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Michael Gray, CPA's Tax and Business Insight

December 20, 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!

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Table of Contents

• Happy Holidays!
• Last chance for year-end planning (2nd reminder).
• Michael Gray's speaking schedule.
• "Humbug!" Says IRS.
• Withholding for bonuses, NQO exercises increased.
• More documentation needed when wages are suspended.
• Marketing master offers complimentary ebook.
• Election result - California tax increase.
• California annual LLC fee is based on income from all sources.
• New FUTA deposit rules issued.
• New standard mileage rates released.
• Payments to sign or cancel employment contracts subject to payroll taxes.
• Questions and Answers
  • Should we buy property under a corporation?
  • Can I take money out of my IRA to buy a new home?
  • What happens if I transfer stock to my children?
  • Is the mileage to college for education deductible?
  • What is the best way to market stock for my corporation?
  • Can I claim my car as a business tax deduction?
  • Can I claim my mother as a dependent?
• Do you have employee stock options?
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Happy Holidays!

We wish you a joyous holiday season and hope you get to enjoy some special moments with your family. This is also a traditional time to reassess on how you have progressed on your goals for this year and make new goals for the coming year. We hope many of your wishes have come true!

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Last chance for year-end planning (2nd reminder).

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.

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Michael Gray's speaking schedule.

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 in Monterey, CA and investment to be announced. Registration 8:30 a.m.; presentation 9 a.m. to noon. For details and registration, call Valerie Bishop at 408-983-1122.

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"Humbug!" Says IRS. Holiday gift certificates for employees are taxable.

The IRS cited its own regulations in a technical advice memorandum, ruling that gift certificates for a certain dollar amount, redeemable at supermarkets for food only, should be included in employees' wages. Non-cash contributions for a similar value, such as for a ham or turkey, are not includable. (TAM 200437030.)

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Withholding for bonuses, NQO exercises increased.

One of the tax law changes in the American Jobs Creation Act of 2004 was to increase the federal income tax withholding rate that applies to certain "supplemental wages", such as bonuses and the ordinary income when a non-qualified option is exercised. For 2004, the rate is 25%.

Effective for payments made after December 31, 2004, the rate will be the maximum individual income tax rate of 35% when the total supplemental wage payments to an employee during a calendar year exceed $1 million. In some cases, employees may be better off receiving their bonuses or exercising non-qualified stock options before the end of 2004. See your tax advisor.

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More documentation needed when wages are suspended for small businesses.

Sometimes owners of small corporations suspend or postpone paying their wages, such as when the business is experiencing cash flow difficulties. The tax law changes in the American Jobs Creation Act of 2004 relating to deferred compensation may apply in this situation. The employee is required to identify the year before the wages are earned the amount to be deferred. Also, you can't simply "catch up" the next year, and, starting for calendar year 2005, the amount of deferred compensation must be disclosed on Form W-2 for the taxable year for which the wages were deferred.

Small business owners have rarely had to have this amount of formality for deferred compensation arrangements. If you think this might apply to you, I recommend that you consult with a tax attorney about it.

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Marketing master offers complimentary ebook.

Long time direct marketer Jim Straw says he is offering his masterwork, "The Most Powerful Wealth Building Secret Ever Told!" to our readers at no charge. You don't even have to provide your name or email address. Just download your FREE copy at http://www.businesslyceum.com/PowerfulSecret.pdf and enjoy it in good wealth!

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Election result - California tax increase.

Effective for taxable years beginning on or after January 1, 2005, individuals will be subject to a tax surcharge at the rate of 1% on taxable income exceeding $1 million. The tax surcharge may not be reduced by any tax credits. The surcharge must be included in 2005 estimated tax computations to avoid penalties for underpayment of estimated tax. The surcharge applies regardless of filing status, so it represents a marriage penalty tax.

The money collected from the surcharge will be used to expand mental health programs for children and adults. (Prop. 63, "Mental Health Services Act".)

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California annual LLC fee is based on income from all sources.

The California State Board of Equalization has ruled that the LLC annual fee is based on total income from all sources "reportable" to California, not total income "taxable" by California. LLCs registered to do business in California must pay the fee based on income from all states, not just California-source income. (Appeal of Northwest Energetic Services LLC (2004) Cal. St. Bd. Of Equal. Case No. 236696.)

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New FUTA deposit rules issued.

The IRS has issued new regulations that will enable many small businesses to reduce the frequency of FUTA deposits. Under the new regulations, which are effective for periods after December 31, 2004, employers won't be required to make a FUTA deposit until the accumulated undeposited liability exceeds $500. Previously a deposit was required when the accumulated undeposited liability exceeded $100. (T.D. 9162.)

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New standard mileage rates released.

