Home
Newsletter Archive
Introducing Our Firm
Our Services
Tax Articles
Tax Organizers
Tax FAQ
Need Help?
Other Websites
Site Map

Recommend Our Site to Your Friends! Print This Page

Michael Gray, CPA's Tax and Business Insight

November 22, 2004

© 2004 by Michael C. Gray

ISSN 1539-395X

A monthly report to help you prepare for your financial future, keep more of what you earn by minimizing your taxes, and build an extraordinary business!

Route to _______   _______   _______   _______   _______

(If you find this information valuable, please pass it on to a friend!)

Table of Contents

Happy Thanksgiving!

This is a time of year for reflection and remembering the blessings in our lives. I hope you have a wonderful Thanksgiving celebration with your family. We had a "preview" celebration the Saturday before last at my sister's home in Folsom. Thanks to you, my clients, readers and friends for your financial and emotional support of our CPA firm.

Return to Table of Contents

About our Washington, D.C. trip...

Janet and I had a great vacation in Washington, D.C. We spent over two weeks. I highly recommend that all Americans visit Washington D.C. and the surrounding area to gain more appreciation for our heritage.

Here are just a few travel tips that we learned. When you arrive at the airports, you can expect some pretty hefty cab fares to go into Washington, D.C. If you arrive at the Reagan airport, you can take the Metro (subway train) to the city for a small fare. If you go to the Baltimore or Dulles airports, you can take the Metrobus for a reduced fare ($3 express fare from Dulles, information telephone 202-637-7000). If you have a lot of luggage or no patience for intermediate stops, pay the cab or limousine fare.

The Metro transportation system is excellent. We didn't rent a car for our trip and saw the sights we wanted to. (But we did walk a lot.) You can even use credit cards to pay for your Metro tickets! Discounted daily and weekly passes are available, but additional charges can apply during commute hours. (See http://www.MetroOpensDoors.com.) We took a cab to Mount Vernon, a shuttle bus to the Air and Space Museum extension by Dulles Airport and took a bus tour to Williamsburg, Virginia. Otherwise, we walked and used the Metro.

If we go again, we'll stay in Alexandria, Virginia. There is a Metro station on King Street that is very convenient for transportation to Washington, D.C. and a lovely new Hampton Inn and other hotels close to the station. It was easier to find nice places to eat in Alexandria, which is a charming, historical town in its own right. George Washington had a townhouse in Alexandria and had a family pew at Christ Church. (You'll want to visit these landmarks.)

There is no admission charge for any of the Smithsonian museums, the National Museum of Art, or federal points of interest like the Archives and Printing Department. The hours are 10 a.m. to 5:30 p.m. Washington, D.C. seems to close down at 5:30 p.m., but there are plays and concerts to be found. Our hotel put out a daily list of activities, which was worthwhile to consult. That's how we learned when we could sit in the audience for oral arguments at the Supreme Court.

You can arrange for Congressional Tours of many sites by calling your local Congressperson or Senator. (Janet laid a wreath at George Washington's grave on our Congressional tour of Mount Vernon.) You need to request tickets for tours of the White House and the Pentagon more than a month in advance. Since they have minimum parties for White House tours of 10 or more, they said it's easier to get them through one of the U.S. Senators from your state.

Be prepared for security checks, similar to those at an airport, for all federal buildings. Try to avoid wearing shoes with metal in them.

Return to Table of Contents

Last chance for year-end planning.

The year is rapidly coming to a close and, with the holidays, I'm not going to be very available. Call 408-918-3161 to reserve your year-end planning appointment.

The final individual estimated tax payments are due on January 15, but state income taxes have to be paid by December 31 in order to deduct them on your 2004 federal income tax return. Instead of deducting state income taxes, there is an alternative deduction for state sales taxes this year. This may be a good time to buy a car so that you can deduct the sales tax. Remember, neither of these taxes are deductible for the alternative minimum tax, so the tax consequences need to be figured in detail.

People who exercised incentive stock options where the stock has declined in value need to determine whether they should sell the stock before the end of the year.

