Michael Gray, CPA's Tax and Business Insight

December 2, 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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A road lined with trees loaded with yellow, red and orange leaves.
Happy Autumn season! We don't have scenes like this now in San Jose, California. Our autumn colors come much later in the year.

Happy Holidays!

This year, Hanukkah begins the evening of December 18. Of course, Christmas Day will be Sunday, December 25. "God Bless us, every one!"

Dawn Siemer won't be available starting December 15, returning January 3.

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Special Holiday Sale Offer -- Get our books for half-price!

As a year-end holiday offer to subscribers of this newsletter, you can get any of our books for half-price: Secrets of Tax Planning for Employee Stock Options, 2018 Edition, Executive Tax Planning for Employee Stock Options, 2018 Edition, Real Estate Tax Handbook, 2020 Edition and How to Use Roth & IRA Accounts to Provide a Secure Retirement, 2021 Edition. Order the books online for half price at www.siliconvalleypublishingcompany.com. Limited copies are available. We have temporarily repriced the books so no code is required. You can also phone your order to Dawn Siemer at 408-918-3162. (Remember Dawn won't be available starting December 15, 2022, returning January 3, 2023. Order now to avoid delayed shipping.) This offer will expire January 31, 2023.

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'Tis the season for year-end planning.

There is less than a month remaining for 2022. Make your year-end planning appointment now. Thi Nguyen, CPA will have limited availability. To make an appointment with her, write to her at thi@atl-cpa.com.

I'm not aware of any major federal tax legislation pending that will relate to 2022.

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Fourth quarter calendar year corporate estimated tax payment is due December 15.

The final 2022 estimated tax payment for calendar-year corporations is due December 15, 2022. Not all corporations can base their federal estimated tax payments on the previous year's income tax return. For example, new corporations and corporations that had no tax liability for the previous year must compute their estimated tax using the current year's facts. See your tax advisor for assistance.

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Fourth quarter estimated tax payment for non-corporate taxpayers is due January 17.

The final estimated tax payment for individuals and calendar-year estates and trusts is due January 17, 2023. (January 15 falls on Sunday and Martin Luther King's birthday is celebrated on January 16.) Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year's facts.

Consider making the California or state payment by December 31, 2022 for a 2022 tax deduction. Watch the alternative minimum tax. Also, remember the total tax deduction for state income tax payments and real estate tax is limited to $10,000 and the standard deduction has been increased to $25,900 for married filing joint and $12,950 for singles and married filing separate.

See your tax advisor.

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First property tax payment is due.

The first property tax payment for the 2022-2023 fiscal year in Santa Clara County is due December 12. Avoid a late payment penalty - mail your payment now!

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Calendar year accrual basis corporations should pay related parties by December 31.

In order to currently deduct expenses due to certain related persons, accrual-basis corporations must pay them by the year-end. These include wages, bonuses, interest expense, rent, etc. Be sure to review the status of these items with your tax advisor by December 31.

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California makes a major change to state disability income (SDI) tax.

California has adopted SB 951, repealing the wage ceiling for (employee) contributions to the SDI fund, effective January 1, 2024.

Starting January 1, 2024, all California wages will be subject to the SDI tax.

For 2023, the SDI rate is 0.09%, with a maximum wage base of $153,164.

Corporate shareholder-employees might want to consider increasing their dividends instead of their wages, subject to reasonable compensation.

Sole shareholders may opt out of paying SDI taxes by filing EDD Form DE 459, Sole Shareholder/Corporate Office Exclusion Statement. The opt out is irrevocable for the calendar year and for at least the two succeeding calendar years. They should compare the SDI tax and benefits with private disability insurance.

The potential wage-replacement benefits of SDI are also being increased.

(Spidell's California Taxletter, December 2022, p. 2, "SDI wage base cap eliminated, benefit amounts increased.")

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California passthrough entity tax credit and nonresident withholding.

The California Franchise Tax Board has notified Spidell Publishing that it will continue to apply nonresident withholding after the Passthrough Entity Elective Tax Credit for post-2021 tax years. The FTB says it will be pursuing a technical correction to the Revenue and Taxation Code in the next legislative session. The FTB will continue to apply nonresident withholding on line 83 of Form 540NR, after the Passthrough Entity Elective Tax Credit. Following this procedure will enable taxpayers to use up the Passthrough Entity Credit and get a refund for any excess nonresident withholding.

(Spidell's California Taxletter, December 2022, p. 4, "Nonresident withholding and Passthrough Entity Tax Credit news.")

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California nonconformity for NOL carryback claims.

