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Michael Gray, CPA's Tax and Business Insight
January 31, 2005
© 2005 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 anniversary, Mom and Dad!
- Have you received your organizer or tax notebook instruction letter?
- Do you need an appointment for a tax return preparation interview?
- 2004 Tax Act includes big 2005 tax hike for single parents with adult children living at home.
- IRS issues guidance for non-qualified deferred compensation plans.
- Ford Escape qualified for tax break.
- IRS releases optional sales tax tables.
- Final regulations issued for 401(k) plans.
- Foreign tax restrictions eliminated for Iraq and Libya.
- Business owner postpones retirement plan distributions with rollover.
- January 2005 Tsunami relief donations may be deducted on 2004 returns.
- Supreme court says contingent legal fees must be itemized.
- Electronic filing becomes mandatory for large corporations and large tax-exempt entities.
- Presidential panel on tax reform created.
- Estate allowed deduction for interest on $38 million loan.
- Guidance issued on new Domestic Production Activities Deduction.
- Guidance issued on repatriation of foreign earnings.
- IRS explains how to apply tax-deferred exchange rules to some principal residence sales.
- Questions and Answers
- What is the limit for capital losses?
- Why aren't retirement checks tax free?
- Can I claim deductions for gas mileage and books?
- Can I deduct mileage for a temporary job commute?
- How do I reduce my paycheck withholding?
- What are the capital gains exemptions for house sales?
- Do I have to pay income taxes on my personal injury settlement?
- Can I deduct expenses for my daughter living in Russia?
- 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 anniversary, Mom and Dad!
Today, my parents, Aubrey and Eleanor Gray are celebrating their 64th anniversary. I feel extremely blessed to have both of my parents still living, mentally clear and in reasonably good health. Congratulations, Mom and Dad, for you example of lifelong devotion to each other and your family. We are very proud of you.
Have you received your organizer or tax notebook instruction letter?
We mailed organizers and tax notebook instruction letters early in January. If you haven't received yours or it was misplaced, please call Dawn at 408-918-3162.
Do you need an appointment for a tax return preparation interview?
We schedule most our tax return preparation interviews during February, and expect to file extensions for clients who submit their information after March 1. Many clients simply mail us their tax information, but some prefer a personal interview. If you want to schedule an interview appointment, please call Dawn at 408-918-3162. Appointment time openings are limited, so make your appointment today.
2004 Tax Act includes big 2005 tax hike for single parents with adult children living at home.
While no one was looking, Congress enacted a major tax increase for single parents with adult children. Effective for 2005, most single parents with adult children living at home will no longer qualify for "head of household" filing status.
Congress was 'sold' this change as tax simplification. The objective was to enact a uniform definition of a child for many different rules, such as head of household status, the dependency exemption and the child credit. In the past, a single parent who paid more than one-half the cost of maintaining a residence shared with an adult child would have qualified for head of household filing status even if the child didn't qualify for a dependency exemption. Under the Working Families Tax Relief Act of 2004, a child or other dependent must qualify for the dependency exemption deduction to qualify.
This is not a 'fat cat' tax benefit. Many of these people are struggling to get by. The tax for a single person with taxable income of $50,000 would be about $9,165, compared to $7,998 for a head of household, or about a 15% increase.
Since this was probably an accidental change, taxpayers should contact their representatives in Congress and ask them to make a technical correction to fix it.
IRS issues guidance for non-qualified deferred compensation plans.
A very significant area of change in the new 2004 tax laws related to non-qualified deferred compensation plans. The scope of the law is very broad. For example, a shareholder employee to whom a small business is unable to pay a salary because of financial distress could be required to report income that isn't received. A non-qualified stock option for which the option price is less than the fair market value on the grant date is also considered a non-qualified deferred compensation plan under these rules.
The IRS has issued urgently needed guidance on these rules in Notice 2005-1. Tax advisors will want to study this guidance, and business owners should consult with their advisors about these deferred compensation rules.
The Notice makes it clear that payments paid after the year-end under a customary payment timing arrangement or paid within 2 1/2 months after the company's year-end aren't covered by the new rules. Neither are payments to independent contractors who are actively engaged in a trade or business of providing substantial services to two or more service recipients to which they aren't related.
Ford Escape qualified for tax break.
The IRS has certified the 2005 Ford Escape sport utility vehicle as a hybrid gas-electric automobile eligible for the clean-burning fuel deduction. (IR 2004-147.) The deduction is up to $2,000 for tax years 2004 and 2005. This is the first SUV model and the first vehicle manufactured by a U.S. company to qualify for the deduction.
IRS releases optional sales tax tables.
One of the provisions of the American Jobs Creation Act of 2004 was to give taxpayers who itemize deductions the choice of deducting state income taxes or state sales taxes. The election is currently only available for 2004 and 2005. Taxpayers who elect to deduct sales taxes may either document their taxes using actual receipts or use an optional sales tax table issued by the IRS, and add additional amounts paid to purchase large items like a car or a boat. The IRS issued the optional sales tax tables to be used for preparing 2004 individual income tax returns, and later issued revised tables to reflect state law changes. Note the table amount only includes the state sales tax amount, which can be adjusted to include local sales taxes. (IR 2005-2.)
