Michael Gray, CPA's Tax and Business Insight

February 3, 2022

© 2022 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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Monarch butterfly, photo taken by Michael Gray
Monarch butterfly at Pacific Grove January 23, 2022

Valentine's Day!

Remember to show your love and appreciation for your loved ones on Sunday, February 14. Book your reservation at your favorite restaurant now.

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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!

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Tax season is here!

The IRS has announced it began accepting and process (including efiling) 2021 individual income tax returns on January 24, 2022. Note that the final versions of some tax forms haven't been released yet and there are other reasons to delay filing 2021 individual income tax returns. Consult with your tax return preparer.

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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.)

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The election to be an S corporation for calendar-year corporations is also due March 15.

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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 contact her at thi@atl-cpa.com.

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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.

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Many taxpayers with California businesses will probably have to file extensions.

Governor Newsom is including several retroactive tax relief items in his budget proposals, including eliminating the alternative minimum tax floor for the passthrough entity credit, extending the passthrough entity credit election to single-member LLCs, retroactively conforming to the federal exclusion for Restaurant Revitalization Grants and Shuttered Venue Operator Grants but still allowing grant recipients to deduct expenses paid with those grants. Families with up to $150,000 of adjusted gross income ($75,000 for singles) who are unable to pay the 2019 - 2021 tax liabilities would be given until September 30, 2023 to make their payments.

(Governor Newsom has also proposed eliminating the net operating loss suspension and $5 million business credit limitation for the 2022 taxable year.)

If past years are any indication, the California legislature won't be able to meet the Governor's request to adopt these changes by March 15, 2022 and whatever changes that are adopted will pass during June or July.

In addition, we are hoping the Internal Revenue Service will issue guidance about when Passthrough Entity Tax payments made by passthrough entities during 2021 are tax deductible on 2021 income tax returns when the liability for the tax isn't fixed until the election is made with the 2021 income tax return for the passthrough entity during 2022, and whether there is a second class of stock issue for S corporations when Passthrough Entity Tax payments are made by some shareholders and not others.

With so many issues being unresolved, many taxpayers with California businesses will probably have to file extensions. See your tax advisor about your situation.

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California wages could be wrong on Form W-2.

Since many people who work for California employers are working remotely, some of them have chosen to move out of state. If the move is permanent, they are no longer residents of California and the wages earned after moving probably aren't California wages. If they haven't notified their employer, the employer would have continued reporting the wages as California wages and done so on Form W-2.

There are exceptions for employment taxes like California unemployment insurance, employment training tax and state disability insurance when most of the services are performed in California, when some services are performed in California and the individual's base of operations is in California, or if some services are performed in California and the place from which the employer exercises general direction and control over the employee's services is in California.

The liability for personal income tax withholding is based on where the work is done.

Ideally, the employee should notify the employer of any error in sourcing wages and a corrected Form W-2 should be issued.

If the employer refuses, the employee should report the corrected information on his or her California income tax return with an explanation. The tax return should be paper filed, not efiled.

There could be a conflict because some employers have said they would reduce the pay scale for employees who move out of California.

Any taxpayer who hires a professional tax return preparer should tell them when remote work for a California employer is performed remotely out of the state.

(Spidell's California Taxletter, February 2022, p. 9, "Employee not working in California but California tax withheld.")

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Update your Forms W-4 and DE-4 for 2022.

L The IRS has issued updated Form W-4 for 2022. Now is a good time to review yours to consider updating it. It isn't required to be updated each year, but is required to be submitted for a new job. California has its own withholding form, Form DE-4. Since California still has personal exemption credits, a separate Form DE-4 form should probably be submitted.

Here are links for the forms. https://www.irs.gov/pub/irs-pdf/fw4.pdf   https://www.edd.ca.gov/pdf_pub_ctr/de4.pdf

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California and Form 1099-NEC.

Form 1099-NEC that is filed with the Internal Revenue Service no longer has to be sent to the Franchise Tax Board. The IRS now electronically notifies the Franchise Tax Board of Form 1099-NEC information. The 2021 form was due January 31, 2022.

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Changing jobs could result in an excess 401(k) contribution.

A common error when changing jobs is not to notify the employer about 401(k) contributions made for the taxable year at your previous employment. Since the maximum voluntary 401(k) contribution for 2021 was $19,500 ($20,500 for 2022 plus $6,500 "catch up" contribution for individuals age 50 or older), having contributions with two employers can result in an excess contribution. If the excess contribution is returned to the employee by April 15 of the following year, the 10% penalty doesn't apply and the returned amount is included in taxable wages for the year of the contribution. If excess contributions aren't timely returned to the employee, they are subject to a 10% excess contribution penalty, they aren't aren't tax deductible and will be taxed a second time if they aren't timely returned to the employee. There is also a risk the employer's plan could be disqualified because of this issue.

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Real estate income can be self-employment income.

The IRS has issued Chief Counsel Advice about whether two rental scenarios can be self-employment income.

