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Michael Gray, CPA's Tax and Business Insight

December 29, 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

• Happy New Year!
• How was your Christmas?
• Final 2006 estimated tax payment is due January 16.
• Tax organizers and tax notebook instructions are in the mail.
• Yes, we do prepare income tax returns!
• Money on sale! Set up an equity line of credit now.
• Congress passes last-minute tax extension legislation.
• Notice issued on information reporting for non-qualified deferred compensation.
• IRS explains how businesses and tax-exempt entities can claim refunds for telephone tax.
• Charitable contributions for payroll will meet new substantiation requirements.
• Final S corporation ESOP regulations issued.
• Signature requirements eliminated for some business returns.
• IRS explains how accrual basis service providers can write off bad debts.
• Questions and Answers
• Sale of principle residence answers.
• If I convert a traditional IRA to a Roth, will my other IRA be taxed?
• Should my Mom make me co-owner of her CD?
• Can I claim my parents as dependents?
• Is there a US tax on my wife's inheritance from her French aunt?
• Does interest or dividends from tax-free mutual funds bypass the AMT?
• Do you have employee stock options?
• Do you have real estate tax issues?
• Visit our new articles!
• PS Marché Aux Fleurs
• Subscribe/Unsubscribe from Michael Gray, CPA's Tax & Business Insight

Happy New Year!

We wish you good health and happiness for 2007.

New Year's Eve is a time for reflecting on the accomplishments and shortfalls of the past year and making plans for the coming year. How did you do for 2006? Did you reach your income and wealth accumulation goals? Did you get that estate plan in place? How can we help you make your dreams a reality in 2007?

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Kyan Baker, age 2, and Santa Claus

How was your Christmas?

Dawn and John had us, family and friends for Christmas Eve dinner. Janet and I enjoyed having our grandson, Kyan, come with us and spend Christmas Eve at our home. He slept great, and his mom and dad, my daughter, Holly and son-in-law, Dan Baker showed up in time for Santa Claus to pay a visit. We got some great pictures of Kyan with Santa.

Janet was suffering from an awful cold and tried to stay in the background so everyone else wouldn't get sick. Family members, especially our chefs Dan and Holly, pitched in to help prepare Christmas breakfast and Christmas dinner.

Everything considered, we had a good Christmas.

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Final 2006 estimated tax payment is due January 16.

Remember the final 2006 estimated tax payment for individuals, estates and trusts is due on January 16. If you need help to determine the appropriate payment to avoid underpayment penalties or avoid a big overpayment, consult with your tax advisor.

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Tax organizers and tax notebook instructions are in the mail.

If we prepared your 2005 income tax returns, we have mailed paper tax organizers or electronic tax notebook instructions to you. If you haven't received them by January 7, please call Dawn at 408-918-3162. Also, please call Dawn if you would like us to prepare your 2006 income tax returns and would like tax notebook instructions or a paper organizer.

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Yes, we do prepare income tax returns!

With our free newsletters and the information we make available at no charge on the web, some people wonder how we make a living. We prepare income tax returns and provide tax and business consulting services. We are accepting selected new clients and are thrilled when our clients and friends refer their friends, associates and family members to us. To inquire about becoming a client of our firm, please call Dawn Siemer at 408-918-3162 or send an email to her at mgray@taxtrimmers.com. We must receive your tax information by March 1 to guarantee delivery by April 15.

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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.

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Congress passes last-minute tax extension legislation, including some AMT relief.

President Bush enacted The Tax Relief and Health Care Act of 2006 on December 20, 2006. The Act includes a provision to enable some taxpayers to get a refund for some of their minimum tax credit carryovers. See the December 28, 2006 issue of Michael Gray, CPA's Option Alert for details. You can find it at www.stockoptionadvisors.com. If you need help, call Dawn Gray at 408-918-3162.

