required to file a California partnership income tax return and pay the $800 minimum tax that applies to limited partnerships.
If the business meets one of these requirements, it's deemed to be doing business in the state:
- Organized or commercially domiciled in the state;
- Having California gross receipts in excess of $500,000, adjusted for inflation ($601,967 for 2019) or 25% of the taxpayer's total sales;
- Having California real and/or tangible property in excess of $50,000, adjusted for inflation ($60,197 for 2019); or
- Having California payroll compensation in excess of $50,000, adjusted for inflation ($60,197 for 2019) or 25% of the taxpayer's total payroll.
In this case, the limited partnership's share of the gross receipts from the passthrough entities exceeded the statutory threshold, so the Office of Tax Appeals ruled it was required to file the tax return and pay the tax.
(Appeal of LCP VIII Holdings, LP, 2019-OTA-399, November 20, 2019.)
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.
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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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