Unless Congress takes action later, 50% bonus depreciation will expire after December 31, 2004. It may be to your tax benefit to buy business equipment before the end of the year.

Return to Table of Contents

Michael Gray's speaking schedule.

December 2. Panelist for presentation on Smaller Practitioners Originating Residential Mortgages. Personal Financial Planning luncheon, Peninsula Chapter, California Society of CPAs. Hobee's Restaurant, 1111 Shoreway Road, Belmont, CA. 12 noon - 1:30 p.m. Pre-registered investment is $25 for CalCPA members and $35 for non-members. For reservations, call Jane Dunbar at 650-802-2466.

December 14. Panelist for explanation of the new federal tax laws for Silicon Valley-San Jose chapter, California Society of CPAs. Lou's Village on San Carlos Street in San Jose, CA. Registration 8:30 a.m., presentation 9 a.m. to noon. Pre-registered investment is $66 for CalCPA members and Silicon Valley Bar Association members and $76 for non-members. For reservations, call Valerie Bishop at 408-983-1122.

January 28. Presentation on tax developments for estates and trusts. Professional Fiduciaries Association of California. In San Jose area. 7:30 to 9 a.m. For details, call Mike Dragomir at 408-978-8101.

February 28. "Handling Retirement Accounts After A Death" with Naomi Comfort, Esq. Santa Clara County Estate Planning Council. Lou's Village on San Carlos Street in San Jose, CA. No-host cocktails 5:30 p.m., Dinner 6:00 p.m., presentation 7 - 8 p.m. Pre-registered investment is $30 for members, $35 for non-members. For reservations, call Wordgraphics at 408-356-1560.

April 23. "Handling Retirement Accounts After A Death" with Naomi Comfort, Esq. Bay Area Regional Education for the California Society of CPAs. Location and investment to be announced in Monterey, CA. Registration 8:30 a.m.; presentation 9 a.m. to noon. For details and registration, call Valerie Bishop at 408-983-1122.

Return to Table of Contents

SUV deduction limit.

President Bush signed the American Jobs Creation Act of 2004 on October 22, 2004 -- earlier than we expected. The maximum first year expense deduction for SUVs with a gross vehicle weight (GVWR) over 6,000 pounds was reduced from $100,000 to $25,000 on that date.

Return to Table of Contents

2004 car donations better than 2005?

Under the new tax laws, the documentation requirements are being tightened up for donations of vehicles. Effective in 2005, when the charity sells the car shortly after the gift, the charity must report the amount to the donor. The donor's deduction will be limited to the sales price for the charity. The new documentation requirement doesn't apply for 2004. However, the taxpayer is required to get an appraisal for non-cash contributions with a value of more than $5,000.

Return to Table of Contents

California tax amnesty program.

To get more dollars into the treasury and reduce the budget shortfall, California has enacted a tax amnesty program. The amnesty period covers years beginning before January 1, 2003. The amnesty period is February 1, 2005 through March 31, 2005. The actual tax returns or amended tax returns must be filed by May 31, 2005 to qualify. Penalties and fees will be waived, but the taxes and interest won't. If you miss the amnesty period, your penalties may double. If you have late income tax returns or issues for back year returns that could result in penalties, consult with a tax advisor right away. Remember, the amnesty does not apply for federal income tax returns! (S.B. 1100)

Return to Table of Contents

California takes punitive damages.

As another "remedy" to the state budget deficit, California has enacted laws to "split" certain punitive damage awards that are awarded by juries on or after August 14, 2004, expiring June 30, 2006. 75% of the award will be "allocated" to the state treasury. Once a judgment debtor gives 75% of the proceeds to the state, the plaintiff's attorney is entitled to 25% of those proceeds. This is in addition to any contingency fee arrangement with the plaintiff.

The law provides that the jury is not to be informed that most of the punitive damage award will go to the state when deliberating the penalty.

