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Table of Contents

• Happy Holidays!
• Another Gray family milestone.
• Last chance for year-end planning.
• Fourth quarter estimated tax time is coming.
• For seniors over age 70 1/2, have you made your IRA distribution?
• Last chance to extend retirement plan distributions.
• Correction to 2004 standard mileage rate.
• Seminar for professional advisors on December 11.
• IRS releases 2004 inflation adjustments.
• Fire victims get tax relief.
• Military tax relief bill passes.
• Questions and Answers
  • How can I get a business deduction for an SUV?
  • How can I avoid paying taxes when I sell my house?
  • Should we convert our condo to a rental?
  • Do I have to pay taxes on a home entertainment center I won?
  • How do I get a business deduction for an electric vehicle?
• Do you have employee stock options?
• Visit our new articles!
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Happy Holidays!

Another year is coming to a close. We wish you and your dear ones a joyous holiday season.

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Another Gray family milestone.

My son James is graduating from the University of California at Berkeley this month. Each of our three children will be University of California graduates, have contributed to financing their own educations, and are debt-free. Hooray!

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Last chance for year-end planning.

With the holidays, preparing for next year and our other commitments, we will have a tight schedule for December. Be sure to make your year-end planning appointment now!

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Fourth quarter estimated tax time is coming.

If you want to deduct your California estimated tax payment on your federal income tax return for 2003, it should be paid by December 31, 2003. (Watch the alternative minimum tax consequences.) The due date for fourth quarter estimated tax payments for calendar year corporations is December 15. The due date for fourth quarter calendar year individuals is January 15, 2004.

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For seniors over age 70 1/2, have you made your IRA distribution yet?

Once a taxpayer reaches age 70 1/2, minimum distributions must be made from any regular IRA accounts that they own by December 31 each year. There is an exception for the year the taxpayer reaches age 70 1/2. In that case, the initial distribution can be made by April 1 of the next year, and there will be two distributions during the year after reaching age 70 1/2. The penalty for failing to make a minimum distribution is 50% of the minimum distribution that wasn't paid. Don't miss this one. Remember the IRS issued new tables for making these distributions during 2002.

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Last chance for special election to extend retirement plan distributions.

When an employee or IRA owner dies before his or her required beginning date, the account must be distributed under one of two rules. (1) The entire account may be distributed no later than the end of the calendar year that includes the date five years after death. (2) The account may be distributed over the life expectancy of the beneficiary of the account.

If no beneficiary is designated and the plan doesn't otherwise provide for an individual beneficiary by default, the account must be distributed under the five-year rule.

A special election is available for beneficiaries who previously were planning to use the five-year rule but now want to use the life-expectancy method. Such a beneficiary may, if the paln provides, switch to using the life-expectancy method. In order to make the election, any amounts that would have been required to be distributed under the life expectancy method for all distribution calendar years before 2004 must be distributed by the earlier of (1) December 31, 2003 or (2) the end of the calendar year including the day five years after death.

There can be significant tax benefits from making the election. If you think this applies to you, you should consult with a tax advisor immediately, because you may need to make "catch up" distributions by December 31, 2003 and to be sure you do in fact qualify.

(Treasury Regulations § 1.401(a)(9)-1, A-2(b)(2).)

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Correction to 2004 standard mileage rate.

There was a typographical error in the last newsletter. The standard business mileage rate for 2004 will be 37.5¢ per mile, not 36.5¢. Thanks to the readers who wrote to point this out.

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Seminar for professional advisors on December 11.

Michael Gray, CPA and attorney Naomi Comfort will give a two-hour presentation about "Handling retirement accounts after a death" for the Tax Interest Group, Silicon Valley San Jose Chapter, California Society of CPAs. The breakfast presentation will be at Lou's Village, 1465 West San Carlos Ave., San Jose on December 11, 2003. Registration will be at 8:30 a.m. and the program will be from 9 to 11 a.m. Pre-registered fee is $40 for members and $50 for non-members. To register, call Valerie Bishop at 408-983-1122.

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IRS releases 2004 inflation adjustments.

The IRS has released the inflation-adjusted amounts for certain items for 2004.

