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Table of Contents

• "Leaving home is oh, so nice; coming home is oh, so much nicer!"
• Happy holidays!
• 'Tis the season for year-end tax planning...
• A year-end reminder for those who exercised ISOs during 2000.
• Announcing: A new organization relating to Employee Stock Options.
• Help wanted!
• Thank you!
• IRS says payments to employees weren't loans.
• S corporations can't accrue charitable contributions.
• Social security wage base increased for 2001.
• "Nanny tax" threshold also increases.
• IRS rules below market interest rules apply to Split Dollar Insurance.
• IRS loses! Routine periodic maintenance of towboat engines is currently deductible.
• Federal per diem rates can't be used by self-employed for lodging expenses.
• Corporation that converted from C to S "stung" on partnership LIFO inventories.
• Gift tax exclusion disallowed for gifts to daughters-in-law.
• Standard mileage rates increased for 2001.
• Visit our new articles.
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax and Business Insight.

"Leaving home is oh, so nice; coming home is oh, so much nicer!"

My wife's grandfather, Eugene Ringhouse, used to say this when he returned from a vacation. Don't you feel that way, too?

Janet and I had a marvelous, head-spinning scenic European tour. We visited nine countries in 15 days! We saw awesome monuments, including Stonehenge; stunning landscapes, including the Swiss Alps and the French Riviera; impressive art, including the Sistine Chapel, David, and the Pieta; and finished with the capstone of our tour, the City of Lights - Paris!

When you experience a visit like this, you can appreciate why the people of these countries have such pride.

I can heartily recommend this tour, offered through Trafalgar Tours, with a word of caution. You must be in good physical condition to enjoy the trip.

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Happy holidays!

As this year comes to a close, we wish you and your families a wonderful holiday season and a prosperous new millennium!

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'Tis the season for year-end tax planning...

We have already alerted most of our clients. There is a very limited time available to prepare for the year-end. Our appointment calendar is filling fast. If you need tax planning support, make your appointment today!

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A year-end reminder for those who exercised ISOs during 2000.

If you exercised your options early in the year and didn't sell the shares, and the value of the employer corporation's stock has sharply declined, it may be to your advantage to sell before December 31, 2000. See your tax advisor.

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Announcing: A new organization relating to Employee Stock Options.

Dawn Siemer and I have formed a new organization, Employee Stock Option Advisors Association, LLC (ESOAA). Our intention is to provide special support to employees who have employee stock options and to the tax advisors who work with them.

Related to this, we are starting a new free newsletter, The ESOAA Option Alert, which will be issued on an irregular basis to alert interested persons of breaking news relating to tax planning for employee stock options, including an occasional "question and answer" from our readers.

Subscribers will also be notified when seminars will be offered and publications and tapes to help better understand the special tax planning problems for taxpayers who have employee stock options.

To subscribe, visit our web site at www.stockoptionadvisors.com.

For tax advisors who work with clients about employee stock option issues, or would like to learn more about this area of practice, please subscribe at the "Join Us" link.

If you are uncomfortable with this "internet oriented" approach and need to talk to a "real person," please call Dawn Siemer on Mondays, Wednesdays or Fridays at 408-918-3162.

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Help wanted!

We don't have a store front to post a sign, so this seemed like the best place to make an announcement. I am looking for a California CPA to work with me as a tax and business consultant. Don't worry too much, I have already hired two interns from San Jose State to help this tax season.

As most of you know, the Silicon Valley labor and housing markets are crazy.

It occurs to me that there may be a subscriber to this newsletter who can appreciate the opportunity for personal and professional development that we offer to people who work in our firm.

If you or a person you know fits this description and would like to explore joining us as a tax and business consultant, please call me at 408-918-3161.

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Thank you!

During November, Craig Martin of the Family Wealth Consulting Group referred Don Chislow, Dick and Janet Rathmann referred Will Kaufman, Paul Rosenberg referred Kurt McInney, and Dick Blakely of Solomon Smith Barney referred Jim Weaver. Thank you for your confidence in us!

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IRS says payments to employees weren't loans.

The IRS recently issued Technical Advice Memorandum 200040004, relating to an incentive loan program of a stock brokerage firm to attract new employees. The ruling is very timely, because many employers in high cost of living areas, such as Silicon Valley, are offering these incentives to help new employees get established in their new areas.

The basic plan is structured as a loan when the employee is hired. A written note and bonus agreement document the arrangement. The employer agrees to pay annual bonuses equal to principal plus interest for the employee to repay the loan over a five-year period. If the employee leaves early, he or she is liable for the unpaid balance of the loan plus interest. The loan is secured by employer stock.

The IRS National Office ruled the arrangement is not actually a loan, but an advance payment of compensation for services. The employee should report the initial payment as income in the year received. The employer should deduct the amount paid as the services are rendered under the "all events" test. Payments of "interest" should be disregarded because the payment of interest is not made by the employee.