The 2005 standard mileage rate for business use of a vehicle will be increased to 40.5¢ per mile from 37.5¢ per mile for 2004. The rate for moving expenses will be 15¢ for 2005, up from 14¢ for 2004. The rate for charitable vehicle use will remain at 14¢ for 2004. (Rev. Proc. 2004-64.)

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Payments to sign or cancel employment contracts are subject to payroll taxes.

The IRS has issued two revenue rulings that reverse a previous position that payments to employees in connection with employment contracts were not subject to payroll taxes. Because the ruling represents a change in position, they wont be effective for payments made before January 12, 2005. (Rev. Rul. 2004-109, Rev. Rul. 2004-110.)

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Questions and Answers

Question

My father and I are thinking of buying a property that is built on two parcels. We are thinking of splitting the two parcels, and building houses on two of them and selling them individually. This would be our first time attempting something like this, and we would like to know if we can avoid paying capital gains taxes by buying the properties under his corporation.

We plan on being finished with the improvements in 3 or 4 months, and would not be able to buy and sell them as individuals without staying in them for more than two years, each.

Answer

Corporations don't enjoy a lower federal income tax rate (15%) on long-term capital gains as most individuals do. Unless the corporation is an S corporation that passes through its income to its shareholders, a double tax can apply, at the corporate level when the sale is made and at the individual level when the corporation pays dividends or is liquidated. That's the reason most tax advisors don't like their clients holding real estate in corporations.

If you want to entirely avoid income tax on up to $250,000 of gain each, your best bet is to use the homes as your principal residences for more than two years.

If you simply buy the properties for development and resell them when the houses are done, the income is probably ordinary income, and you won't even be eligible for a tax-deferred exchange.

Since you are getting involved in an area you aren't familiar with, I highly recommend that you work with advisors to help you avoid making costly tax and legal errors.

Question

I will be getting married in 2005 and my fiancée and I would like to purchase a home. We are using all of our savings to pay for our wedding. I have about $32,000 in a SEP-IRA account and was considering withdrawing $10,000 for a down payment and my fiancée was thinking of doing the same. Will there be any penalties for doing this? My fiancée sold his previous residence more than two years ago.

Answer

There is an exception to the 10% penalty for early withdrawals from IRAs that specifically applies to the situation you have described. The penalty won't apply, but the distributions will be subject to income taxes. The proceeds must all be applied to the purchase of the house, so you might have a hardship coming with the money to pay your income taxes.

When your finances are as tight as they are, it seems to me you might be better off waiting until things improve.

Question

If I want to transfer stock that I own to my children, what must I do and is there a cost?

Answer

If the stock is in a brokerage account, see your broker about how to make the transfer. If the stock is not publicly traded, you should consult with an attorney. You may transfer up to $11,000 in value to each of your children without being required to report the transfer on gift tax Form 709. If your transfer exceeds that amount, consult with a tax return preparer for help with the form.

Question

Is the mileage to college for education deductible?

Answer

In some circumstances it can be (for continuing education relating to a business or profession), but generally it's not.

Question

I have an incorporated business. I'm trying to sell stock of my company. What is the best way for me to market the stock? I have recently purchased 80 acres and am trying to develop the property. I'm looking for investors.

Answer

You should consult with a securities lawyer. This may be a much more expensive undertaking than you think.

Question

I just started working after graduating from college. I'm thinking of getting a new car. Can I claim tax deductions for the car if I use it 100% for business?

Answer

Very few individuals who are employees qualify as using their cars 100% for business. Commuting to and from work is not business use. Most people use their cars to buy groceries, go for weekend (or evening) activities and for vacations. You must have documentation supporting a deduction for business use of the car.

In addition, employee business expenses are itemized deductions, and are reduced, together with other "miscellaneous itemized deductions" by 2% of adjusted gross income. Most people just starting a job after graduation don't qualify to itemize their deductions.

Question

We recently moved in with my mother after my dad passed. His pension stopped when he died so we moved in and are paying the mortgage and utility bills for my mother. Is it possible to deduct her as our dependent, since we are paying almost all of her bills?

Answer

Possibly. In order to claim a dependency deduction, five tests must be met. (1) The dependent must have less than $3,100 of gross income for the taxable year (excludes tax exempt amounts like the exempt part of social security); (2) the taxpayer who is claiming the exemption deduction must have provided more than half of the support for the dependent for the taxable year; (3) the dependent must have a qualifying relationship (parent qualifies); (4) the dependent must not have filed a joint return with his or her spouse; and (5) the dependent must be a citizen, national or resident of the United States, a resident of Canada or Mexico at some time during the calendar year in which the tax year of the taxpayer begins, or an alien child adopted by and living with a U.S. citizen or national as a member of his household for the entire year.

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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 Michael Gray, CPA's Option Alert?

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

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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.

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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.