Michael Gray, CPA's Tax and Business Insight

January 8, 2019

© 2019 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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Mike and brother Steve doing the final bow at the Prospect High School 50th Anniversary Showcase
The final bow of the performers for the Prospect High School 50th Anniversary Alumni Showcase. My brother, Steve, is wearing the blue shirt. I'm at the far right.

Happy New Year!

Opening the New Year with a federal government shutdown and a House of Representatives with a Democrat majority promises "interesting times" ahead. Under the new tax laws and IRS guidance, the tax laws have become more complex. Also, paid tax return preparers are subject to new due diligence rules, requiring them to ask more questions and request more supporting documentation, like Social Security cards and birth certificates for taxpayers and their dependents. This will be annoying for taxpayers who have been working with the same tax return preparer for many years. Add the situation that California (and many other states) hasn't conformed to the federal tax law changes, and you can see that it's likely your tax return preparation fees will be higher for the upcoming tax season.

Your CPA, enrolled agent and financial planner should be working with you to help you achieve your financial goals, but it's up to you to ask for that help.

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January celebrations.

My son in law, Dan Baker, is celebrating his birthday this month. Happy birthday Dan!

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Fourth quarter estimated tax payment for non-corporate taxpayers is due January 15.

The final estimated tax payment for individuals and calendar-year estates and trusts is due January 15, 2019. Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year's facts.

See your tax advisor.

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Tax preparation materials will soon be on the way.

Koehler & Associates is in the process of mailing instructions for sending their 2018 tax return preparation instructions. If you haven't received instructions by January 20 or you would otherwise like to receive instructions, call Thi Nguyen at 408-286-7400, extension 206.

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Make your tax return preparation interview appointment now.

Most personal interview appointments for preparing 2018 individual income tax returns will be scheduled in February. Many clients send their information without having an interview, but if you need that personal attention, you should schedule your interview appointment now. Call Thi Nguyen at 408-286-7400, extension 206.

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Estates and trusts should plan distributions.

The maximum 37% federal income tax rate and the 3.8% tax on net investment income hit estates and trusts especially hard. For 2018, they apply when the undistributed estate or trust income exceeds $12,500. If possible, the income of the estate or trust should be distributed to beneficiaries before the year-end, since the threshold for these taxes is much higher for individuals. (The income of some trusts is automatically considered distributed. See your tax advisor.) An election is also available to treat distributions made during the first 65 days of the following year (for example, January 31, 2019) as distributed for a taxable year (for example 2018).

In most cases, capital gains don't qualify for the distribution deduction. See your tax advisor.

The beneficiaries should be involved in this decision and be informed about the additional income to be reported on their income tax returns (in writing) to avoid unpleasant surprises.

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Remember to take a physical inventory as of January 1.

Calendar year businesses with inventories should take a physical count as of January 1. This creates a "clean" record for the income tax return.

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W-2s, 1099s and DE 542 reminder.

Remember that most 2018 annual information returns, such as W-2s and 1099s, should be issued to payees and sent to the tax authorities by January 31, including electronically filed forms. (The new filing date applies to Form 1099-MISC for services.) Congress moved up the filing date to fight identity theft.

Amounts paid using a credit card should not be included on Form 1099. Those amounts are being reported by the merchant companies.

Also remember that Form 542, Report of Independent Contractors, should also be submitted for ongoing independent contractor arrangements by January 20. The due date is the earlier of 20 days after the date $600 or more of payments have been made to the independent contractor or the date a contract has been entered for $600 or more of services during a calendar year.

Although requirements for real estate operators to issue Forms 1099 were repealed, real estate operators that claim their real estate operations are a trade or business (including for the 20% federal tax deduction for trade or business income) should prepare them anyway. See your tax advisor for details.

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Standard mileage rate for 2019.

The standard business mileage rate for 2019 is 58¢ per mile, up from 54.5¢ per mile for 2018. The medical mileage rate is 20¢ per mile, up from 18¢ per mile for 2018. The mileage rate for moving is also 20¢ per mile for 2019, up from 18¢ per mile for 2018 and now only applies for military personnel, because the deduction has been repealed for everyone else starting 2018. The charitable mileage rate is 14¢ per mile, unchanged.

I expect more taxpayers will be electing to claim bonus depreciation or the expense election for their business vehicles purchased during 2018. The standard mileage rate will NOT apply for those vehicles.

(Notice 2019-2.)

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Remember to "reset" payroll on January 1.

Software providers will issue updates including the new payroll tax tables as of January 1, 2019. Be sure you have installed those updates before processing your first payroll for 2019.

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IRS releases 2019 Form W-4.

The IRS has released 2019 Form W-4. It's similar to the 2018 version of the form. Employers should have employees complete the form for their 2019 withholding. Here is a link to the form: https://www.irs.gov/pub/irs-pdf/fw4.pdf

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No California FUTA makeup payment for 2018.

