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Michael Gray, CPA's Tax and Business Insight
May 5, 2006
© 2006 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
- It’s tax planning season.
- Congratulations, James!
- Employer payment of travel expenses subject to withholding and employment taxes.
- List of hybrid credit vehicles released.
- Spendthrift trust is not insulation against tax leins.
- $1 million compensation limit didn’t apply to partnership with public corporation partner.
- 9th Circuit says sole shareholder of a professional corporation is a statutory employee.
- 6th Circuit reverses Tax Court—shareholder advances are loans.
- $100,000 penalty for cash reporting failures reversed.
- Since no QDRO, retirement plan distributions to ex-spouse are taxable to employee.
- Questions and Answers
- Do you have employee stock options?
- Do you have real estate tax issues?
- Read our new article!
- PS Marché Aux Fleurs
- Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight
It’s tax planning season.
Now that the frenzy of preparing income tax returns and extensions is over, we can take more time to think.
- How can you improve your tax situation for 2006 – especially considering the alternative minimum tax? (Planning is even more tricky for 2006 because pending extensions of tax breaks are uncertain.)
- Should your federal or state tax withholding be adjusted to avoid potential penalties and match state income tax deductions with income?
- Should you be planning gifts of appreciated property to a favorite charity?
- Have you started a business for which you need to schedule estimated tax payments?
- Are you winding up a business this year?
- Do you have an estate plan in place? If so, is it time for a review and update?
- Are there significant transactions – a sale of real estate or a big block of stock – to be planned for?
- For a business, should you consider any changes to a more tax-favorable or correct accounting method?
- Has your business changed so that the form of doing business should also be changed?
If we can be of service in helping you with these issues or any others that come to mind, call Dawn Siemer on weekday afternoons at 408-918-3162 to make an appointment for a consultation.
Congratulations, James!
My son, James, is studying to earn his master’s degree in Philosophy at San Jose State University. He intends to eventually earn his doctorate and become a university professor. James has been accepted to teach his first class in Ethics at San Jose State University next fall. Congratulations James! We are proud of you.
Employer payment of employee travel expenses was subject to income tax withholding and employment taxes.
A taxpayer lived in Minnesota and worked in Anchorage, Alaska. The employer reimbursed the employee for travel expenses between his residence and his job location and for lodging in Anchorage. Income taxes, social security taxes and medicare taxes were withheld from the reimbursements as additional taxable wages.
The employee disagreed with this treatment and sued for a refund. The employee said these amounts were ordinary and necessary business expenses of the employer in order to get workers in a remote job location, based on HB&R, Inc. v. U.S. (229 F.3d 688 (CA-8, 2000)).
The federal district court ruled against the taxpayer. In the HB&R, Inc. case, the jobs were located in remote and uninhabitable parts of Alaska. In this case, the employment was in a major city. The taxpayer merely made a personal decision to keep his residence in Minnesota.
The reimbursement of expenses incurred for the personal convenience of the employee are taxable as additional wages.
(Jordan, DC-Minn., March 23, 2006.)
List of hybrid credit vehicles released.
The IRS has announced a list of vehicles qualifying for the 2006 hybrid vehicle tax credit. Taxpayers may rely on the manufacturer’s certification when they claim the credit on their tax returns.
- 2005 Toyota Prius: $3,150
- 2006 Toyota Prius: $3,150
- 2006 Toyota Highlander 4WD Hybrid: $2,600
- 2006 Toyota Highlander 2WD Hybrid: $2,600
- 2007 Toyota Camry Hybrid: $2,600
- 2006 Lexus RX400h 2WD: $2,200
- 2006 Lexus RX400h 4 WD: $2,200
- 2007 Lexus GS 450h - $1,550
- 2006 Ford Escape Hybrid Front WD: $2,600
- 2006 Ford Escape Hybrid 4 WD: $1,950
- 2006 Mercury Mariner Hybrid 4 WD: $1,950
More vehicles are still moving through the certification process.
(IR-2006-56, IR-2006-57, IR-2006-67.)
Spendthrift trust is not insulation against tax liens. Trustee may be liable.
The IRS Chief Counsel says the IRS may levy against a spendthrift trust to recover unpaid amounts due to the IRS.
Under the terms of a spendthrift clause, a beneficiary is only entitled to certain amounts (which may be monthly support payments and scheduled principal distributions) from a trust, but doesn’t otherwise have an ownership interest in the assets. This trust provision is usually effective in insulating a trust from claims of the creditors of a beneficiary.
According to the IRS Chief Counsel, the right of the federal government to collect taxes overrides a state-created exemption.
If the trustee makes a distribution to the beneficiary when a federal tax lien is in effect, the trustee could be held liable for tortious conversion of a tax lien. The IRS could then recover the erroneously distributed amount from the trustee, personally.
(CCA 200614006.)
