Michael Gray, CPA's Tax and Business Insight
February 3, 2023
© 2023 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
- Tax season is here!
- Remember federal income tax returns for calendar-year S corporations and partnerships are due March 15.
- The election to be an S corporation for calendar-year corporations is also due March 15.
- Have you received your tax preparation materials?
- File your tax return early, if you can.
- California wages could be wrong on Form W-2.
- California delays basis reporting requirement for partnerships.
- Update your Forms W-4 and DE-4 for 2023.
- Changing jobs could result in an excess 401(k) contribution.
- Backdoor Roths.
- No loss for cryptocurrency that wasn't sold.
- Employer-provided housing was taxable.
- Donation deduction of cryptocurrency required an appraisal.
- California hasn't conformed to all SECURE Act 2.0 changes.
- Payment at death was alimony, not a bequest.
- Don't report taxable income twice!
- Remember to report the sale of option stock.
- Watch reporting qualified sales of ISO stock.
- Do you sell services or software to CPAs?
- Please share your good experiences with Michael Gray, CPA.
- Financial Insider Weekly past episodes.
- Visit our new book review: Built To Sell
- Follow me on social media!
- Check out my blogs.
- Subscribe/Remove from Michael Gray, CPA's Tax & Business Insight
Janet and I celebrate their wedding anniversary with Lane and Gail Johnston at the Red House Cafe in Pacific Grove Valentine's Day!
Remember to show your love and appreciation for your loved ones on Tuesday, February 14. 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!
Tax season is here!
The IRS has announced it began accepting and processing (including efiling) 2022 individual income tax returns on January 23, 2023. Note that the final versions of some tax forms haven't been released yet and there are other reasons to delay filing 2022 individual income tax returns. Consult with your tax return preparer.
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 18.) For taxpayers located a disaster area like many counties in California, the IRS has extended the filing deadline to May 15, 2023. See your tax advisor.
The election to be an S corporation for calendar-year corporations is also due March 15.
If you are in a disaster area like many counties in California, the IRS has extended the filing deadline to May 15, 2023. For taxpayers located a disaster area like many counties in California, the IRS has extended the filing deadline to May 15, 2023. See your tax advisor.
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.
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.
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. This is one situation when 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.")
California delays basis reporting requirement for partnerships.
The California Franchise Tax Board has announced that taxpayers may report the Federal tax basis capital accounts on partners' California Schedule K-1 for 2022. (Also applies for LLCs taxed as partnerships.) The requirement to report partners' California tax basis capital accounts will apply for the 2023 taxable year.
(FTB Notice 2023-01.)
Update your Forms W-4 and DE-4 for 2023.
The IRS has issued updated Form W-4 for 2023. 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
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 2022 was $20,500 for 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 tax deductible and will be taxed a second time. There is also a risk the employer's plan could be disqualified because of this issue.
Backdoor Roths.
SECURE Act 2.0 did NOT include any provisions eliminating "backdoor Roth" contributions. 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 2023, up to $66,000 can be contributed to these accounts.
Find out if your employer permits mega backdoor Roth contributions
Taxable Roth conversions of IRA accounts are also still allowed. With higher federal income tax rates scheduled to return after 2025, making a taxable Roth conversion might be a wise tax planning move.
No loss for cryptocurrency that wasn't sold.
A taxpayer bought cryptocurrency during 2022 for $1 per unit. It declined in value to 1¢ per unit by December 31, 2022. The taxpayer asked the IRS whether is loss under IRC § 165 could be claimed for the obsolescence or loss of usefulness of nondepreciable property. The IRS Chief Counsel response was the investment wasn't worthless because it still had a value of 1¢ per unit, greater than zero, it continued to be traded on a cryptocurrency exchange, and it wasn't sold as of December 31, 2023. Even if the loss was realized, it would be a nondeductible miscellaneous itemized deduction.
(CCM 202302011.)
Employer-provided housing was taxable.
An engineer working in Australia as an independent contractor was assigned off-base housing that wasn't located on the business premises of the employer. He performed some work from home. An amount was reported on Form 1099-MISC for the housing allowance. The entire amount on Form 1099-MISC was initially reported on the engineer's federal income tax returns. A tax return preparer prepared amended income tax returns for 2016 and 2017 and an original return for 2018 on which the housing allowance was subtracted as a tax-free fringe benefit.
The Tax Court upheld the IRS in disallowing the exclusion because the housing wasn't located on the business premises of the employer under IRC ¶ 119. His business activities there weren't significant enough to show the housing was "integral" to the employer's business.
(Smith v. Commissioner, T.C. Memo. 2023-6.)
Donation deduction of cryptocurrency required an appraisal.
A taxpayer claimed a charitable contribution deduction for $10,000 of cryptocurrency. The cryptocurrency was valued using a cryptocurrency exchange value.
The IRS Chief Counsel advised the deduction wasn't tax deductible. An appraisal was required in order to meet the substantiation requirements for donations of property with a value of $5,000 or more.
Crypotocurrency doesn't meet the definition of "publicly traded securities."
(CCM 202302012.)
California hasn't conformed to all SECURE Act 2.0 changes.
Although California automatically conforms to many federal income tax law changes for retirement accounts, it doesn't conform to all of them. For example, the deduction for IRA "catch up": contributions that are indexed for inflation after 2023 will be limited to $1,000 for California. An increase in the catch-up contributions for employees who are age 50 or older to the greater of the regular catch-up contribution limit ($7,500 for 2023) or $10,000 (indexed for inflation beginning in 2026) for employees age 60, 61, 62 or 63 for 401(k) plans for taxable years beginning after December 31, 2024 will not be tax-deductible in California.
The non-deductible amounts would be recovered as a tax-exempt recovery of capital when future plan distributions are received.
This list isn't complete. See your tax advisor for more details.
California will probably pass conformity legislation, but that isn't certain. Watch for future developments.
(Spidell's California Taxletter®, February, 2023, p. 1, "Be secure with SECURE 2.0 Act conformity issues.")
Payment at death was alimony, not a bequest.
A divorced taxpayer received a $500,000 payment at the death of her ex-husband and didn't report the payment as income. She said it was an inheritance bequest, not subject to California income tax. The California Office of Tax Appeals upheld the Franchise Tax Board in finding the payment was taxable as alimony. It was specified to be made in the event of death if the taxpayer survived her ex-husband in a marriage settlement agreement as spousal support.
This payment was made in 2015.
Effective for divorce and separation agreements executed after December 31, 2018, the federal deduction for alimony to the payer and income to the recipient was repealed.
California hasn't conformed to this change, so the same results to these facts would apply for 2022 or 2023.
(Appeal of Dunbar-Sherrill, 2022-OTA-423.)
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. Contact Thi Nguyen, CPA at thi@atl-cpa.com to make an appointment.
Do you sell services or software to CPAs?
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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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