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Table of Contents

• Happy Thanksgiving!
• It's time for year-end planning.
• My schedule for November and December.
• Janet and I enjoyed our cruise.
• The cruise ship as allegory.
• Social security tax change announced.
• Certain community property entities can be disregarded.
• Most retirement plan limits remain unchanged for 2003.
• IRS ruling helps preserve some retirement accounts.
• IRS warns that reinsurance arrangements may be disallowed.
• We can track mortgage rates for you, so you don't have to.
• Marché Aux Fleurs has special events coming up.
• Questions and Answers

  How do we convert rental property to our personal residence?

  Can I deduct an office my husband uses for business purposes?

  Are living trusts more effective than wills?

  Can a tax-deferred exchange involve a new building?

• Do you have employee stock options?
• PS Marché Aux Fleurs
• Visit our new articles
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Happy Thanksgiving!

It may seem a little premature, but Thanksgiving may be here before our next newsletter. As we approach the end of the year, it's time for reflection. Now is the time to "finish up" some of those goals we have been postponing. It's also time to be thankful for blessings of family, friends and good health.

Thank you, dear clients, for the opportunity to be of service to you. Thank you friends, for your referrals and the pleasure of your company. Thank you, dear readers, for your ongoing encouragement and interest.

2002 has been a challenging year for many people. Those of us who are more fortunate should be especially generous this year in donating time and money to help others.

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It's time for year-end planning.

How has your year been? It may be you should make some adjustments for your estimated tax or withholding before the end of the year. People with capital loss carryovers (including AMT capital loss carryovers for those who sold ISO stock) should look for capital gains that can be offset by the losses. With the stock market improvement during October, this may finally be a possibility for some people. Be sure to reserve a time now for your personal consultation.

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My schedule for November and December.

I will be out of the office on Monday, November 4. Dawn and I will be at Dan Kennedy's Copywriting Boot Camp in Phoenix on November 7 and 8. Janet and I will be going to Ireland from November 16 to 24. Danny and I will be at tax update classes on December 3 and 5. Throw in Thanksgiving and Christmas, and you can see time is going to be pretty tight.

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Janet and I enjoyed our cruise.

We just returned from a one-week Mexican cruise on the Carnival ship Elation. Our ports of call were Puerto Vallarta and Mazatlan. We missed going to Cabo San Lucas because of bad weather. Overall, we had a great time. You can see a photograph of the happy travelers on our website.

Janet enjoyed some treatments at the onboard spa. I was able to catch up on some studying and participated in karaoke and a talent show. The "all-inclusive" cruise fare included all of our meals, the captain's reception, our room, some spa classes and evening entertainment. There were plenty of opportunities to spend more for side trips, gambling in the casino, other spa classes and treatments, art auctions, photographs, etc. The service was excellent.

If you ever go on a cruise, be aware that initial boarding and final disembarkation are very time consuming. If you've been on an international flight, imagine processing an airplane with 2,500 passengers through customs. We arrived in San Pedro at 2:30 p.m. and weren't on the bus to the airport until 6:30 p.m. Fortunately, our flight was scheduled for 8:30, but some passengers weren't so lucky.

We learned that the ship employees who work in the dining rooms, room service and housekeeping are mostly paid from tips, so be sure to bring plenty of cash if you travel on a cruise. Also, this is one place that it's an advantage to bring your American Express card.

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The cruise ship as allegory.

I remember hearing a tape by Earl Nightingale, years ago, where he compared the subconscious mind to a cruise ship. Once the destination is set, the ship continues steady progress and continues traveling while you are asleep. Despite a relatively slow speed, huge distances are covered during the cruise. Likewise, your mind continues working on problems you give it or goals as you sleep. Have you ever awakened during the night with the answer to a problem that you went to bed with? Be sure to have a pen or pencil and a pad of paper handy to write it down before you go back to sleep. Something to think about.

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Social security tax change announced.

