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Table of Contents

• Halloween is coming!
• Final due date for individual returns is almost here.
• Camping out in our own home!
• Thinking of buying a California home?
• Will all high-income California taxpayers be subject to AMT?
• How to pay for over-the-counter drugs with pre-tax dollars.
• IRS loses!
• Back pay award for discrimination is taxable income.
• Split-dollar regulations is finalized.
• Fiscal year taxpayers don’t get federal tax break for dividends.
• Questions and Answers
  • Will we be taxed on the sale of our rental home?
  • Does a trust qualify for the 15% federal rate on dividends?
  • How should I report income from the sale of inherited property?
  • Will there be gift taxes if my wife’s brothers give her their share of their parents’ house?
• Do you have employee stock options?
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Halloween is coming!

Boo! The end of the year has sneaked up on you, just like me, right? 2003 is an interesting year. We had a federal "treat" of a dramatic tax cut -- especially for qualifying dividends and long-term capital gains. The Republicans played a "trick" on California Governor Gray Davis that may result in our having a new governor who looks suspiciously like the costumes some children will be wearing on Halloween. Never a dull moment!

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Final due date for individual returns is almost here.

Remember the due date for 2002 individual income tax returns is October 15, 2003. If you haven't given the information to your income tax return preparer yet, DO IT NOW!

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Camping out in our own home!

Janet and I have had the joyful experience of having our home look like a bomb hit it. We have been having our family room and kitchen remodeled. After weeks without a stove or a kitchen sink, things are getting finished and becoming operational. How do you spell "relief"? After this week, our new countertops will be installed and we'll be 95% done. Looking good!

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Thinking of buying a California home? Get a loan pre-approval now.

Getting an approval in place before shopping for your home will help reduce the closing period so you can move in and enjoy your new home sooner.

Please remember we can provide financing for buying a California residence at very competitive interest rates. Because there are higher costs involved in financing a home purchase, there are costs for this type of loan.

The end-of-year doldrums in the stock market is helping mortgage interest rates drop, creating another potential refinancing opportunity.

For details, please call Michael Gray at 408-918-3161. Agent for Wymac Capital, Inc. Michael Gray's California Real Estate Broker License number is 01269331.

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Will all high-income California taxpayers be subject to the alternative minimum tax?

With the recent changes in the tax law, we are finding that more of our clients are paying the federal alternative minimum tax (AMT). The maximum federal income tax rate for 2003 is 35%, not much more than the maximum AMT rate of 28%. Throw in the disallowance of deductions for state income taxes and property taxes when computing the AMT, and you have a recipe assuring more taxpayers are subject to AMT. In this environment, you may not have a tax benefit for some "traditional" year-end tax planning strategies, like paying the California tax before the end of the year. Also, some tax software and some tax advisors don't handle the AMT very well. Be careful out there!

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How to pay for over-the-counter drugs with pre-tax dollars.

The IRS recently ruled that over- the-counter drugs for employees and their families can be paid using employer-provided medical benefit plans, including flexible spending accounts. This is a great employee benefit, because these expenses usually don't qualify for the itemized deduction for medical expenses. With the 7.5% threshold for medical expenses, it's hard to get the deduction, anyway. (Rev. Rul. 2003-102.)

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IRS loses!

Federal Express successfully defended deducting repair expenses for overhauling jet engines in its off-wing maintenance program for its fleet of jet aircraft. The IRS believed the expenses should be capitalized. A U.S. District Court ruled the engines were not functionally independent from the entire aircraft. (FedEx Corp. et. al. v. United States, W.D. Tenn.)

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Back pay award for discrimination is taxable income.

The Tenth Circuit affirmed a district court decision that an award to an employee of compensation under the Americans With Disabilities Act was not for personal injury but for discrimination, and therefore was taxable. (Rodell Johnson v. United States, 10th Cir.)

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Split-dollar regulations finalized.

