Michael Gray, CPA's Tax and Business Insight

Table of Contents

• Happy New Year!
• Tax season is almost here.
• My schedule for January.
• We can track mortgage rates for you.
• Improving software not eligible for research credit.
• Insurance Manager's termination payments not capital gain.
• Professor qualifies for capital gains treatment for royalties.
• California tax increase coming.
• IRS per diem expenses for "incidental expenses".
• Uncashed retirement payment is taxable.
• Recognition of advance payments deferred.
• IRS proposes allowing deferred recognition of advance payments.
• Adjustments for pension overpayments.
• Interest rates for overpayments and underpayments will drop.
• New IRS phone numbers.
• CPA's expenses for airplane and apartment rental disallowed.
• What tax law changes would you like to be enacted?
• California rules for non-residents and part-year residents explained.
• Questions and Answers

  Can short term capital gain dividends be reduced by capital losses?

  Does the IRS require brokerage firms to report the cost basis of stock sold?

  How can we deduct mortgage interest or property taxes on a rental?

  Does registering a car in my name cause a problem when listing it as a corporate asset?

  Can dealers sell a "roll-back" vehicle as new?

  What is the current status of the luxury tax?

  Do I need to apply for a business license?

  Can I contribute the same amount to an IRA as my 401(k)?

• 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 New Year!

Now is the time to make your goals and plans for the New Year. If you have a business, what marketing campaigns will you have? When? For those without a business, what financial goals do you have? Have you planned for your retirement? For your children's or grandchildren's education? What vacations will you take? When? Are you planning for a new home or a vacation or retirement home? What are your charitable and personal growth goals for 2003?

Please let us know if we can be of any help to you in planning or achieving your goals. That's part of what we're here for.

Return to Table of Contents

Tax season is almost here.

We have already mailed paper organizers to continuing clients. We should receive the Tax Notebook computerized organizers soon and will ship them immediately. Interviews for tax return preparation will be scheduled during February. Please call Dawn at 408-918-3162 for your appointment today.

Return to Table of Contents

My schedule for January.

I will be at meetings outside the office on January 6 and 7. Otherwise, I should be here during the work week most of the month.

Return to Table of Contents

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

Mortgage rates have fallen, again. We are refinancing mortgages that were processed last year. 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, home improvements, a vacation, or a new home, please call Michael Gray at 408-918-3161. There is no fee or obligation for this service.

Return to Table of Contents

Improving software not eligible for research credit.

The 7th Circuit Court of Appeals has ruled that a software developer's improvements to its software package did not qualify for the research tax credit because the improvements did not involve "experimentation."

The Tax Court previously found the work on the software did not produce an innovation in underlying principle and the research was not designed to eliminate uncertainty about the technological possibility of developing the particular type of software.

The 7th Circuit said that "tinkering" is not the same as "experimentation" and does not qualify for the credit.

(Eustace v. Commissioner, No. 01-4222 (7th Circuit, 12/13/02.))

Return to Table of Contents

Insurance manager's termination payments not capital gain.

A Farmer's Insurance district manager claimed his relationship with Farmer's was a franchise, and his termination payments should be taxed as capital gains. The Tax Court held the payments were self-employment income, subject to self-employment taxes and taxed as ordinary income. The termination payments were based on a contract determined based on the quantity and quality of services provided by the manager to Farmer's Insurance. The agreement had no language indicating a franchise had been created.

(Parker v. Commissioner, T.C. Memo 2002-305 (12/16/02))

Return to Table of Contents

Professor qualifies for capital gains treatment for royalties from university.

A professor at a university transferred rights to a patent to the university, as required under his employment contract. The university paid royalties to the professor under a royalty distribution agreement for the transfer of the patent. The IRS National Office ruled that the payments were not compensation for services, but compensation for transfer of the patent, qualifying as capital gains. The right to continued receipt of the payments is not contingent on continued employment with the university, but on the use or value of licensing the patent.

(TAM 200249002.)

Return to Table of Contents

California tax increase coming.

Governor Davis has announced that his budget proposal to eliminate a $20 billion deficit for California will include a tax increase.