The California Office of Tax Appeals has rendered a decision that is a good reminder that the California statute of limitation for filing a claim for refund from a net operating loss (NOL) carryback is different from the Federal statute of limitations.

Federal law allows taxpayers to claim a net operating loss carryback as long as the statute of limitations is still open for the year the NOL is generated.

Unless a specific exception applies, California requires a refund claim to be filed within the later of:

Remember the taxpayer may elect to waive carryback of a net operating loss. If the waiver is not elected and the taxpayer misses the date for filing a refund claim, the deduction for the loss that could have been applied to the now-closed years is lost.

(Appeal of Albrecht, 2022-OTA-363SCP, Spidell's California Taxletter, December 2022, p. 8, "Statute of limitations for NOL carrybacks.")

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Restaurant NOL deductions disallowed to prominent CPA.

The Tax Court upheld the IRS in disallowing deductions from net operating losses from Fuddruckers restaurants owned by a well-respected CPA. The tax returns for the loss years (1999 and 2000) were prepared by a CPA firm. The Tax Court said she failed to produce evidence to substantial the losses. The taxpayer prepared her own 2014 income tax return. The IRS disallowed the loss carryover on the taxpayer's 2014 and 2015 income tax returns. The case illustrates the requirement that taxpayers keep their records for loss years when a net operating loss is carried forward. Those years remain open until the losses are ultimately used.

Most taxpayers should be puzzled by this case. If a prominent CPA can't substantiate her net operating loss carryover, what chance do they have? In this case, the loss carryovers were over $4 million, which must have piqued the attention of the IRS. I've claimed net operating loss deductions for clients without being questioned. It could be I've been lucky.

(Amos v. Commissioner, T.C. Memo. 2022-109.)

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S corporation ownership interest wasn't abandoned.

Taxpayers and their dependent child didn't report taxable income from an S corporation. The corporation had entered involuntary bankruptcy and the taxpayer had forfeited assets relating to securities fraud. The taxpayers were notified by the bankruptcy trustee of taxable income reported on Schedules K-1 for themselves and their daughter for 2015 and didn't report the income. The taxpayers claimed they had abandoned their ownership interest in the S corporation, so the income wasn't taxable to them.

The Tax Court upheld the IRS in finding that the intention to abandon wasn't sufficient. The taxpayers had to take actions in order to abandon the S corporation ownership interest, so the K-1 income was taxable to them (including kiddie tax on their daughter's share).

(Joshua M. Yaguda et. vir. V. Commissioner, T.C. Summary Opinion 2022-21.)

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Tax Court says IRS's listed transaction notice for conservation easements is invalid.

The Tax Court has held Notice 2017-10, which identifies certain syndicated conservation easements as listed transactions, is invalid. The court said the IRS did not follow the notice-and-comment requirements under the Administrative Procedure Act.

The IRS will continue to look for and question tax deductions for conservation easements. We might see them go through more formal procedures to have them classified as listed transactions, requiring special disclosure.

(Green Valley Investors, LLC et al v Commissioner, 159 TC. No. 5 (2022).)

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Interest rates for underpayments and overpayments of tax announced.

The IRS has announced the federal interest rates for underpayments and overpayments of tax for the first quarter of 2023. The rate for overpayments is 7%, 6% for corporations. The interest rate for any corporate overpayment exceeding $10,000 is 4.5%. The rate for underpayments is 7%, 9% for large corporate overpayments.

(Revenue Ruling 2022-23.)

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If you exercised an incentive stock option and haven't sold the stock, consider using the "escape hatch."

I explained the details in the November 2022 edition of Michael Gray, CPA's Tax and Business Insight. When you sell the stock during the same year as the year of exercise, the alternative minimum tax adjustment is eliminated and the ordinary income is limited to the excess of the selling price of the stock over the option price. If the stock is replaced with a wash sale (buying back the stock during the period from 30 days before the sale to 30 days after the sale) or the sale is to a related person, the strategy doesn't work. This strategy generally only works for vested publicly traded stock.

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Pay passthrough entity tax by December 31, 2022.

Owners of passthrough entities like partnerships, S corporations and some LLCs can elect for the entity to pay state income taxes so the owners can avoid the itemized state income tax deduction limit and get the tax benefit on their individual income tax returns. In order to claim a tax deduction on the owners' 2022 income tax return, the entity must pay the tax by December 31, 2022. So make a good (high) estimate of the state tax and pay it by December 31, 2022.

(Notice 2020-75.)

If the passthrough entity is an S corporation doing business in California, it probably shouldn't make the election unless all of the owners elect to be included and all of the owners are California residents. Otherwise, the corporation could violate the single class of stock rule, revoking its S election.