The standard deduction amounts for 2004 are $9,700 for married filing jointly and surviving spouses; $7,150 for heads of household, and $4,850 for singles and married, filing separately. The additional standard deduction for taxpayers who are at least age 65 or blind is $950 for each. The senior addition is increased to $1,200 if the individual is unmarried and not a surviving spouse. The standard deduction amount for an individual who may be claimed as a dependent by another taxpayer is the greater of $800 or the sum of $250 plus the individual's earned income.

The itemized deductions phaseout will apply when adjusted gross income exceeds $142,700, $71,350 for married, filing separately.

The personal exemption will be $3,100. The exemptions are phased out starting with adjusted gross income of $214,050 for married filing joint and surviving spouses, $178,350 for heads of household, and $142,700 for singles.

The maximum amount a taxpayer can elect to expense for qualifying property is $102,000. This limitation is reduced for each dollar of equipment placed in service during the year over $410,000.

The annual gift tax exclusion remains at $11,000.

There are more items adjusted for inflation, including new tax rate schedules, that are beyond the scope of this article. See Revenue Procedure 2003-85 for more details.

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Fire victims get tax relief.

The IRS has announces that victims of the wildfires in the southern California counties of Los Angeles, San Bernardino, San Diego and Ventura qualify for tax relief as a Presidentially-declared disaster area. In addition, the IRS is giving affected taxpayers until December 29, 2003 to file tax returns or make tax payments that either had an original or extended due date during the "extension period" of October 21, 2003 through December 29, 2003.

The extension does not apply to information returns, or to employment and excise tax deposits. The IRS may abate penalties for those deposits for affected taxpayers as a "reasonable cause" during the federal tax deposit penalty waiver period of October 21, 2003 through November 7, 2003, provided the payment was made by November 7, 2003.

Taxpayers should mark in red at the top of the affected form "CA Wildfires", except on form 5500, where you should check Box D.

Remember taxpayers in a Presidentially declared disaster area have the option of claiming disaster-related casualty losses on their federal income tax return for either the year of the loss or the previous year. If you claim them on the previous year's return, mark the top of the form "CA Wildfires" in red ink to expedite processing.

(IR-2003-126.)

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Military tax relief bill passes.

Congress has passed H.R. 3365, the Military Family Tax Relief Act of 2003. The Act includes an exclusion for $12,000 of death gratuity payments for military deaths occurring after September 10, 2001. Another provision gives some relief from losing tax benefits relating to the sale of a principal residence when the taxpayer is away from home because of active duty military service. Astronauts who die in the line of duty on or after January 1, 2003 would also qualify for military tax relief. There are more tax benefits in this new tax law that are beyond the scope of this newsletter. Military families should consult with a tax advisor or study a copy of the Act.

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Questions and Answers

Question

I have some questions surrounding purchasing an SUV that weighs over 6,000 pounds for my business.

1. Aside from the weight requirement and using it 100% for business, what other restrictions or guidelines are there to qualify for the depreciation?
   
   
2. If I finance the car, can I deduct the interest?
   
   
3. Do I have to finance the car under my business name or can it be financed personally?

Answer

1. The requirement is not 100% use for business, but more than 50% use. If the business use falls below 50% during the first five years of use, the first-year expense amount is subject to recapture. Reductions from higher percentages (example, 80% to 51%, may also be subject to recapture. Be prepared to document the business use of the vehicle. I recommend that you keep a log accounting for your mileage.
   
   
2. Assuming the car is used 100% for business, the interest is deductible as a business expense. If it's not, the business portion is deductible.
   
   
3. You should consult with a tax professional about your form of business. If the business is a proprietorship, you can finance the vehicle in your name. You can also do the same as an agent for a partnership.

There is a good chance this tax benefit for SUVs will be scaled back to $25,000 next year. People are responding to almost an irrational level by buying Sherman Tanks as business vehicles, when it really doesn't make economic sense. It's the old "flushing tax deductible dollars down the toilet" routine.

I predict the IRS will take a very hard look at any taxpayer who is audited and claims an expense deduction for an SUV to assure the vehicle was in fact used for a trade or business.