The key to avoid this state theft is to settle the case out of court. I think it's likely that a victim of this statute will challenge it as an unconstitutional tax under Proposition 13. (S.B. 1102)

Return to Table of Contents

California real estate withholding rules change.

Some California taxpayers will have some relief thanks to changes in the California real estate withholding rules, effective January 1, 2005. Remember the withholding amount is 3 1/3% when the sales price for a real estate transaction exceeds $100,000, with certain exceptions. The most notable change is withholding will not be required when the last use of the real estate was the principal residence of the seller, even when the gain is taxable. The exemptions from withholding for irrevocable trusts with California trustees and estates for California resident decedents have been eliminated. Other non-individual sellers (partnerships, corporations and LLCs) will no longer be exempt from withholding, but will have a self-certification process to avoid or reduce withholding when selling the property at a loss or when the gain is avoided because of a tax-free exchange.

For a table comparing the withholding requirements for 2004 with the new ones for 2005, see this web page on the Franchise Tax Board's web site - http://www.ftb.ca.gov/individuals/wsc/comp_chart.pdf. (A.B. 1338)

Return to Table of Contents

New storage and signature requirements for Form I-9.

Congress has passed legislation permitting electronic signatures and storage of electronic copies of Form I-9, which is used to verify an employee's eligibility to work in the United States. The law will become effective when the Department of Homeland Security issues implementing regulations or 180 days after enactment, whichever is earlier. (H.R. 4306)

Return to Table of Contents

Goodbye to Jerry Kasner.

Former Santa Clara University Professor, CPA and attorney Jerry Kasner passed away on October 21. Jerry was a teacher, mentor and role model to the estate planning community throughout the United States. He was a frequent lecturer at Tax Institutes and the author of books and publications viewed as vital references by tax advisors. He had the ability to give lectures on tax issues that were fun to listen to. Jerry will be sorely missed.

Return to Table of Contents

Retirement plan contribution limitations announced.

The cost of living limits for 2005 are as follows:

  1. Annual benefit under a defined benefit plan increased from $165,000 to $170,000;
  2. Limitation for defined contribution plans (profit sharing, ESOP, money purchase pension, SEP) increased from $41,000 to $42,000;
  3. Annual compensation limits for qualified plans increased from $205,000 to $210,000;
  4. Dollar limitation for definition of a key employee in a top-heavy plan increased from $130,000 to $135,000;
  5. Dollar amount to determine maximum account balance in an ESOP subject to a five-year distribution period increased from $830,000 to $850,000 and dollar amount to determine the lengthening of the five-year distribution period increased from $165,000 to $170,000;
  6. Limitation for definition of highly-compensated employee increased from $90,000 to $95,000;
  7. Annual compensation limits for eligible participants in certain governmental plans that were effective on July 1, 1993 and allowed COLAs for the compensation limit increased from $305,000 to $315,000;
  8. Limit for elective deferral (401(k)) increased from $13,000 to $14,000;
  9. Limit for SIMPLE retirement accounts increased from $9,000 to $10,000;
  10. Limit for deferrals for deferred compensation plans of state and local governments and tax-exempt organizations increased from $13,000 to $14,000;
  11. Limit for catch-up contributions to employer plans other than a SIMPLE for individuals age 50 or over increased from $3,000 to $4,000;
  12. Limit for catch-up contributions to a SIMPLE plan for individuals age 50 or over increased from $1,500 to $2,000. (IR-2004-127)

Return to Table of Contents

Social security wage limits announced.

The wage base for the social security portion of employment tax withholding will be increased to $90,000 for 2005 from $87,000 for 2004. The rate for the employee and employer shares will remain at 6.2% each. There is no limit for the Medicare portion of employment tax withholding, for which the rate is 1.45% each. (Self-employed persons pay the employee and employer shares for their self-employment income.)

Return to Table of Contents

Standard mileage rates for 2005 announced.

The standard mileage rate for business mileage will increase to 40.5¢ per mile for 2005 from 37.5¢ for 2004. The standard mileage rate for medical or moving expenses will increase to 15¢ per mile for 2005 from 14¢ for 2004. The standard mileage rate for charitable vehicle use for 2005 will remain at 14¢ per mile. (Rev. Proc. 2004-64.)

