Michael Gray, CPA's Tax and Business Insight

November 1, 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!

Route to _______   _______   _______   _______   _______

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

Here's my grandson, Kyan Baker, in his Halloween chef costume with his daddy, Dan Baker. Dan and my daughter, Holly, have just opened their second restaurant, AVA, in San Anselmo, California.

Table of Contents

• The holiday season is here!
• Our firm and family news.
• Not much time left for year-end planning!
• Money on sale! Set up an equity line of credit now.
• Review defined benefit plans.
• Special opportunity for charitable giving.
• IRS proposes to eliminate benefits of private annuities.
• IRS explains W-2 wages for domestic production activities deduction.
• Alternative motor vehicle credit reduced for Toyota buyers.
• Questions and Answers
• Sale of principle residence answers.
• Can a business claim a deduction for forgiving part of a bill?
• What part of game show winnings are withheld for taxes?
• What retirement planning options are available to highly compensated employees?
• Can I claim my Ukrainian stepson as a dependent?
• Do you have employee stock options?
• Do you have real estate tax issues?
• Visit our new article!
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

The holiday season is here!

Now that Halloween is over, Thanksgiving will soon be here. Hope you have a good one with your friends and family. Then comes the December holidays and the end of the year!

This is the time of year for counting blessings. We are very thankful to be able to be of service to a great group of clients. My office is located very close to my home, which makes it oh, so nice! Janet and I have been enjoying babysitting Kyan most Saturdays. Life is good.

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Our firm and family news.

Now that October 15 is behind us, we are going through a cycle of vacations.

Thi Nguyen is vacationing in Cancun with her husband, Alan Le. She will be returning on November 6.

Janet and I will be going to the Charleston, South Carolina and Savannah, Georgia area. I won't be available in the office from November 2 until November 16.

Dawn Siemer and her husband, John, are planning a three-week vacation after Thanksgiving. They are still working on the details for their vacation.

Newlyweds Dawn and John have announced they are expecting their first child (my second grandchild!) soon after April 15! We are thrilled! Janet has been hard at work on a playroom in our home for our little visitors.

Dan and Holly Baker just opened their second restaurant, called AVA. It's located at 636 San Anselmo Ave., San Anselmo, California, just 15 minutes from their first restaurant, Marché aux Fleurs, in Ross. AVA will focus on serving food and drinks produced in California. For reservations, call 415-453-3407. The web site is avamarin.com. Janet and I visited the restaurant, and it is lovely. There will be patio dining during the summer.

My brother, Steve, and I will be celebrating our 55th birthday on November 17.

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Not much time left for year-end planning - make your reservation now!

One might think that with two months left, there is plenty of time to get ready for the end of the year, but think again. I'll be gone from November 2 until November 16. Then comes Thanksgiving weekend on November 23 and 24. Thi and I will be at a Dan Kennedy program on December 1 and 2 and tax update classes on December 18 and 19, and Christmas is Monday, December 25.

That leaves a very limited calendar for tax consultations. If you need a tax consultation appointment, call Dawn Siemer at 408-918-3162 to reserve your time now (before she disappears starting Thanksgiving weekend)!

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Money on sale! Set up an equity line of credit now.

There are some great opportunities for below prime rate home equity lines with no fees. We think this especially worth considering for seniors, and is almost always a superior alternative to reverse mortgages. To discuss this further, call me at 408-918-3161 after November 15.

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Review defined benefit plans.

Defined benefit plans are mostly traditional pensions where a regular benefit is paid based on compensation during employment. There are a ton of changes relating to defined benefit plans in the Pension Protection Act of 2006, signed by President Bush on August 17. If you are an employer with one of these plans, it is especially important to consult with your pension consultants right away.

Other retirement plans will also be affected by the new law, including new vesting and reporting requirements.

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Special opportunity for charitable giving.

Taxpayers who are over age 70 1/2 can avoid federal tax by having their IRA accounts make direct distributions of up to $100,000 per year to qualifying charities. These distributions count for the minimum distribution requirements. See your tax advisor for more information. This election is only currently available for 2006 and 2007.

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IRS proposes to eliminate benefits of private annuities.

Private annuities are a widely-used estate planning tool. A senior family member can sell an appreciating asset, such as a family business, to a younger family member in exchange for payments to be received for the rest of the seller's life. In the past, the gain from the sale would be prorated over the payments received.

The IRS recently issued proposed regulations that would eliminate the benefit of private annuities. Under the proposed regulations, the entire gain would be taxable in the year of sale.