Final regulations issued for 401(k) plans.
The IRS has issued final regulations on the requirements, including nondiscrimination requirements, for cash or deferred arrangements under Section 401(k) and matching contributions and employee contributions under Section 401(m). The regulations will be fully effective for plan years that begin on or after January 1, 2006, but employers may use the new regulations for any plan year that ends after December 28, 2004. (TD 9169.)
Foreign tax restrictions eliminated for Iraq and Libya.
Iraq and Libya have been removed from the list of countries for which special tax limitations, including restrictions on the foreign tax credit, apply. (Rev. Rul. 2005-3.)
Business owner postpones retirement plan distributions with rollover.
A taxpayer who was employed by one corporation in which he was a 5% owner and another in which he was not was able to avoid having to make required minimum distributions from the retirement plan of the 5%-owned company by rolling over his account assets to the plan of the other company. Employees who are participants in a retirement plan of a company for which they do not own at least 5% of the company's stock may postpone mandatory retirement distributions after age 70 1/2 if they continue to work. (Letter Ruling 200453015.)
Tsunami relief donations during January, 2005 may be deducted on 2004 returns.
President Bush has signed H.R. 241 (Public Law 109-01), which allows taxpayers to claim charitable contribution deductions on their 2004 individual income tax returns for cash donations made for Tsunami relief during January, 2005. Note this law does not automatically apply in all states, notably in California. In California, taxpayers will claim these donations on their 2004 federal income tax returns and their 2005 California income tax returns, which will probably result in many erroneous California income tax returns being filed.
Supreme court says contingent legal fees must be itemized.
Contingent legal fees have been creating a hardship for many taxpayers. The Supreme Court held in favor of the IRS in reviewing Commissioner v. Banks and Commissioner v. Banaitis. As a result, taxpayers who receive taxable judgments net of contingent legal fees must report the entire award as income and deduct the legal fees as a miscellaneous itemized deduction. Since the miscellaneous itemized deduction for legal fees is disallowed when computing the alternative minimum tax, the deduction is effectively disallowed.
Congress has provided some relief from this ruling in the American Jobs Creation Act of 2004. Effective for fees and costs paid after October 22, 2004 with regard to any judgment or settlement after that date, individual taxpayers may deduct attorney's fees and court costs from gross income when they are in connection with (1) unlawful discrimination; (2) claims against the federal government under subchapter III of chapter 37 of Title 31 United States Code (civil rights suits); or (3) a private cause of action under the Medicare Secondary Payer statute.
Taxpayers who receive taxable judgments need further relief. Perhaps the tax laws could be changed to allow the deduction for legal fees and costs for taxable judgments for the alternative minimum tax.
Remember the states, notably California, don't automatically conform to federal legislation. California hasn't adopted the new "above the line" rules.
Also, California has adopted new legislation effectively expropriating many punitive damages. See the November 22, 2004 issue of this newsletter.
Electronic filing becomes mandatory for large corporations and large tax-exempt entities.
The IRS has issued temporary and proposed regulations that will make it mandatory for corporations with $50 million or more in total assets to efile Forms 1120 and 1120S, and tax-exempt entities with $100 million or more in total assets to efile Form 990, effective for tax year 2005 returns.
Effective for tax year 2006 returns, efiling will be mandatory for corporations with $10 million or more in assets and all private foundations and charitable trusts, regardless of size. (IR 2005-8, TD 9175.)
Certain exceptions are listed for situations where the tax returns don't have to be efiled, including the initial income tax return for an entity.
Presidential panel on tax reform created.
President Bush has formed a bipartisan panel to study federal tax laws and make recommendations for changes. This may be a significant opportunity to submit recommendations for tax simplification and fairness.
Estate allowed deduction for interest on $38 million loan.
A decedent's estate was allowed an estate tax deduction as an administrative expense for interest and closing costs for a $38 million loan. The loan was needed to provide liquidity to pay specific bequests, estate taxes and administration costs. (Gilman v. Commr., T.C. Memo 2004-281 (12/28/2004).)
Guidance issued on new Domestic Production Activities Deduction.
An important provision of the American Jobs Creation Act of 2004 is a tax deduction for domestic production activities after 2004. The IRS has issued guidance on how this tax deduction will work. (Notice 2005-14.)
Guidance issued on repatriation of foreign earnings.
The reason for the American Jobs Creation Act of 2004 being created was the elimination of U.S. tax subsidies found to be in violation of foreign trade treaties, which resulted in penalties being assessed against U.S. companies. With the repeal of the subsidies, provisions were enacted to enable U.S. companies to bring the cash back to the U.S. for foreign activities on a tax-advantaged basis. The intention of Congress was to encourage these companies to invest the foreign earnings at home and create more jobs in the United States.
The IRS has issued guidance about how these repatriation rules will work. (Notice 2005-10.)
IRS explains how to apply tax-deferred exchange rules to some principal residence sales.