Return to Table of Contents

MBA education expenses non-deductible.

The Tax Court recently ruled that education expenses to earn an MBA degree were not deductible because the degree qualified the taxpayer to perform significantly different tasks and activities than she performed before she received the education. The taxpayer was formerly a financial analyst. Her undergraduate degree was in mathematics and economics. After she received her MBA degree, she started working for a manufacturer of home furnishings in the company's "general management program." Tax commenters are saying cases like this one indicate that MBA education expenses are probably non-deductible personal expenses. My personal belief is MBA programs for people with business degrees and backgrounds are just continuing education, but the judges aren't agreeing with me. (McEuen v. Commissioner, T.C. Summary 2004-107)

Return to Table of Contents

Internet tax moratorium extended.

On November 19, Congress passed an extension of the moratorium prohibiting state and local taxes for internet access and multiple or discriminatory state and local taxes on electronic commerce. The previous moratorium expired on November 1, 2003. The moratorium is generally extended until November 1, 2007. There are grandfather clauses permitting taxes for internet access charges that were generally imposed and actually enforced as of November 1, 2003 and for Texas municipal access line fees. (S. 150 and S. Con. Res. 146)

Return to Table of Contents

Questions and Answers

Question

My client bought a business in 1994, which included about $400,000 of goodwill. I did not amortize the goodwill for 1994 - 1996 and did amortize the goodwill for the years after that until he abandoned the business in 2002. In 2002, I took the abandonment loss as $400,000 less the actual accumulated amortization. He is under audit for 2002 and the tax auditor is reducing his basis by the amortization allowable.

I think the catch-up depreciation rules apply, but under what revenue procedure? Do I file a Form 3115 for 2002? Is that the year of change?

Answer

I think your situation happened a year too early to remedy. Revenue Procedure 2004-11 allows a "catch up" election for unclaimed depreciation and amortization in the year of sale effective for years ending on or after December 30, 2003. The previous applicable Revenue Procedure was 2002-9. Under Revenue Procedure 2002-9, a change won't be allowed when the item has been raised as an issue in a tax audit. Your professional liability carrier may have some input to help you. Give them a call.

Question

I have a home in Hayward, which I lived in for about a year. I lost my job in 2002. Since then, I moved to a less expensive home in Stockton, CA and have been living on savings while renting out the home in Hayward. I can't hold onto the Hayward home anymore and have to sell it. How much tax will I have to pay on the gain? Does an exclusion apply in this situation?

Answer

You may be eligible for a partial exclusion of gain because you are selling the home relating to the unforeseen circumstance of losing your job. (Reg. § 1.121-3(3)(2)(iii)(B).) If you lived in the home for 12 months and you are a single person, you would be able to exclude $125,000 of gain from the sale of the residence. (12/24 X $250,000)

The accumulated depreciation during the rental period isn't eligible for exclusion and will be subject to a maximum federal tax rate of 25%. The maximum California tax rate is 9.3%. You should meet with a tax advisor to determine the actual rates that apply for your situation.

Question

I paid my local property taxes on my principal residence for 2003 in January of 2004 and will pay my property taxes for 2004 in December, 2004. Are both of these payments deductible on my 2004 income tax returns, since that's when they were paid?

Answer

Yes. Remember that property taxes aren't deductible for the alternative minimum tax, so be sure you aren't subject to AMT when you prepay the April, 2005 installment.

Question

I have two residences. What amount of time must I live in a residence per year to declare it as my primary residence? Can I write off the interest of both homes?