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Consider accelerating or deferring income.

Personal tax rates are low right now, so many high-income taxpayers would actually benefit from accelerating income to 2022. Usually, we would be thinking about deferring income at the year end.

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"Harvest" losses or gains?

If you had capital gains this year and you're holding stock with a lower value than when you bought it, consider selling the stock to use the loss as an offset to your capital gains. Remember the wash sale rule - if you purchase the same stock during the period 30 days before the sale until 30 days after the sale, the loss is disallowed and added to the tax basis of the replacement stock.

If you decide the sell stock this year to report gains, the wash sale does NOT apply to gains, so you can repurchase the stock during the wash sale "window" without spoiling your tax strategy.

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Estates and trusts should plan distributions.

The maximum 37% federal income tax rate and the 3.8% tax on net investment income hit estates and trusts especially hard. They apply when the undistributed estate or trust income exceeds $13,450. If possible, the income of the estate or trust should be distributed to beneficiaries before the year-end, since the threshold for these taxes is much higher for individuals. (The income of some trusts is automatically considered distributed. See your tax advisor.) An election is also available to treat distributions made during the first 65 days of the following year (for example, on January 31, 2023) as distributed for a taxable year (for example, 2022).

In most cases, capital gains don't qualify for the distribution deduction. See your tax advisor.

The beneficiaries should be involved in this decision and be informed about the additional income to be reported on their income tax returns (in writing) to avoid unpleasant surprises.

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Should you buy business equipment before December 31?

The expense election for business equipment purchases is now $1,080,000. This election is even available for some SUVs and heavy trucks with a $27,000 limit, and some trucks and cargo vans don't have a limit. The excess might be eligible for bonus depreciation. See your tax advisor for details. Remember the expensed amount is only deductible against business income.

100% bonus depreciation also now applies to used property. Congress has corrected errors relating to expanding bonus depreciation for some building improvements.

See your tax advisor.

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Should you buy a new electric vehicle by December 31, 2022?

The rules for "Clean Vehicles" or plug-in electric motor vehicles were changed by the Inflation Reduction Act of 2022. One of the changes effective for vehicles purchased after December 31, 2022 is a modified adjusted gross income (MAGI) threshold. When MAGI exceeds the threshold, the credit is disallowed. For taxpayers filing joint returns, the limit is $300,000. For heads of household, the limit is $225,000. For other taxpayers, the limit is $150,000. If you are a high-income taxpayer and you can find a qualified vehicle (harder under the new tax law), this could be your last chance to qualify for the tax credit of up to $7,500.

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Seniors, remember required minimum distributions for 2022.

Anyone age 72 or older as of December 31, 2022 who owns an IRA or qualified retirement account (like a 401(k)) is required to take a required minimum distribution for 2022. Most must take the distribution by December 31, 2022, but those who became age 72 during 2022 may take their first distribution by April 1, 2023. (If they do, two distributions will be payable during 2023.)

Also remember the election for taxpayers age 70 or older to have up to $100,000 of the distribution paid to a charity to avoid the charitable contribution deduction limit. Each spouse who meets the requirements may make the election, for a potential exclusion of $200,000. Doing this can also help reduce your Medicare premiums and increase your tax deduction for medical expenses, if you itemize deductions. See your tax advisor.

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Consider a Roth conversion for 2022.

Many taxpayers have experienced reduced income for 2022. Also, consider income tax rates are scheduled to increase after 2025. It may be that making a Roth conversion for 2022 makes sense for you. Some taxpayers should consider a four-year Roth conversion plan. In order to apply for 2022, the conversion must be done by December 31, 2022. Consult your tax advisor.

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Remember to take a physical inventory on January 1.

Calendar year businesses with inventories should take a physical count as of January 1. This creates a "clean" record for the income tax return.

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Remember to "reset" payroll on January 1.

Software providers will issue updates including the new payroll tax tables as of January 1, 2023. Be sure you have installed those updates before processing your first payroll for 2023.

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California FUTA makeup payment for 2022.

California employers will have an additional tax for a credit reduction on their Federal Unemployment Tax Return, Form 940, for 2022. The credit reduction is .03% of FUTA wages, or a maximum of $21.00 per employee.

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Should you make additional tax payments before December 31?

State estimated tax payments and early property tax payments made by December 31 are generally tax deductible for the regular tax. However, many people are finding they are subject to the alternative minimum tax. Deductions for taxes (and miscellaneous itemized deductions) aren't allowed for the alternative minimum tax, so there could be no benefit for a tax prepayment. A tax advisor can project your tax picture to determine if the AMT will apply. Turbo Tax and other tax preparation software can also be used to make the computations.

