Michael Gray, CPA's Tax and Business Insight

Table of Contents

• Happy Tax Season!
• Remember to prepare information returns for businesses.
• Will you make these mistakes handling an estate or trust?
• We can track mortgage rates for you.
• New sale of residence rules may change home office strategy.
• IRS liberalizes IRA rollover rule.
• New regulations issued for redemption of stock for a divorce.
• Questions and Answers
  • Are home proceeds treated differently for out-of-state owners?
  • Can we claim a deduction for points paid to refinance our home?
  • Can I deduct a loss from a Roth IRA?
  • Can I claim a business deduction for my auto loan interest?
  • Are there exceptions to the residence rule for a home sale exemption?
  • What is the difference between a living trust and a will?
• Do you have employee stock options?
• Visit our new articles
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight.
• PS Marché Aux Fleurs

Happy Tax Season! Make your appointment now.

Yes, it's that time of year, again! This year, more clients should be motivated to file early to get refunds. We make most of our tax interview appointments during February, which leaves March and early April to finish income tax returns and prepare extensions. If you haven't scheduled an appointment yet, call Dawn Siemer at 408-918-3162.

Continuing clients should have already received their organizers. If you need a tax data organizer, call Dawn Gray. Be sure to let her know if you prefer a paper organizer or a computerized "tax notebook".

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Remember to prepare information returns for businesses.

Forms 1099 should have been sent to payees of interest income, dividends, service income, rents, etc. by January 31. The copy to the IRS is due February 28. There are severe potential penalties, including the potential denial of deductions. Please let us know if you need any help with this requirement.

Individuals also issue Forms 1099 when they receive income as a "nominee" (under their social security number) for someone else.

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"Will you make these mistakes handling an estate or trust after a death?"

This is the title of a complimentary presentation by Michael Gray on Monday, March 3 at the Community Room of the Campbell Library. The presentation will be from 7 to 8:30 p.m. The Campbell Library is located at 77 Harrison Avenue in Campbell. Seating is limited. For reservations, call Dawn Gray at 408-918-3162. Bring a friend!

Why would you want to come to this seminar? After a death, family and friends are dealing with the emotions of loss. At the same time, critical tax decisions must be made and other legal and recordkeeping matters must be attended to. Making mistakes when handling an estate or a trust after a death can cost a family thousands of dollars. In this complimentary seminar, Michael Gray, CPA will share experiences of mistakes he has seen or helped families avoid when dealing with estate and trust issues in his tax practice.

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

The sagging stock market is continuing to drive interest rates lower than we have seen in many years. (In turn, the sagging stock market and low interest rates are driving a hot residential real estate market.)

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.

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New sale of residence rules may change "home office" strategy.

When the rules were changed to create an exclusion of gain for the sale of a principal residence back in 1997, many tax advisors started discouraging their clients from claiming a deduction for a "home office". The reason was it appeared the gain for the part of the home used in a trade or business wouldn't qualify for the exclusion.

Under new regulations issued by the IRS, the gain relating to a home office that is part of the principal residence "dwelling unit" will qualify for the exclusion. (Any depreciation claimed for the home office must still be "recaptured" or reported as income when the residence is sold.) If the business use is of a structure or land that is not part of the "dwelling unit" (such as a separate building), that part will not qualify for the exclusion.

In an example in the regulations, a taxpayer buys a three-story townhouse and converts the basement level, which has a separate entrance, into a separate apartment for rental. Since the basement is converted into a separate "dwelling unit", it doesn't qualify for exclusion of gain if the residence is sold.

Some taxpayers who have been using a separate structure for a home office may decide to convert the structure back to personal use and move the home office back in the "dwelling unit."

The rules for home offices are very complex, so be sure to consult with a tax advisor before changing your home office arrangements. (TD 9030)

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IRS liberalizes IRA rollover rule.

The IRS has issued guidelines for when it will automatically waive the 60-day rule for rollovers from IRAs and qualified plans. The waiver will be granted when the failure to timely complete the rollover is caused by an error of the financial institution. Otherwise, taxpayers must apply for a private letter ruling to get a hardship waiver.