Return to Table of Contents

IRS per diem expenses for "incidental expenses."

The IRS has issued Final and temporary regulations for per diem amounts to be used instead of documenting individual expenses for incidental expenses paid or incurred while traveling away from home. The allowance is $2 per day. T.D. 9020.

The regulations outline rules similar to Rev. Proc. 2002-63 and apply to expenses paid or incurred after September 30, 2002.

Return to Table of Contents

Uncashed retirement payment is taxable.

A payment from a 401(k) plan that was uncashed during a period of imprisonment was constructively received when issued, not when it was cashed. (Roberts v. Commissioner, T.C. Memo 2002-281 (11/13/02.)

Return to Table of Contents

Recognition of advance payments deferred.

An accrual-basis dealer who orders goods and temporarily stores them in an office before delivering and installing them may include non-refundable deposits for goods in income in the tax year the goods are delivered and installed. (FSA 200246016.)

Return to Table of Contents

IRS proposes allowing deferred recognition of advance payments for accrual taxpayers.

Under a proposed revenue procedure, accrual basis taxpayers would be allowed to defer including advance payments in income until the year following receipt. Currently, Rev Proc 71-21 permits certain taxpayers to defer income recognition for services, if the services are to be performed by the end of the following tax year. The proposal would extend the deferral to other advance payments. (Notice 2002-79, 2002-50 IRB.)

Return to Table of Contents

Adjustments for pension overpayments.

When a defined benefit plan reduces future pension payments to compensate for overpayments included in income in previous years, the recipient is taxed on amounts acturally received.

A plan participant who is required to repay the overpayments to the plan in a later year may claim the repayment as a loss.

(Rev. Rul. 2002-84.)

Return to Table of Contents

Interest rates for overpayments and underpayments will drop.

The interest rates for tax overpayments and underpayments for the calendar quarter beginning January 1, 2003 will drop 1% from the current quarter. For non-corporate taxpayers, the rate will be 5%.

For corporations, the overpayment rate will be 4%. The rate for overpayments exceeding $10,000 will only be 2.5%. The underpayment rate will be 5%, and 7% for large underapyaments.

(Rev Rul 2002-70.)

Return to Table of Contents

New IRS phone numbers.

A new IRS phone number for EIN applications, employment taxes, partnership, corporation, estate gift, trust, excise taxes or other small business issues is 800-829-4933.

A new IRS phone number for status of refunds is 800-829-1954.

(IR-2002-130 (11/27/02.))

Return to Table of Contents

CPA's expenses for airplane and apartment rental disallowed.

A CPA claimed expenses for travel between a temporary work location and his other residence (Memphis and Knoxville.) He established the residence in Knoxville with his girlfriend about the time his employment in the temporary work location started. The Tax Court held the CPA had chosen to reside in a different location from his principal place of employment for personal reasons, so the residence was not recognized as his tax home. The expenses were incurred for personal reasons, and deductions for them were disallowed. (Kernan v. Commissioner, T.C. Summary 2002-148 (11/20/02.))

Return to Table of Contents

What tax law changes would you like to be enacted?

It's almost certain a new federal tax law will be passed during 2003. President Bush has asked for a tax break on dividends and to accelerate some of the tax breaks enacted during 2001. Whenever Congress has a tax law on the table, it's an opportunity for tax reform proposals to be made. Write your representatives in Congress to let them know if you are suffering a hardship because of a tax law or have a suggestion about how to make the system work better. For contact information, see www.house.gov and www.senate.gov.

Return to Table of Contents

California rules for non-residents and part-year residents explained.

The tax rules for reporting income and deductions of non-residents and part-year residents to California are very complex. When you study the rules, the transition of moving to or from California is especially intimidating. The Franchise Tax Board has issued Publication 1100, Taxation of Nonresidents and Individuals Who Change Residency, and Publication 1031, Guidelines for Determining Resident Status, with details about how these rules work. You can request the Publications at 800-852-5711 or find them on the Web at www.ftb.ca.gov.

Return to Table of Contents

*   *   *

Questions and Answers

Question

Can "short term capital gain" dividends from a mutual fund be reduced by capital losses from other investments?