Answer

The principal residence is determined based on the facts and circumstances in each case. Usually, the home in which you live for the most days during the year is the principal residence. Other things considered include 1) the taxpayer's place of employment; 2) where the taxpayer's family members live; 3) the address used on the taxpayer's income tax returns, driver's license, auto registration and where the taxpayer is registered to vote; 4) the address the taxpayer's bills are mailed to; 5) where the taxpayer's bank accounts are located; and 6) where the taxpayer attends church and the location of recreational clubs with which the taxpayer is affiliated. (Regulations § 1.121-1(b)(2))

A taxpayer may deduct interest for acquisition indebtedness (up to $1 million) and home equity indebtedness (up to $100,000) for the principal residence and a second residence. (IRC § 163(h)(3))

Question

I have a four-bedroom home that I bought in 1997 in Las Vegas, Nevada. It was a rental property from the time of purchase until September, 2003. Since then it has been a vacation home for my personal use.

I have been thinking about selling the property and buying a smaller home/condo and taking the excess equity from there and remodeling my home here in California.

What are my tax liabilities on this type of transaction? If you have any suggestions, let me know. (I am a California resident.)

Answer

You haven't provided enough information for me to give you a detailed answer. If you sell the home outright, the gain will be subject to California tax at rates up to 9.3% and federal tax at a 25% maximum rate on gain up to the amount of accumulated depreciation plus 15% for any additional gain. As an alternative, consider exchanging the property. You can limit your gain to the cash that you receive plus any reduction in your debt.

Question

We did a 1031 exchange in 2000 and rented out our new property at first. The rental did not perform as expected and put us in debt. We decided to sell our home and move into our rental.

In October of 2005, my husband's plant is closing its doors and he will be laid off. We are planning on selling this townhome in the spring of 2005 and relocating. This townhome has been our primary residence for 3 1/2 years, thus far.

Today I heard the IRS changed the law on these trades. Previously we only had to live in our rental for two years as our primary residence and supposedly on 10/22/04 this law changed to having to live in it for 5 years as a primary residence?

Is this information correct? Can the government go back on people like this and change the rules mid-stream? We've purchased land to build a home in a less expensive area where my husband is planning to get another job.

If you know of this new law, could you please direct me to the exact document issued by the federal government?

Answer

This new rule was adopted as part of the American Jobs Creation Act of 2004 (H.R. 4520.) The section number of the Act is 501(b), adding Internal Revenue Code § 164(b)(5).

Let me clarify the change and I hope you will feel better. You are not required to use the home as a principal residence for five years to qualify for the exclusion. The rules that you have to have used the home as your principal residence for two of the last five years and that you haven't claimed the exclusion for a previous sale during the last two years continue to apply. However, you have to have held the home more than five years after the acquisition date.

Since you acquired the home during 2000 and will sell it during 2005, you should be able to plan to have held the home for more than five years when it is sold and qualify for the exclusion. Alternatively, the IRS should be issuing guidance allowing a part of the exclusion when you sell the home due to unforeseen circumstances, such as a loss or change of employment.

The tax laws change often, and sometime people are hurt. For example, back in 1986 the passive activity loss rules were enacted to limit deductions from tax shelters. Shortly after this change was enacted, the Savings and Loan industry collapsed, and the FSLIC was tapped out, resulting in a huge federal bailout of the industry.

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 Michael Gray, CPA's Option Alert?

To subscribe or review past issues, go to http://www.stockoptionadvisors.com/optionalert/.

Return to Table of Contents

Visit our new articles!

Return to Table of Contents

P.S.

My daughter and her husband, Holly and Dan Baker, have 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 and their website address is http://marcheauxfleursrestaurant.com. For the best meal of your life, call 415-925-9200 for a reservation and give them a try! 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.
The November 2004 issue of Michael Gray, CPA's Tax and Business Insight.

Home | Newsletter Archive | Introducing Michael Gray, CPA | Articles | Tax FAQ | Need Help? | Other Links

Michael Gray, CPA
2190 Stokes St., Suite 102
San Jose, California 95128-4512
(408) 918-3162
Fax (408) 998-2766
email: mgray@taxtrimmers.com
Sign up for our free monthly newsletter,
Tax & Business Insight,
for the latest tax news!
subscribe html
unsubscribe text only

We respect your email privacy!