Question

I own a house in San Diego and am looking to upgrade. I've only lived in the house for one year. I heard if it's less than two years, then you have to pay taxes on the capital gain, but I've also heard that if you buy a more expensive home then you do not have to pay taxes on the gain. My gain would be about $100,000.

Answer

Your friends who are advising you are confused because of recent changes in the tax law. For many years, the tax was postponed for any gain on the sale of a principal residence provided it was replaced with a more expensive residence within a certain period of time after the sale. That law was repealed back in 1997.

Under the present law, there are exclusions available provided you used the home as a principal residence during at least two of the five years before selling it. The exclusions are $250,000 for most individuals and $500,000 for married persons who meet certain requirements, filing a joint return. ($250,000 would cover your gain.)

Unless you are willing to pay the tax for selling your home, I recommend that you sit tight until you have lived in it for at least two years. Then you can sell your present home and upgrade. Remember that you will also increase your property tax base when you buy your new residence.

Question

My husband and I purchased a condo in September. We intend to fix it up over the next year while we live in it, and at the end of 2004 or the beginning of 2005 we were planning to purchase a second property for our principal residence and to rent out the condo that we bought this year.

Do we need to live in the property longer before purchasing an additional home in order to avoid tax on the capital gain? Also, do you have a percentage of what the capital gains tax would be for the above scenario, and does the percentage come off the assessed value of the property if it is not being sold but used as an investment? Finally, are there any other taxes that we need to be made aware of in doing this?

Answer

Rather than get into a long, drawn out answer, here is an observation and a recommendation. Since you are planning on living in the property as you fix it up, I think it's best for you to live in it until you qualify for the exclusion for the sale of a principal residence. That's more than two years. Then you can sell the condo and exclude up to $500,000 of gain. If you convert the property to a rental in a year, you will lose the exclusion.

If you are serious about investing in real estate, find a good tax advisor to work with.

Question

I just won a home entertainment center worth about $10,000. Is this taxable?

Everyone tells me I will have to pay about 30%. Please tell me that isn't right.

Answer

I'm sorry, but prizes and awards are taxable. The rate that applies depends on how much other taxable income you have. Why don't you visit a tax advisor, have a projection done, and ask for suggestions about what you might do before the end of the year to reduce your tax bill?

Question

Can you provide some details about deductions for electric and hybrid vehicles in addition to the $2,000 Clean Fuel Deduction?

Answer

Internal Revenue Code Section 280F(a)(1)(C)(ii) triples the depreciation limitations that generally apply to luxury automobiles for "purpose built passenger vehicles." A purpose built passenger vehicle is defined by § 4001(a)(2)(C)(ii) as a passenger vehicle produced by an original equipment manufacturer and designed so that the vehicle may be propelled primarily by electricity (an electric vehicle).

Here are the first-year depreciation limits for luxury automobiles. The limitation when bonus depreciation is not elected is $3,060. The general limitation when 30% bonus depreciation is elected is $4,600 (§ 168(k)(2)(E)(i)) plus the $3,060 "base amount" = $7,660 and when 50% bonus depreciation is elected is $7,650 plust the $3,060 "base amount" = $10,710 (§ 168(k)(4)(D).) (50% bonus depreciation may be elected for depreciable business property acquired by the taxpayer after May 5, 2003 and before January 1, 2005.)

According to Revenue Procedure 2003-75, the limitations for electric vehicles are $9,080 "base amount", $22,880 when 30% bonus depreciation is elected and $32,030 when 50% bonus depreciation is elected.

The limitations with bonus depreciation for electric vehicles are academic, because no new electric vehicles qualifying for the higher depreciation deductions are currently being sold. General Motors discontinued its EV-1 electric vehicle.

Hybrid vehicles, like the Toyota Prius, do not qualify as electric vehicles. Therefore, the first-year depreciation limits for hybrid vehicles used for a trade or business are the $3,060, $7,660 and $10,710 amounts that apply for luxury automobiles.

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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!

• Are You Changing A Winning Lottery Ticket?
• The Success System That Never Fails 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 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.