Answer

No. Short-term capital gain dividends from mutual funds are included with "regular" dividends and reported as ordinary income on Schedule B. Only long-term capital gain dividends from mutual funds are separately reported on Schedule D and may be reduced by capital losses from other investments. (Internal Revenue Code Section 852(b).)

Question

As I understand it, brokerage firms are required to report the proceeds on the sale of stock to the IRS. They are also required to report the cost basis of the stock sold. Can you tell me what year the IRS required the cost basis to be reported by the brokerage firm?

Answer

Brokerage firms are not required to provide cost basis information for security sales to the IRS or their customers. The firms don't have the information for securities transferred from other brokers or for securities received as certificates from their customers. Some brokers will provide the information they have as a courtesy to their customers.

Mutual funds are required to provide average basis information for sales to their customers, but I don't have the details of when the requirement was enacted.

Question

My husband had a temporary one-year job. We rented out our primary residence temporarily before we moved and sold the house. Because of heavy expenses, we have a passive loss on our residence. We did not take any depreciation.

Since this was a primary residence, can we deduct any of the mortgage interest or property taxes on Schedule A, even though it was rented for virtually all of the time?

Answer

No. The information should be reported on Schedule E, Part I. Since you sold the residence, any suspended passive activity losses are deductible in the year of the sale. I highly recommend that you get professional help in preparing your tax returns in this situation.

Question

I have a client with a C corporation who has a vehicle which is registered in his name. The corporation makes all the payments on the loan and he treats it as a corporate asset.

Is this a potential problem in an audit?

Answer

Yes. Anytime you have a vehicle used for business purposes, there is a potential audit issue. Since the title for the car was taken personally, payments on the loan could be found to be compensation or dividends, and the depreciation may be disallowed for the car. The vehicle use can be reimbursed as an employee business expense. I suggest that your client and you get together with a tax attorney and clean this situation up.

Question

I bought a car that I thought was new, but discovered the car was a "roll back" from a previous sale. As I understand it, a subsequent sale should not be made as "new" for title or luxury tax in this situation. What do you suggest?

Answer

This isn't really a tax question. Relating to the title, I suggest that you visit your local Department of Motor Vehicles and discuss it with them. Since the result of not treating a sale of a "roll back" vehicle as a "first sale" is to subject the seller, not the buyer, to the luxury tax, I don't think that is the correct conclusion, but that's not an authoritative answer. You might ask for some help from the IRS about recovering the luxury tax and see what their response is.

Question

What is the current status of the luxury tax as of January 1, 2003?

Who do Florida licensed automobile dealers pay luxury tax to?

Answer

The federal luxury tax on automobiles is repealed as of January 1, 2003. Thank God!

Florida automobile dealers paid the federal luxury tax to the IRS. I don't know if there is a Florida luxury tax. Ask a local auto dealer. They should know.

Question

I am currently a subcontractor. I provide cleaning services. I receive a Form 1099 each year and I do not have a business license. I don't want to provide services for anyone else. Do I need to apply for a business license? Is there an advantage in applying for one?

Answer

Applying for a business license strengthens the argument that you are an independent contractor. If you are only providing services for one customer, your classification as an independent contractor is a weak one, likely to fail if challenged. Some tax considerations are whether you are subject to self-employment tax, whether deductions should be claimed for business expenses on Schedule C and the ability to have your own retirement plan.

Question

I participated in my employer's 401(k) plan, but lost my job in May. I contributed $4,000 before terminating employment. Can I contribute the difference ($4,000) to an IRA for 2002 and claim a deduction on my tax return?

Answer

No.

*   *   *

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

Return to Table of Contents

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

To subscribe or review past issues, visit http://stockoptionadvisors.com/optionalert/.

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.

Return to Table of Contents

Visit our new articles!

• "How to Master the Art of Selling" Book Review
• "To Do", "Doing", "Done!"

Return to Table of Contents

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 website at http://www.taxtrimmers.com/directions.shtml.

Return to Table of Contents

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.

Return to Table of Contents

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.