The social security wage base for 2003 will increase to $87,000 from $84,900 for 2002. The rate remains at 6.2%. The medicare tax remains at 1.45%, with no ceiling on medicare wages. The combined rate of 7.65% has been the same since 1990. To compute the self-employment tax, double to social security tax and medicare tax that applies to employees.

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Certain entities owned as community property can be "disregarded entities".

The IRS has announced that certain entities that are owned by married couples as community property would be "disregarded" for income tax reporting. These are the same type of entities, such as limited liability companies, that are disregarded when owned by an individual taxpayer. The income and deductions of a disregarded entity are reported on the income tax return of the owner, not on a separate income tax return. (Revenue Procedure 2002-69.)

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Most retirement plan limits remain unchanged for 2003.

The IRS has announced the changes for contributions to qualified retirement plans for cost of living adjustments for 2003. Since the rate of inflation for 2002 was low, few limits changed. The items that changed included the compensation limit for certain grandfathered government plans, which will increase from $295,000 to $300,000; the maximum elective deferral for 401(k) plans, 403(b) annuities, SAR-SEPs and the federal Thrift Savings Plan will increase from $11,000 to $12,000, and the maximum contribution to a SIMPLE will increase from $7,000 to $8,000.

Under the Economic Growth and Tax Relief Act of 2001, the catch-up contribution for taxpayers age 50 or over for employer plans except SIMPLE 401(k) or regular SIMPLE plans increases from $1,000 to $2,000. For SIMPLE 401(k) plans or regular SIMPLE plans, the catch up amount will increase from $500 to $1,000. (IR 2002-111)

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IRS ruling helps preserve some retirement accounts.

Generally an IRA account is required to be distributed after the owner reaches age 70 1/2 using a life expectancy computation. One method of distribution is a fixed annuity payment. With the decline in the stock market, many taxpayers who made the fixed annuity payment election found their accounts were rapidly becoming depleted. The IRS has issued a ruling allowing a one-time switch in method to an annual recalculation method. The ruling applies for any series of payments beginning on or after January 1, 2003, and may be used for distributions beginning in 2002. If you think this ruling may benefit you, I recommend that you consult with a tax advisor. (Revenue Ruling 2002-62.)

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IRS warns that reinsurance arrangements may be disallowed.

The IRS has issued a notice that tax benefits for certain arrangements for selling insurance may be disallowed. These arrangements, commonly used for credit life insurance by auto dealers, involve shifting commission income away from the dealer to an offshore affiliate by using a reinsurance arrangement. If your business has such an arrangement, you should consult with a tax advisor. (Notice 2002-70.)

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We can track mortgage rates for you, so you don't have to.

With the stock market improving, mortgage rates may increase slightly, giving the industry some breathing room to clear the backlog of refinancing that has built up. At no charge or obligation, we can track your home mortgage and notify you when refinancing is to your advantage.

Remember, we offer home mortgages as a service to our clients and newsletter subscribers located in California through our strategic partner, Wymac Capital. We specialize in financing with no points and no costs, if certain conditions are met.

To find out if we can reduce your home mortgage costs or help provide financing for education, a vacation, or a new home, please call Michael Gray at 408-918-3161. There is no fee or obligation for this service.

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Marché Aux Fleurs has special events for November and December.

My daughter and her husband, Holly and Dan Baker have a wonderful Southern French restaurant in Ross, California. They are featuring wine education classes on November 12 and December 3. The November class features wines of Burgundy and the December class features wines of Alsace/Champagne. The investment for each class is $45 for 2 hours of instruction, tastes of regional wines, and food pairings. Marché Aux Fleurs was awarded the Wine Spectator Award of Excellence for the second straight year, so these classes are great events for our readers who enjoy wine. For reservations and details, call 415-925-9200.