The "risk of forfeiture" rules do not apply to an arrangement like this because the loan is not "property" but cash. The IRS concluded the requirement to repay the balance of the loans on early termination represents liquidated damages for violation of the employment agreement.

I believe we haven't seen the last of this issue. These loan arrangements are widespread, so these issues will probably be litigated - possibly by the taxpayer involved in the ruling. As attorney Owen Fiore, says, "Substance prevails over form; but form can give substance." The transaction was carefully documented, and loans to employees have been historically respected.

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S corporations can't accrue charitable contributions.

The IRS has ruled the rule that allows accrual-basis corporations to deduct charitable contributions authorized by its board of directors before the end of a taxable year and paid by the 15th day of the third month after the year end does not apply to S corporations. The IRS believes that since the income and deductions of an S corporation pass through to its shareholders, the timing rules for individuals should also apply to S corporations. (Rev Rul 2000-41, IRB 333.)

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Social security wage base increased for 2001.

The Social Security Administration has announced the wage base for computing the Social Security tax will increase to $80,400 for 2001 from $76,200 in 2000. The FICA tax rate for employees and employers remains unchanged at 7.65% each. The FICA rate for self-employed persons is $15.3%. (Social Security Administration Fact Sheet, 10/18/2000.)

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"Nanny tax" threshold also increases.

The Social Security Administration also announced that if an household employee is paid less than $1,300 for 2001 ($1,200 for 2000), the amount isn't FICA wages. (Social Security Fact Sheet, 10/28/2000.)

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IRS rules below market interest rules apply to Split Dollar Insurance.

Under split-dollar insurance arrangements, an employer pays for life insurance on the life of an employee and is reimbursed for the premiums paid from the proceeds of the life insurance policy. Some of these arrangements are structured as an interest-free loan with a "collateral assignment" of the insurance proceeds to secure the loan.

Based on some old rulings issued before the below-market rate interest rules were enacted, life insurance companies have suggested the below-market rate rules do not and should not apply to split-dollar life insurance arrangements.

Now the IRS has finally issued Field Service Advice 200040001 stating below-market rate interest rules do apply to these arrangements. Perhaps this "sleeping dog" is finally awakening and we'll see some action on this issue.

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IRS loses! Routine periodic maintenance of towboat engines is currently deductible.

The Tax Court recently ruled against the IRS that periodic maintenance of towboat engines was currently deductible. The periodic maintenance cost Ingraham Industries about $100,000 per engine. The Tax Court found this expense was reasonable, considering a new towboat would cost $6.25 million. The IRS claimed the engine was being "overhauled", resulting in prolonging its useful life. The court found the maintenance was required in order for the towboat to realize its 40-year expected life. The IRS tried to claim INDOPCO had changed the rules relating to repairs and maintenance. The court held the pre-INDOPCO standards still apply. (Ingham Industries, Inc., TC Memo 2000-323.)

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Federal per diem rates can't be used by self-employed for lodging expenses.

The Tax Court recently ruled against a self-employed person who tried to rely on Federal per diem rates to substantiate his deductions for lodging expenses. The court said the per diem rates could only be used for meals and incidental expenses, not for lodging expenses. (William K. Starr v. Commr., T. C. Memo 2000-305.)

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Corporation that converted from C to S "stung" on partnership LIFO inventories.

An auto dealership group that had been structured as a consolidated group reorganized with an S corporation management company and partnership operating companies. The IRS "looked through" to the management company's shares of the partnerships and required the recapture of the management company's share of the LIFO reserves as of the date of the S election. The Tax Court upheld the IRS's position, resulting in accelerating the tax on about $5 million in LIFO reserves. (Ouch!) (Cogging Automotive Corp v. Commr., 115 TC No 28.)

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Gift tax exclusion disallowed for gifts to daughters-in-law.

Marie Bies made annual gifts of corporate stock to her sons and her sons' wives. Immediately after the transfers, the wives would transfer the stock to their husbands. The Tax Court held the transfers to Mrs. Bies's daughters-in-law were indirect transfers to her sons, so they did not qualify for additional annual exclusions. (This arrangement obviously would not pass the "smell test"!) (Estate of Bies v. Commr., T.C. Memo 2000-338.)

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Standard mileage rates increased for 2001.

The IRS has announced the standard mileage rates that will apply for 2001. The rate for business use will be 34.5¢ per mile of 2001 (32.5¢ for 2000). The charitable rate will be 14¢ per mile for 2001 and 2000. The medical and moving rate will be 12¢ per mile for 2001 (10¢ for 2000.)

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Visit our new articles!

• Warning! The Interest Expense For Your Margin Account May Not Be Tax Deductible!
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• Upsell Your Customers To Increase Your Profits

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.