In the first scenario, the taxpayer is an individual who solely owns and rents a full-furnished vacation property via an online rental marketplace. The taxpayer is not a real estate dealer. The taxpayer provides daily mail service and the average period of customer use for the year at issue is seven days. In this case, since the taxpayer is providing substantial services and the use of the property doesn't exceed seven days, the income is self-employment income. The activity is like a hotel or motel.

In the second scenario, the taxpayer is an individual who solely owns and rents a fully-furnished room and bathroom in a dwelling via an online rental marketplace. The taxpayer cleans the room and bathroom between each occupant's stay. The average period of customer use for the year at issue is seven days. In this case, the activity is not considered a rental activity under the passive activity loss rules because the average use doesn't exceed seven days. The service provided in this case aren't for the convenience of the occupants, but only those required to maintain the space in a condition suitable for occupancy. Also, the services provided aren't substantial. The status of the property as not a passive activity doesn't control whether the income is self-employment income. Therefore, the income isn't self-employment income.

Taxpayers who provide temporary use of residential real estate via Air BNB and other services or otherwise rent their vacation property should discuss the status of the income from their property as self-employment income with their tax return preparer in light of this Chief Counsel Advice. (Note in these scenarios the income should be reported on Schedule C as trade or business income, not Schedule E as rental income.)

(Chief Counsel Advice 202151005, December 23, 2021.)

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IRS corrects American Opportunity Tax Credit identification requirement in FAQ.

The IRS has changed a FAQ relating to the identification requirement to qualify for the American Opportunity Tax Credit. According to the corrected FAQ, "You can't claim the AOTC on either an original or an amended return if the student (you, your spouse or your dependent student claimed on the return) didn't have a taxpayer identification number by the due date of your return (including extensions), even if the student later gets one of those numbers.

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IRS updates guidance on "substantially equal periodic payments" from retirement accounts.

The 10% penalty tax on early distributions." These payments are computed based on the life expectancy of the taxpayer or the joint life expectancy of the taxpayer and a designated beneficiary.

There are three methods for computing substantially equal periodic payments (for details, see your tax advisor).

  1. Required minimum distribution (RMD) method;
  2. The fixed amortization method; or
  3. The fixed annuitization method.

The IRS has issued updated guidance, including an updated alternative Uniform Life Table for making the computations and interest rates for the fixed amortization and annuitization methods.

The guidance is effective for any series of payments beginning on or after January 1, 2023 and may optionally be relied upon for any series of payments beginning in 2022.

(Notice 2022-6.)

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Four states ask Supreme Court to reverse limit to state tax deduction.

Attorneys general of New York, New Jersey, Connecticut and Maryland have asked the U.S. Supreme Court to hear their challenge to the $10,000 limit for the deduction of state income and property taxes. The states claim the limitation violates the 10th and 16th Amendments to the U.S. Constitution.

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Backdoor Roths are threatened.

The Build Back Better tax proposals have been blocked in the U.S. Senate. Some of them could be passed in other legislation, including budget reconciliation legislation that doesn't require 60% approval. One to watch is a ban on backdoor Roth accounts. These are generally funded by making a nondeductible IRA contribution that is immediately rolled over to a Roth IRA.

Another type of backdoor Roth is the mega backdoor Roth. These are set up via employer 401(k) plans with Roth accounts. Some permit voluntary employee contributions. For 2022, up to $61,000 can be contributed to these accounts.

Find out if your employer permits mega backdoor Roth contributions. 2022 might be the "last hurrah" for making a backdoor contribution to these accounts.

Taxable Roth conversions of IRA accounts would still be allowed under the Build Back Better tax proposal.

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Defined benefit plan covered compensation announced.

The IRS has announced the covered compensation for computing the maximum defined benefit plan contribution for 2022 is $147,000.

(Revenue Ruling 2022-2.)

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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.

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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.

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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. Contact Thi Nguyen, CPA at thi@atl-cpa.com to make an appointment.

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Do you sell services or software to CPAs?

Maybe I can help with writing promotional material and marketing ideas. Call me, Michael Gray, at 408-918-3161 or email mgray@taxtrimmers.com.

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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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Attention Accountants! Speed up processing your 2020 business closings!

Do you still have 2020 business income tax returns on extension that need to be done? Check out this trial balance software, EZ Trial Balance, that's super-easy to set up and use. There is a desktop version and an online version. The online version includes consolidations and ratio analysis for analytical review. http://www.eztrialbalance.com

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Attention business owners with remote workers or remote customers!

Are you concerned about protecting your conversations and communications from hackers? Now there is a secure collaboration application including (unlimited) team member assignments, video conferencing (no Zoom bombing!), text messaging, voice messaging, PDF capture, electronic signature and large file transfer. Remote computer access feature is almost complete. Communications take place in a secure envelope. Cloud application so no installation is required on your computer network. Meets IRS security standards. http://www.securelycollaborate.com

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Check my blog for coronavirus-related tax developments.

We have been sending most of my blog posts relating to coronavirus-related tax developments to you. You can find them at www.michaelgraycpa.com.

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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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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, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
Hours: 8am - 5pm PDT Monday - Friday

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