California employers will NOT have an additional tax for a credit reduction on their Federal Unemployment Tax Return, Form 940, for 2018. (Finally! California has paid off its outstanding federal loans.)

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Interest rates for tax overpayments and underpayments are increasing.

The IRS has announced that interest rates for tax overpayments and underpayments for the calendar quarter beginning January 1, 2019 will increase one percent over the rates for the fourth quarter of 2018.

For noncorporate taxpayers, the rate for both underpayments and overpayments will be 6%.

For corporations, the overpayment rate will be 5% for overpayments up to $10,000, and 3.5% for overpayments exceeding $10,000. The underpayment rate will be 6% for most corporations, and 8% for large corporations.

These rates are becoming more significant, so be diligent about making estimated tax payments and payments with tax returns and extensions.

(Revenue Ruling 2018-32, December 6, 2018.)

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'Tis the season to exercise ISOs?

Since stock received from exercising an incentive stock option has to meet two holding period tests (more than two years after grant and more than one year after exercise) to avoid having the excess of the fair market value over the option price taxed as ordinary income, exercising early in the year can be advantageous when you decide to hold the stock after exercise. The reason is you have the alternative of selling the stock before the end of the year of exercise and possibly avoiding the alternative minimum tax if the value of the stock drops after exercise. I call this tax strategy the "escape hatch."

If the company's stock isn't publicly traded and you can't sell the shares, this strategy won't work.

Be careful about blackouts. I have had some individuals call me who wanted to use the escape hatch during December, only to discover they were prohibited from selling their shares because they were subject to an employee blackout. Sometimes blackouts can happen unexpectedly, like when an employer becomes a party to a lawsuit. There's no magic solution in these cases - you could be stuck with a significant tax liability.

For many people, the exercise and immediate sale of the shares is the most comfortable alternative, even if the tax bill is higher. Also remember the wash sale rules can spoil an "escape hatch" transaction. You can't repurchase the shares or even receive an employee stock option or buy a put option during the period starting 30 days before the sale to 30 days after the sale.

Another advantage of an exercise early in the year is to be able to meet the holding period requirements and sell the shares before the tax is due on April 15. But check the estimated tax payment requirements to avoid penalties for late estimated tax payments. (The alternative minimum tax liability can also be payable as an estimated tax liability.)

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Deduction disallowed for employer-provided parking.

Under provision of the Tax Cuts and Jobs Act of 2017 that hasn't been widely publicized, employers can no longer deduct qualified transportation fringe benefits, including parking, provided to their employees. Tax-exempt entities are required to report these benefits as unrelated business taxable income. The IRS has issued guidance about how to determine the amount for the benefit provided.

These rules are rather complex. Amounts paid to a third party are straightforward, but when the parking facility is owned or leased by the taxpayer, things get more involved. Tax return preparers should study them to determine the adjustments required for their business clients.

(Remember that amounts paid to a third party during 2018 exceeding $260 per month should be included on the employee's Form W-2 as taxable compensation. These amounts are also tax-deductible for the employer.)

(Notice 2018-99, Notice 2018-100.)

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Proposed regulations for business interest issued.

The IRS has issued proposed regulations for the new limitation on deducting business interest under Internal Revenue Code Section 163(j), enacted as part of the Tax Cuts and Jobs Act of 2017.

Effective for tax years beginning after December 31, 2017, the deduction for business interest is limited to 30% of "adjusted taxable income." Flooring interest of motor vehicle dealerships is a separate category of interest that isn't subject to the limitations.

The good news is taxpayers, except tax shelters required to use the accrual method of accounting, with gross income of up to $25 million aren't subject to the limitations. The test is applied to combined income of controlled groups, including partnerships under common control.

The limitations are first applied at the entity level for partnerships and S corporations. For partnerships, the limitations are computed for each individual partner. (The explanation of how to do this is almost incomprehensible.) Then "excess income" and "excess interest expense" are passed through to the owners. The "excess interest expense" is carried forward to the next taxable year, and can only be allowed as a deduction in the future based on passed through "excess income" in subsequent years. For S corporations, only "excess income" is passed through to shareholders and disallowed interest expenses are carried forward by the S corporation.

Partnerships and S corporations that aren't subject to the limitation still have to provide information to any owners who might be subject to the limitations on their individual, fiduciary, partnership or corporate income tax returns.

My printout of the regulations and preamble is 332 pages. I'm not going to explain them in detail. Tax return preparers certainly should study them. Taxpayers should consult with a tax professional whether the rules affect them.

(REG-106089-18, November 26, 2018.)

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IRS issues worksheet for 20% of qualified business income deduction.