The IRS has finalized its regulations for split-dollar life insurance. The regulations change the old method of determining compensation from this employee benefit and will probably result in more taxable income for employees covered by a split-dollar life insurance arrangement. The benefit will be determined based on an economic benefit when employer owns the policy or as imputed interest for an employee loan when the employee owns the policy and the employer makes the payments. Family split-dollar arrangements will have gift tax consequences. The final regulations are effective for split-dollar arrangements executed or materially modified after September 17, 2003. (T.D. 9092.)

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Fiscal year taxpayers don't get federal tax break for dividends.

The IRS has issued guidance for fiscal year taxpayers about implementing changes enacted in the Jobs and Growth Tax Relief Reconciliation Act of 2003. The guidance includes a reminder that the 15% maximum tax rate for qualifying dividends is effective for taxable years beginning after December 31, 2002. That means fiscal year taxpayers with years beginning during 2002 and ending during 2003 aren't eligible for the new maximum rate. Long term capital gains for transactions after May 5, 2003 are eligible for the 15% rate, including those taxpayers with fiscal years I just described. (Ann 2003-56, 2003-39 IRB.)

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Questions and Answers

Question

My husband and I have owned a house for 12 years. We lived in the house until five years ago. It has been a rental since then. We are also living in a rental. We would like to sell the Vallejo home and buy a home to live in. Will we be taxed? Is there a way to avoid any tax? We should be able to sell the house for about $200,000 and owe about $90,000 on the mortgage.

Answer

The rental home that you own no longer qualifies as a residence, and so doesn't qualify for the exclusion of gain from the sale of a principal residence. Selling the home would be taxable. In fact, 3% of California tax would be withheld from the sale proceeds.

You could make a tax-deferred exchange to another rental house, and eventually convert the rental house to your residence. Two years might be a reasonable waiting period before the conversion.

If you decide to exchange the property, I highly recommend that you work with a good tax advisor and find a qualified intermediary to handle the exchange, or it could still be taxable.

Question

Does a trust qualify for the 15% federal tax rate for qualified dividends?

Answer

Yes, for taxable years beginning after December 31, 2002.

Question

Can you help me understand what and how I need to report income from the sale of property located in California that was inherited from my my grandmother by myself and four other children in her family?

Answer

I'll give you some information, but you should still consider hiring a tax return preparer to help you. I hope your family has done the right thing and worked with a lawyer to administer your grandmother's estate or trust. I'm assuming the title was in her name or under her trust and the property has been distributed to you after administration.

Each beneficiary's share of the sale proceeds and the tax basis of the property should be reported on his or her federal and California individual income tax returns. (Beneficiaries who are not California residents may have to file non-resident returns -- Form 540NR.) The tax basis of the property is the fair market value of the property as of your grandmother's date of death or the alternate valuation date, reported on your grandmother's federal estate tax return. If no estate tax return was filed, the tax basis is the fair market value as of your grandmother's date of death, which should be determined by an appraisal. The fair market value should be available from the trustee or executor. The acquisition date is your grandmother's date of death. Sales of inherited capital assets automatically qualify as long-term capital gains.

Question

My wife and her four siblings inherited a home together from their mother. The eldest daughter wants to force a sale and my wife's three brothers want to let her use their share of the money to buy the house so it will stay in the family. My wife is worried about having to pay gift taxes. Would their be any gift taxes, and if so, how much?

Answer

I hope your family has consulted an attorney relating to administering your wife's mother's estate or trust. What you have described to me does not sound like a taxable gift. It should be a sale. The sale by the oldest sister to her siblings should result in a minimal gain, if any, because the tax basis of the residence is the fair market value of the residence as of the date of death or the alternate valuation date, if elected on the federal estate tax return.

Personally, I think your wife's family is asking for headaches by keeping the house. Why keep something that will probably result in future family conflicts? Let it go.

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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 www.stockoptionadvisors.com. You can review our last issue at 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 www.stockoptionadvisors.com/seminar.shtml.

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

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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 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.