$1 million compensation limit didn’t apply to partnership with public corporation partner.
Publicly-held corporations generally can’t deduct compensation paid to certain employees exceeding $1 million. (Applies to the CEO and the four non-CEO highest-compensated officers for a taxable year.)
The IRS has privately ruled that this limitation doesn’t apply to compensation paid by a partnership with respect to services performed as an employee of the partnership, even though one of the partners of the partnership was a publicly-held corporation.
(I think this is what they call a "loophole".)
(LTR 200614002.)
9th Circuit says sole shareholder of a professional corporation is a statutory employee.
The 9th Circuit Court of Appeals affirmed a 2003 decision by the Tax Court that an individual who was the sole shareholder and president of an incorporated law firm was also an employee of the corporation. Payments by the corporation to the shareholder were subject to withholding and employment taxes.
Apparently the corporation deducted amounts paid to the shareholder as officer compensation to an independent contractor, but the shareholder told his accountant that the amounts were non-taxable loans. No Forms W-2 or 1099 were issued with respect to the payments.
The Tax Court previously found the corporation was not eligible for penalty relief under Section 530 of the Revenue Act of 1978 because there was no reasonable basis for claiming the shareholder was not an employee and the amounts paid weren’t taxable wages and no Form 1099 was issued for the payments, which is required to qualify for penalty relief. The taxpayer waived consideration this issue in the appeal.
(Western Management, Inc., CA-9, April 12, 2006.)
6th Circuit reverses Tax Court – shareholder advances are loans.
Family members who owned stock in a privately-held corporation periodically made loans to the corporation. The corporation paid 10% interest on the loans, deducted the interest and the individuals reported the interest income on their income tax returns. Notes were eventually issued as evidence of the loans, which were unsecured, payable on demand and had no payment schedule. The corporation paid no dividends.
The Tax Court ruled the advances should be treated as capital contributions and the payments of principal and interest as dividends, which would not be tax deductible for the corporation.
The 6th Circuit Court of Appeals reversed the Tax Court’s ruling and held the advances should be treated as loans. According to the 6th Circuit, the interest rate was reasonable, the issuance of written notes supported debt treatment, and there is no prohibition from having loans payable on demand, without a payment schedule. The repayment of the loans was not contingent on profits because the loans were repaid using funds borrowed from a bank.
(Indmar Products Co. CA-6, April 14, 2006.)
$100,000 penalty for cash reporting failures reversed.
A District Court has reversed $100,000 of penalties imposed by the IRS on an auto dealership for failure to report cash payments of more than $10,000 for a transaction. The penalty was $25,000 each for four unreported transactions.
The IRS performed a compliance review in 1996, and found some unreported transactions. The management of the dealership installed procedures to assure compliance. The management also signed a written statement acknowledging responsibility for meeting the requirements.
Another compliance review was performed for 1999 and 2000, and four unreported transactions were found. (There were 3,000 vehicles sold during the period, and of eight transactions requiring reporting, four transactions were reported.)
The IRS asserted that, since errors were previously found in the 1996 compliance review and management acknowledged responsibility for compliance in writing, the noncompliance was willful and subject to the $25,000 per occurrence penalty.
The District Court found that sloppiness is not the same as willfulness. The Court found no evidence that the employees of the dealership intentionally disregarded the reporting rules. There was no evidence of money laundering or other illicit activity. Nor was there any evidence that a customer requested or that a company representative promised that a transaction would not be reported.
The Court also said that a taxpayer could also avoid the penalty based on a reasonable cause, including acting in a responsible manner before and after the failure occurred, including exercising reasonable care and undertaking significant steps to avoid or mitigate the failure.
(Taxpayers who receive large tax payments in their businesses should install procedures to educate their employees and assure that Form 8300 is filed for large cash receipts.)
(Tysinger Motor Company, Inc. v. U.S. (DC VA, 4/7/2006)
Since no QDRO, retirement plan distributions to ex-spouse are taxable to employee.
Robert and Gloria Reichner were married in 1970 and divorced in 2000. Under the property settlement agreement, Robert was to pay Gloria $1,000 per month from his retirement pension check. The retirement plan made the retirement payments to Robert, and Robert paid $1,000 to Gloria each month.
In May, 2002, a state court issued a stipulated order that the arrangement was intended to be a QDRO, and the retirement plan should issue the monthly $1,000 payments directly to Gloria.
Robert wasn’t sure when he stopped paying Gloria, but it was "probably" in December, 2002, when the retirement plan started paying Gloria directly.
The retirement plan issued a Form 1099-R to Robert for 2002 showing $25,100 of taxable distributions. Robert reported the total amount on his income tax return, but also claimed a $12,000 alimony deduction for payments made to Gloria.
The IRS determined the payments weren’t alimony and disallowed the deduction.