Here are some of the tax provisions extended in the Act:

• The "above the line" deductions for certain higher education expenses has been extended for two years through December 31, 2007.
• The ability to deduct state and local sales taxes instead of state and local income taxes has been extended for two years through December 31, 2007.
• The research credit has been modified and extended through 2007.
• The "above the line" deduction for teachers for classroom supplies has been extended through December 31, 2007.
• 15-year straight-line depreciation for qualified leasehold improvements and qualified restaurant property has been extended through December 31, 2007.
• Tax breaks for Archer medical savings accounts have been extended for two years through December 31, 2007.
• Capital gains treatment for self-created musical works has been made permanent.
• Certain interest-free loans to continuing care facilities have been made permanent.

The tax legislation includes enhancements to the tax benefits of Health Savings Accounts.

Certain premiums paid or accrued from January 1 through December 21, 2007 for qualified mortgage insurance contracts issued during 2007 will qualify for a mortgage interest deduction. This tax benefit may be extended in future legislation.

The IRS wasn't able to include these changes in its 2006 tax forms, and has suggested that it will have the fewest problems processing tax returns incorporating the changes if they are e- filed.

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Notice issued on information reporting for non-qualified deferred compensation.

The IRS has issued a notice explaining information reporting requirements for non-qualified deferred compensation plans for 2005 and 2006.

The notice is lengthy, so there isn't space for a detailed explanation.

In short, an employer is not required to report deferred compensation that isn't currently taxable in box 12 of Form W-2 using code Y, and a payer isn't required to report deferred compensation for non-employees that isn't currently taxable in box 15a for Form 1099-MISC.

An employer is required to include deferred compensation amounts that are currently taxable as additional wages in Box 1 of Form W-2, and also report the amount of Section 409A income in box 12 of Form W-2, using code Z. The taxable income amounts are supplemental wages, eligible for alternative withholding amounts (generally 25% federal income tax withholding), and are also to be reported on line 2 of Form 941.

A payer of taxable deferred compensation to a non-employee reports those amounts as non-employee compensation in box 7 of Form 1099-MISC and as Section 409A income in box 15b of Form 1099-MISC. (Notice 2006-100, 2006-51 IRB.)

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IRS explains how businesses and tax-exempt entities can claim refunds for telephone tax.

Taxpayers may claim refunds for federal excise taxes paid for long distance service for the period after February 28, 2003 and before August 1, 2006.

To claim a refund, Form 8913, Credit for Federal Telephone Excise Tax Paid, must be completed. Businesses and tax-exempt organizations may determine the actual amount of refundable excise taxes paid or use a formula to figure their refunds. Form 8913 is attached to the income tax return for the business or to Form 990-T for a tax-exempt entity.

The formula method is to use the bills with statement dates in April, 2006 and September, 2006 to compute the telephone tax as a percentage of the April, 2006 and September, 2006 bills. The difference is the percentage attributable to the long-distance excise tax to apply to quarterly or annual telephone expenses to determine the amount of the refund. The maximum refund is 2% of the total telephone expenses for businesses and tax-exempt organization with 250 or fewer employees. The maximum refund is 1% of total telephone expenses for businesses and tax-exempt organizations with more than 250 employees. (IR 2006-179, 11/16/2006.)

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Charitable contributions for payroll will meet new substantiation requirements.

The IRS has announced that taxpayers who make charitable contributions through payroll deductions (such as traditional United Way programs) will meet the new substantiation requirements enacted in the Pension Protection Act of 2006, provided they keep the pay stub or W-2 indicating the contribution amount and the donee organization's pledge card. (Notice 2006-110, 2006-51 IRB; IR 2006-186, 12/1/2006.)

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Final S corporation ESOP regulations issued.

The IRS has issued final regulations designed to ensure that S corporation employee stock ownership plans (ESOPs) benefit a broad range of employees. If you are shareholder of an S corporation that has one of these plans, you should discuss these new regulations with your pension administrator to assure your plan is in compliance. (TD 9302, 12/19/2006.)

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Signature requirements eliminated for some business returns.

In order to encourage electronic filing, the IRS has eliminated signature requirements for many business tax and information returns. Here are some examples:

• Corporations may elect to treat charitable contributions as paid during a tax year even if the contributions are actually paid in the following year without attaching a signed declaration and a copy of the board resolutions to the return.
• An unsigned copy of Form 972, Consent of Shareholder to Include Specific Amount in Gross income, may be submitted with the corporation's income tax return provided the corporation retains the signed original in its records.
• Partners are no longer required to attach the partnership consent for basis reduction due to discharge of indebtedness. The partners must retain the consent statement in their records.