This situation has changed somewhat because of the 3.8% net investment income (NII) tax. Part of the state tax payment may be a "good" deduction for the NII tax even though there is no AMT benefit. See your tax advisor.

This decision has been more complicated by the federal limit of $10,000 for the total of state and local income taxes and real estate taxes.

See your tax advisor.

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Should you donate appreciated publicly traded stock?

It's the season for giving. Many of us make extra donations during December to share our bounty with others. Appreciated publicly-traded stock that has been held for more than a year is an ideal asset for a donation. Under the Internal Revenue Code, the long-term capital gain is excluded from taxable income and the charitable contribution deduction is the fair market value of the stock, so there is a double tax benefit. Also, publicly traded stock isn't subject to the appraisal requirements that apply to other property. It's a win-win-win! Remember to get a good acknowledgement letter to document the donation, including a statement that "no goods or services were received in exchange for the donation."

Charitable contributions of appreciated long-term capital gain property are limited to 30% of adjusted gross income.

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Donating a car to charity?

Remember that an appraisal is required for noncash contributions with a value exceeding $5,000. See Form 8283 and instructions as the IRS web site, www.irs.gov. (There is a Declaration of Appraiser on the form.) There is an exception to the rule for vehicles donated to a charity. If the charity sells the car, the taxpayer may rely on the sales price disclosed on Form 1098-C. The original Form 1098-C is submitted to the IRS with your income tax return (or otherwise sent to the IRS with Form 8453 if you efile).

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Will you benefit from itemizing deductions for 2022?

Since itemized deductions have been reduced or eliminated for 2022 and the standard deduction has been increased, many taxpayers won't benefit from itemizing their deductions for 2022, so scrambling for year-end deductions could be wasted. See your tax advisor about your situation.

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Donation deduction for non-itemizers has expired!

The deduction for up to $300 of cash donations ($600 for married couples filing a joint return) on your federal income tax return, even when you don't itemize deductions has expired. It only applied for 2021.

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Federal cash donations limit is 60% of AGI for 2022.

The federal 100% of adjusted gross income limitation for cash donations has expired. It only applied for 2021. The limitation for cash donations for 2022 is 60% of adjusted gross income.

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Should you adopt an accounting policy for small equipment purchases by December 31, 2022?

An election is available to currently deduct small expenditures when the taxpayer doesn't have an applicable (audited) financial statement. Items up to $2,500 may be currently deducted, effective for amounts paid or incurred for tangible property on or after January 1, 2016, for taxable years beginning on or after January 1, 2016. The election doesn't apply for inventoriable costs.

Among other requirements, in order to qualify for the current deduction: at the beginning of the taxable year, the taxpayer must have accounting procedures treating as an expense for non-tax purposes - (1) amounts paid for property costing less than a specified dollar amount; or (2) amounts paid for property with an economic useful life of 12 months or less. The taxpayer must also treat the amount paid for the property as an expense on its books and records in accordance with the accounting procedures. The amount paid for the property may not exceed $2,500 per invoice or per item, as substantiated by the invoice.

Note the de minimis election is made each year on the income tax return for the business.

In order to be in position to make the election for 2022, you must have the accounting policy in place by December 31, 2021 and implement that policy in your accounting throughout 2022. If you didn't have the policy for 2022, consider getting it in place by December 31, 2022. We recommend that the policy should be written.

Under tax reform, the tax benefit of making this election has been reduced because of more generous expense election limits and bonus depreciation.

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Remember personal exemptions have been repealed for 2022.

Exemption deductions for dependents have been repealed for tax years beginning after 2017 and before 2026. Instead, taxpayers may claim a tax credit for dependent children and other qualifying relatives. The credit is $2,000 for each qualifying child age through age 17 and $500 for each other qualifying child and relative. This credit is phased out if the taxpayer's modified adjusted gross income exceeds $400,000 for married filing jointly and $200,000 for other taxpayers.

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Reminder - Federal deduction limited for donations to California College Access Tax Credit Fund.

A taxpayer's California income tax liability can be reduced by 50% of donations to the California College Access Tax Credit Fund. The IRS has announced that, effective for contributions made after August 27, 2018, the federal charitable contribution deduction should be reduced for the amount allowed as a reduction of state income taxes as a "quid pro quo" (benefit received back by the donor).

(IR-2018-172, August 24, 2018.)

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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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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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Check out my blog.

I have also started a blog at www.michaelgraycpa.com. Check it out!

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Michael Gray, CPA
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