The Tax Court ruled that, since a QDRO wasn’t in place at the time, Robert had to include them in his income. The QDRO couldn’t have been submitted to the retirement plan until December, 2002.
Since the payments to Gloria under the property settlement were not designated as alimony, they weren’t deductible as alimony.
This case shows that there are many complexities in divorces, especially relating to handling retirement plans. Some family law lawyers aren’t well versed in the tax laws. If you are going through a divorce, you should probably hire a tax consultant to help out, too.
(Reichner v. Commissioner, T.C. Summary 2006-50 (4/11/06).)
Questions and Answers
Dear readers:
Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" (www.realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.
Question
My ex-husband hasn’t filed income tax returns since 1999, and does not seem to plan to. I learned this from my child support caseworker. What would happen if the IRS catches up with him? He didn’t owe any tax because he claimed our son as a dependent. I don’t want my kids to see their father go to jail. I amended my income tax returns for three back years and claim the exemption for my son. Can I go back any more?
Answer
You haven’t given me enough details to even know if your ex-husband is required to file an income tax return. This is a matter that is beyond your control, so I suggest that you just accept it.
Whether you are entitled to the exemption for your son doesn’t depend on whether your ex-husband claims him, but the facts that establish qualification to claim the exemption.
The earlier years are closed, so you can’t amend income tax returns and claim the exemption for them.
Question
I am married and have a 1.5 year old child. We will file a joint income tax return for 2006.
I am considering buying a hybrid car. (The dealer says we can get a $3,150 tax credit for a Prius.) The credit is only allowed for the excess of the regular tax after other credits over the tentative minimum tax.
Scenario 1 – Total wages $120,000, capital gains $60,000. Will we have an AMT?
Scenario 2 – Total wages $120,000, capital gains $300,000. Will we have an AMT?
What is the maximum income that we can have and still qualify for the $3,150 credit?
Answer
You haven’t given me enough details to compute the AMT. There are many factors involved, including your state income tax situation, whether you have property taxes for a residence, and whether your capital gains are long-term or short term.
I recommend you meet with a tax advisor and pay to have him or her work through your particular situation.
Another issue – we don’t know what the AMT exemption will be for 2006. Congress has been arguing over this for the last seven months. If we’re lucky, there might be a resolution in a couple of weeks.
Question
I am an outside salesperson. My home is in Mountain View. The corporate office is in San Francisco. Although I do not claim a home office deduction, I will not be going to the San Francisco office most days. My home will be my base of operations. How will I figure what is commuting and what is legitimate business travel? There is a desk I can use in San Francisco, but not my own office.
Answer
The tax rules aren’t friendly for outside salespersons.
The ideal arrangement would be to live next door to the corporate office, and to start and finish each day there.
Go to the IRS web site (www.irs.gov) and get a copy of Publication 463. Especially study the section on transportation (starting page 13).
Since you don’t have a "regular job location", I suggest that your transportation from your home to the first call of the day and from your last call of the day to your residence should be commuting and your other transportation for calls to customers are business transportation. Keep a log or diary listing the customers called and your beginning and ending mileage for your business transportation.
Since there are so many outside salespersons in our country, it’s amazing that we have such poor guidance for their deductible expenses. Everyone is too busy making money to fight with the IRS to create case law for the rest of us.
By the way, some salespersons have been found to have no tax home, and can’t qualify to deduct "out of town" travel expenses, despite constantly traveling on business!
Question
I am in the middle of a divorce. I’m separated now and have been receiving "temporary maintenance" since November, 2005. Do I have to report and pay taxes on this amount on my separate income tax return for 2006, or only for the amount I receive after the divorce is final?
Answer
Spousal support received before the divorce is final is also taxable income. Alimony can be paid based on a divorce or separation agreement.
Question
I would like to consolidate my non-IRA funds from Ameritrade into my non-IRA account at Vanguard. I think the only way to do that is to liquidate, put the cash proceeds into my checking account, and then transfer the funds out of my checking account to Vanguard. As long as I reinvest the same amount I receive from Ameritrade back into Vanguard, are there any tax implications?
Answer
Of course.
There is no such thing as a "tax deferred rollover" except for retirement accounts. Performing the transfer as you describe it will be a taxable sale. If you complete the "rollover" within 30 days and reinvest in the same funds previously held in the Ameritrade account, any losses are disallowed as a wash sale.
Sometimes you can arrange for transfers of the actual funds from one account to the other. Ask the people at Ameritrade and Vanguard if this can be arranged.
Question
Do we need two separate tax identification numbers – one for the trust and another for the estate?
Answer
Generally, a trust and an estate are required to have separate tax identification numbers.
There is an election to have a trust included on the income tax return with an estate, which would initially require only one identification number.
I recommend that you retain a tax consultant familiar with these rules to help you with income tax reporting for the trust and estate. (We provide this service.)
Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.
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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.
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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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