Tax return preparers need to be familiar with these requirements to assure proper processing of elections and returns for efiling.

(TD 9300.)

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IRS explains how accrual basis service providers can write off bad debts.

The IRS has issued a revenue procedure explaining how accrual- basis professional service providers can adopt or change to the nonaccrual-experience method of accounting for bad debts. Taxpayers may use their actual experience or a safe harbor to determine how much of their billings can be written off as uncollectible. In addition to professionals in health, law, engineering, architecture, accounting, actuarial and performing arts fields, the method is also available to corporations and partnerships that averaged no more than $5 million in gross receipts over the previous three years.

The IRS will give automatic consent to accounting changes under the safe harbor guidelines. Form 3115, Application For Change of Accounting Method, is attached to the income tax return for the year of change.

If a non-safe harbor method of nonaccrual experience method is adopted, IRS consent is required and Form 3115 will have to be submitted to the IRS national office under the regular procedure.

(Rev. Proc. 2006-56, TD 9285.)

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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.

Question

I want to take advantage of the new rules allowing conversion of a regular IRA to a Roth without an income limitation after 2009. I want to make non-deductible IRA contributions and roll those accounts to a Roth account in 2010. I also have a traditional IRA rollover account from a previous pension plan. I thought I read an article that the rollover account will be taxed even if I just transfer the non-deductible IRA accounts. Is that right?

Answer

Yes. The change allowing these conversions was adopted in the Tax Increase Prevention and Reconciliation Act. For many purposes, your IRAs are combined, and this is one of them.

I believe you can avoid this result by transferring the rollover IRA to another employer plan before making the conversion of your nondeductible IRA accounts.

There is quite a bit of time before this provision becomes effective. Be sure to keep the rollover account separate, and watch for further developments and announcements on this topic.

If the rollover account is a big one, consider applying for a ruling from the IRS on this issue.

Question

Mom has a $150,000 CD maturing soon and she wanted to put my name on the new CD as a co-owner, with the earnings being reported under her social security number and tax return. Would $75,000 be a taxable gift? If either of us died, would only one-half be included in the decedent's estate?

Answer

I don't think your mother should make you the joint owner of the account.

$75,000 would be a taxable gift. You would be taxable on one- half of the interest, even though it's reported under your mother's social security number.

All of the account could be included in your mother's taxable estate, and one-half would be included in yours.

As an alternative, your mother should consider having the account set up as a "totten trust" account, under her social security number. You would automatically inherit the account at her death, and the interest income would be taxable to her.

Question

Can I claim my parents as dependents? They have no income, and I pay their rent, bills, etc. What documentation do I need?

Answer

It sounds like you should be able to claim your parents as dependents. You will need to be able to document (using bills, statements, cancelled checks and credit card receipts) that you are paying their living expenses and that they have no income.

Question

My wife has been notified that her aunt left an estate in France to her, including money and property. Is there any way around the 55% inheritance tax? My wife is a U.S. citizen.

Answer

The federal estate tax is imposed on the estate or trust of the decedent, not the beneficiary. Since your wife's aunt was presumably a citizen and resident of France and assuming she had no U.S. property, her estate shouldn't be subject to U.S. estate tax. The people who are administering her estate should resolve the tax liabilities relating to the transfer before distributing your wife's inheritance.

If you haven't already taken care of it, you and your wife should review your own estate plans. She will have separate property to plan for.

Question

Does interest or dividends from tax-free mutual funds bypass the AMT?

Answer

Interest or dividends from tax-free mutual funds that represents private activity bond interest is subject to the AMT. The fund should provide you with a notification about any income subject to the AMT.

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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/optionalert/.

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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 realestatetaxletter.com.

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Visit our new articles!

• Guerrilla Marketing book review
• "Build customer relationships with personality in your communications"

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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.

They also have a second restaurant, AVA, at 636 San Anselmo Ave., San Anselmo, California. AVA serves food and drinks produced in California. For reservations, call 415-453-3407. The web site is avamarin.com.

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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.