Without the waiver, the distribution from an IRA or qualified retirement plan may be subject to income tax, not qualify for a rollover and may be subject to a 10% penalty for early distribution. (Revenue Procedure 2003-16)

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New regulations issued for redemption of stock relating to a divorce.

The courts have issued conflicting decisions about how or whether a redemption of stock should be taxed relating to a divorce. Under the IRS guidelines, stock that is redeemed and the cash given to a spouse relating to a marital dissolution is treated as first being a non-taxable transfer to the recipient spouse. Then the recipient spouse is treated as redeeming the stock from the corporation, which will usually be treated as a taxable sale of the stock. However, the spouses may make a written agreement that the redemption should be taxed to the other ("nontransferor") spouse.

Tax planning relating to a divorce can be very complex. Be sure to get professional help. (TD 9035)

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Questions and Answers

Question

Is there special consideration of home sales proceeds for a California home which is owned and subsequently sold by out of state residents?

My friends in Nevada are selling their "second home."

Answer

A sale of real estate located in California is subject to California income tax and should be reported on a California income tax return. California gives no "break" for long-term capital gains. They are taxed at the same rate as ordinary income - up to 9.3%! In addition, California has enacted withholding at a rate of 3 1/3% of the sales price for the sale of most real estate that applies to both residents and non-residents.

Question

Can we claim a deduction for the points paid to refinance our home during 2002?

Answer

Points can only be deducted for the purchase of a principal residence. Points for refinancing a loan on a residence must be amortized over the term of the loan. If the loan is later refinanced with a different lender, the unamortized balance of the points for the previous loan can be deducted at that time.

Points that can't be traced to Form 1098 are reported at line 12 on Schedule A.

Question

I made a $2,000 contribution to a Roth account during 2000. The value of the account dropped to $1,000, so I closed the account out during 2002 and used the money for my daughter's education. Can I deduct the loss?

Answer

Assuming this is your only Roth account, yes. The loss is deducted as a miscellaneous itemized deduction on Schedule A, subject to reduction by 2% of adjusted gross income. Since the distribution is a recovery of basis, it is not subject to an early distribution penalty. The distribution must be reported on Form 8606, even though it's not taxable. See IRS Publication 590.

Question

Can I claim a business deduction for interest paid on my auto loan?

Answer

If you aren't using the standard mileage allowance and are claiming the depreciation and expenses for your car, you can claim a deduction for the business use portion of the interest.

Question

I am getting ready to sell a condominium that is my principal residence. I expect to realize about $30,000 of gain on the sale. Do I have to live in the residence for more than two years to qualify for the $250,000 exclusion.

Answer

That is the general rule. The IRS has just issued guideline for exceptions to the rule where you can qualify to use a portion of the exclusion, such as if you have to sell the house because of a health-related issue or because you need to move because of a change of employment. If you don't have any "extenuating circumstances" and want to avoid paying tax on the gain, wait until you meet the two-year residency requirement before selling the residence.

Question

What is the difference between a living trust and a will?

Answer

This is a complex legal question for which you should consult with an attorney. Here are four important considerations. 1) With a will, your property must go through a court-supervised administration called probate. There are published "statutory" fees paid to an attorney and, unless waived, to the executor. Assets in a living trust are not subject to probate, and the fees paid for administering the trust after death are often less than when a probate is required. (Don't kid yourself. It's still expensive!) 2) Since assets administered under a will are subject to probate, they are a matter of public record. Anyone can go to the courthouse and find out about your family's assets. Assets in a trust are not a matter of public record, so your family enjoys privacy in its financial affairs. 3) Property received after going through probate is not subject to contingent liabilities of the decedent. There is a procedure in California (and possibly other states) to give similar benefits to beneficiaries of a trust, but it increases administration costs and prolongs administration. Traditionally, attorneys have preferred to probate the assets of professionals like doctors, lawyers, dentists and accountants for this reason. 4) The income and estate consequences of wills and revocable trusts can be very similar. (But some living trusts, such as an irrevocable life insurance trust, can avoid estate tax.) (A revocable trust means a trust you can change or cancel.)

Estate planning is not a "do it yourself" project. Get thee to an attorney!

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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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Visit our new articles!

• Method Marketing Book Review

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

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P.P.S.

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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.