Generally sales of personal assets, including a principal residence, don't qualify for tax-deferred exchanges. However, a residence can qualify for the principal residence exclusion when it was used as a principal residence during two of the last five years, so a residence may be converted to a rental property and still qualify for the exclusion. If the home is converted to a rental property, it may qualify for a tax-deferred exchange, so both rules can apply. For example, Patty, a single person, converts her residence to a rental property after using it as her principal residence for three years. Two years later, she exchanges the house for another rental property. The total realized gain is $300,000. Assuming she otherwise qualifies, Patty can exclude $250,000 of gain from the exchange and also defer $50,000 of gain as a reduction of basis for the replacement property. In Revenue Procedure 2005-14, the IRS gives six examples of how these rules apply, including the treatment of gain, depreciation and boot.
Questions and Answers
Question
I have 3 stock investments held long-term that I sold during 2004. I had tax losses as follows: Stock A, $2,160; Stock B, $2,462; Stock C $9,933. When I entered the loss for Stock C in my tax return preparation software, the taxable income and federal tax refund didn't change. Why?
Answer
Because the maximum capital losses that may be deducted in any tax year on an individual's federal income tax return is limited to $3,000. Excess capital losses are carried over to the next year. See line 21 of Schedule D.
If you are going to be an investor, you need to learn the rules of the game. At least read the section on capital gains and losses in a good tax guide. Your stock broker might also have some booklets on tax rules relating to investments that you can study.
Question
Why aren't PBGC retirement checks tax free, since our company, which is now bankrupt, paid PBGC insurance premiums and insurance claims aren't taxed?
Answer
Not all insurance proceeds are tax-free. Life insurance and most medical insurance benefits are usually tax-free, but even life insurance benefits are occasionally taxable.
Question
Can I claim items like gas mileage and books on my tax return? What about loans? I haven't begun to pay them and will begin to pay when school is completed. I only make the interest payments.
Answer
You haven't given me many details for your situation. Personal mileage, including driving to school to earn your first college degree, isn't deductible.
There may be some credits or deductions available relating to your education expenses. I recommend that you go to the IRS web site at www.irs.gov and get Pub 970, Tax Benefits of Education, and Pub 508, Tax Benefits for Work-Related Education.
Question
I have been contracted by an IT staffing company to a company that is a 104-mile commute (round trip) from my house.
The staffing company pays me and issues my W-2.
Can I take the mileage as a deduction because of the temporary nature of the job?
Answer
Probably not. The IRS has recently been "looking through" these arrangements and finding the contracting company to actually be the employer.
Question
Since I started a new job a couple of years ago, I've been having too much taken out of my paycheck to cover Federal and state taxes. We're ending up with a big refund. I'd rather the money was in our pockets throughout the year.
Do I change my W-4 to have less income taxes taken out?
Answer
Yes. There is a worksheet on the form to help you figure the number of exemptions you are entitled to. Watch your withholding after the change to be sure you are at least paying in last year's tax. Consider having a tax advisor help you with this.
Question
My aunt bought a house in December, 1999. She has let my wife and me live there from that time to the present without charging us rent. If she wants to sell the house and buy another one, will she be charged tax on capital gains? What is the rate?
Answer
Since your aunt never charged you rent, it's questionable whether she can make a tax-deferred exchange for the residence. Since she never lived there, it won't qualify for the exclusion for the sale of a principal residence.
The maximum federal income tax rate that applies to long-term capital gains is 15%. State taxes can also apply. In California, net long-term capital gains are taxed at the same rate as other income. If she lives in a different state from the one where the residence is located, she may be required to file income tax returns in both states. Your aunt should consult a tax advisor about her situation.
Question
I was seriously injured on my job and won a settlement. They also have to pay my medical bills for the rest of my life. Do I have to pay income taxes for the award? It is for a physical injury.
Answer
Nonpunitive damages and other amounts received for personal injuries are excluded from taxable income. (IRC Section 104(a)(2).) Punitive damages are taxable, even when they relate to a physical injury.
Question
My wife for 5 years is Russian and our daughter is still in Russia - a full time student and ill.
We are sending $2,000 per month for her support, school and medicines. She has no other income.
Can any of this be deducted on our joint US income tax return.
Answer
In order to qualify as a dependent, the child must be a citizen, national or resident of the United States, or 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 or her household for the entire tax year. (IRC Section 152(b)(3).) It doesn't appear your daughter will qualify for a dependency exemption or medical deductions unless you bring her here to live with you or otherwise meet the requirements. (Also, remember full-time students only qualify if they are under age 24 at the end of the calendar year.)
Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.
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/.
Visit our new articles!
- The Science of Influence book review
We have also updated the following articles:
- "Your Residence-The Ultimate Tax Shelter?"
- "Alternative Minimum Tax: Prepare for this Tax Trap"
- "Roth IRA: Major Wealth-Building Power for Taxpayers with Modest Earnings"
- "Warning! The Interest Expense for Your Margin Account May Not Be Tax Deductible!" and
- "Tax-Deferred Section 1031: Real Estate Exchanges"
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.
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.
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Michael Gray, CPA
2190 Stokes St., Suite 102 San Jose, California 95128-4512 (408) 918-3162 Fax (408) 998-2766 email: mgray@taxtrimmers.com |
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