Marché Aux Fleurs also will be featuring special dinners focusing on certain ingredients. The first dinner, on Wednesday, November 13 at 6:30 pm., will have five courses of local Autumn Squash. The main courses of the dinner include Kabocha squash crusted halibut and Braised Niman Rand shortribs. The investment is $35. The second dinner on Wednesday, December 11 at 6:30 p.m. includes four courses with Fresh Truffles. The main courses are seared diver scallops and Niman Ranch steak. The investment is $69. By reservation only, 415-925-9200.

On Christmas Eve, a special menu will be offered including a 3-course dinner for $39 and a children’s meal for $15.

For the best meal of you life, call for a reservation today!

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Questions and Answers

Question

During 2001, my wife and I purchased a replacement property for a 1031 exchange. We planned to hold the replacement property to help with our retirement. It was a financial stretch to buy the replacement property. After the World Trade Center attack on September 11th and the ensuing recession, we decided to improve our finances by selling our principal residence. We have been renting an apartment and had tenants in the replacement property. Our tenants are going to be vacating at the end of December and we would like to move into the replacement property.

1. Would there be any tax consequences?
2. How do we convert the rental property to our personal residence?

Answer

Under the circumstances you have described to me, no tax should result from converting the property to your principal residence.

To convert the property to your principal residence, simply move in, claim the homeowner's exemption, register to vote, and notify the post office and others that this is your residence. Warning to other readers - you can't simply exchange from an investment property to a personal residence. Get advice from a tax advisor when you are planning a tax-deferred exchange.

Question

One year ago, my husband's company turned their sales staff into virtual office employees. My husband works out of our small home.

We need to move him out of the house. We only have one bedroom and a small child.

Can we rent a small studio apartment and deduct the cost of the rent as a business office? He must have a place to work besides my kitchen table?

Answer

If your husband rents a separate apartment (office) that he uses exclusively for business purposes, you may claim an itemized deduction for the expenses as employee business expense. Remember that miscellaneous itemized deductions, including employee business expenses, are reduced by 2% of adjusted gross income. It sounds like you might still have trouble getting a tax benefit for this expense, because you may not have enough itemized deductions to exceed the standard deduction. The standard deduction for 2002 for married persons filing a joint return is $7,850.

Question

Your website promotes wills. What about living trusts? Aren't they a more effective tool to transfer assets?

Answer

Of course I encourage people to investigate using living trusts. Bear in mind that living trusts help you avoid probate, not estate taxes. You can accomplish the same tax benefits with a trust under a will (testamentary trust) as with a will.

You still should have a will, typically called a "pourover will", with a living trust.

You would be shocked to learn how many of the people I interview have no will or trust. First things first.

Question

Can a tax-deferred exchange be made when the replacement property has just been constructed and hasn't been rented yet?

Answer

Yes, provided you don't use the property as a personal residence and start renting it shortly after the exchange is completed. (The replacement property can even have been someone elsés principal residence and converted by the buyer to a rental after the exchange is completed.)

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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

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If you have employee stock options, have you subscribed to the ESOAA Option Alert?

To subscribe, go to http://www.stockoptionadvisors.com. You can review our last issue at http://www.stockoptionadvisors.com/optionalert/news.shtml.

Advisors may find information about joining the Employee Stock Option Advisors Association, LLC and training materials about tax planning for employee stock options at http://stockoptionadvisors.com/seminar.shtml.

Employee option holders may find information about self-study materials relating to planning for employee stock options at http://stockoptionadvisors.com/seminar.shtml.

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Visit our new articles!

• Secrets of Closing the Sale Book Review
• "Do you give your customers a 'reason why' they should do business with you today"

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P.S.

My daughter and her husband, Holly and Dan Baker, have opened 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. For the best meal of your life, call 415-925-9200 for a reservation and give them a try soon! For directions, visit our directions page at http://www.taxtrimmers.com/directions.shtml.

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P.P.S.

To receive the next issue of Michael Gray, CPA's Tax & Business Insight with more tax developments, another book review, and upcoming deadlines automatically via email, subscribe by filling out the form below.

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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.