The regulations would be effective for transactions entered into after October 18, 2006, but certain transactions before April 19, 2007 would continue to be subject to the old rules. In order to qualify, the taxpayer who purchases the asset must be an individual, the annuity can't be secured, and the asset can't be resold by the buyer within the next two years.

If you are considering a private annuity, you should discuss this development with your tax advisors.

(IR 2006-161, 10/17/2006.)

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IRS explains W-2 wages for domestic production activities deduction.

The domestic production activities deduction is mostly available for U.S. manufacturers and builders. The deduction is limited based on W-2 wages paid by the taxpayer. The IRS has issued a revenue procedure explaining how W-2 wages are calculated for this limitation.

(Revenue Procedure 2006-47, 2006-45 IRB)

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Alternative motor vehicle credit reduced for Toyota buyers.

The IRS has announced that only 50% of the otherwise available alternative motor vehicle credit will be available for qualified Toyota hybrids and advanced lean burn vehicles after September 30, 2006 and before April 1, 2007. The credit will be further reduced to 25% of the otherwise available amount after March 31, 2007 and before October 1, 2007. After September 30, 2007, no credit is scheduled to be available for these vehicles.

The reason for the reduction is there is a limit on the number of vehicles for each manufacturer that is eligible for the credit at various credit levels.

(Notice 2006-78, 2006-41 IRB; IR 2006-145 9/20/2006)

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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?" (realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.

Clarification for a previous answer

Question

Can a business claim a tax deduction for forgiving part of a bill to a 501(c)(3) (charity)?

Answer

Yes. I'm not aware of any prohibition from claiming such a deduction. You should get an acknowledgement of the gift from the charity with a statement that no goods or services were given to you in exchange for the donation.

Stanley Balsky, CPA of Rutherford, NJ and Andy Goloboy, CPA pointed out that not all gifts of accounts receivable are deductible.

Thanks for staying alert!

I didn't include all of the details for this question, so I apologize.

An accrual basis taxpayer can claim a tax deduction for forgiveness of a debt to a charity because it has a tax basis in the account receivable from reporting the income. A cash basis taxpayer that is performing services, such as a CPA firm, will not qualify for a tax deduction for forgiving the receivable because there is no tax basis in the account receivable. The income isn't reported until it's collected.

Question

What part of game show winnings are withheld for federal income taxes?

Answer

As far as I can see, federal income tax withholding isn't required for game show winnings. That may be why Richard Hatch is sitting in a federal prison for failing to report and pay federal income taxes on his winnings from Survivor. Game show winnings of more than $600 are reported to the tax authorities on a Form 1099.

Question

If you are classified as a highly-compensated employee, your 401(k) contribution is limited. What other options does a highly-compensated employee have?

Answer

If the employer is willing to contribute 3% of compensation for all employees, the limitation for highly-compensated employees is eliminated.

The Pension Protection Act of 2006 includes a provision permitting automatic enrollment of employees in a 401(k) plan, with an election available to opt-out of participation, effective for plan years beginning after December 31, 2007.

Another possibility that has become much more complex is to set up a non-qualified deferred compensation plan with your employer. There a many new rules that make setting up such a plan more difficult and increases the risk for employees.

These are not simple, inexpensive solutions. You and your employer should work with qualified legal counsel to explore your alternatives.

Question

I'm in the military and stationed in Belgium. My wife is a citizen of Ukraine and has her ITIN. My stepson, who is a citizen of Ukraine, does not have an ITIN or SSN. He has lived with me over a year and is 8 years old.

What will I need to do to claim him as a dependent in 2006?

Answer

I'm sorry, but as far as I can tell your stepson would have to be a citizen or national of the US or a resident of the US, Mexico or Canada in order to qualify as a dependent. I haven't found an exception for children of military personnel.

If the child was a resident of the U.S. for even a few days, he might qualify.

There is an exception for an adopted child. A non-citizen, non-resident adopted child can qualify as a dependent provided the child had the same principal place of abode as the taxpayer, is a member of the taxpayer's household and the taxpayer is a citizen or national of the United States. (Internal Revenue Code Section 152(b)(3)(B).)

Two months is a short time to process an adoption, but this might be a possibility for you.

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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 www.stockoptionadvisors.com/subscribe.shtml.

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We are starting a newsletter devoted to real estate tax issues.

Like this newsletter, we will talk about new developments, have reports on special tax concerns, and answer questions and answers. The subscription rate is $19.95 per month. For a sample issue, visit www.realestatetaxletter.com.

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Visit our new articles!

• There's a Customer Born Every Minute book review

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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.