The IRS has issued a draft of Publication 535 that includes an explanation of the 20% of qualified business income deduction and a worksheet for making the computations. Here is a link to the document: https://www.irs.gov/pub/irs-dft/p535--dft.pdf

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Amended 2017 returns required for fiscal year passthrough entities.

Since proposed regulations were not issued for owner/beneficiary information relating to the 20% of qualified business income deduction until August 8, 2018 and it wasn't listed on the 2017 forms, that information was omitted on many passthrough entity income tax returns for fiscal years ending in 2018. According to proposed regulations issued on August 8, 2018, that information should be included on the 2018 income tax returns for the owner. (Proposed Regulations Sections 1.199A-1(f)(2) and 1.643(e)-(2)(ii).) If that information is listed on the owner's Schedule K-1, it's presumed to be zero. (Proposed Regulations Section 1.199A-6(b)(3)(iii).)

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IRS issues guidance on Expense Election and Alternate Depreciation

The IRS has issued guidance on changes to the expense election under IRC Section 179 and the alternate depreciation system from the Tax Cuts and Jobs Act of 2017. The Revenue Procedure is effective December 21, 2018.

(Revenue Procedure 2019-8, December 21, 2018.)

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Final partnership audit regime regulations issued.

The IRS has issued final regulations implementing the centralized partnership audit regime. The regulations will apply for partnership tax years beginning after December 31, 2017 and ending after August 12, 2018 and to partnerships that make the election to apply them for partnership tax years beginning on or after November 2, 2015 and before January 1, 2018.

Tax return preparers should study the regulations for elections to be made on partnership income tax returns.

(TD 9844, December 21, 2108.)

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Federal court says Affordable Care Act is unconstitutional.

A federal District Court in Fort Worth, Texas has ruled the Affordable Care Act which incorporates "Obamacare" is unconstitutional because Congress, in the Tax Cuts and Jobs Act of 2017, eliminated the tax penalty under the individual mandate for those who don't have medical insurance.

The ruling is likely to be appealed to the Supreme Court. For now the ACA is continuing to be implemented.

(Checkpoint Newsstand, December 18, 2018, "Federal ruling strikes down ACA."

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IRS issues guidance on new deferral option for certain stock-based compensation.

The IRS has issued a Notice with guidance on the new election for stock based compensation for companies whose stock isn't publicly traded. The Notice does not include a form for make the election, and says to use the Section 83(b) election as a model. See my blog post on the notice: http://www.michaelgraycpa.com/posts/new-irs-guidance-for-deferral-of-income-from-stock-options-and-rsus/

(Notice 2018-97, December 7, 2018.)

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Second Circuit reverses Tax Court on Roth DISC arrangement.

The Second Circuit Court of Appeals reversed a Tax Court ruling and found that commissions paid to a Domestic International Sales Corporation (IC-DISC) owned by a Roth account were not constructive dividends under the substance over form doctrine. A corporation that held the IC-DISC shares paid income taxes on dividends received from the IC-DISC, but dividends paid by the holding company to the Roth account owners of the holding company were not taxable to the Roth account. The IC-DISC is a Congressionally - mandated tax incentive for U.S. export income.

(Benenson v. Commissioner, No. 16-2953, 2nd Circuit, December 14, 2018.)

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Plug-in vehicle credit for Teslas reduced for 2019.

The IRS has announced that the cumulative sales of qualified plug-in Tesla vehicles reached the 200,000 vehicle limit during the calendar quarter ended September 30, 2018. Therefore, the plug-in vehicle credit will be reduced to 50% of the otherwise allowable amount ($7,500 reduced to $3,750) for vehicles purchased for use or lease on or after January 1, 2019 and on or before June 30, 2019 and the credit will be reduced to 25% of the otherwise allowable amount ($7,500 reduced to $1,875) for vehicles purchased on or after July 1, 2019 and on or before December 31, 2019. For vehicles purchased for use or lease after 2019, no credit will be allowable.

(Notice 2018-96.)

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Plug-in vehicle credit for General Motors vehicles reduced after March 31, 2019.

General Motors reached cumulative sales exceeding 200,000 vehicles during the calendar quarter ended December 31, 2018. Therefore, the plug-in vehicle credit will be reduced to 50% of the otherwise allowable amount ($7,500 reduced to $3,750) for vehicles purchased for use or lease on or after April 1, 2019 and on or before September 30, 2019 and the credit will be reduced to 25% of the otherwise allowable amount ($7,500 reduced to $1,875) for vehicles purchased on or after October 1, 2019 and on or before March 31, 2020. For vehicles purchased for use or lease after March 31, 2020, no credit will be allowable.

(Checkpoint Newsstand, January 3, 2019, "GM Sold 200,000 Electric Vehicles In U.S. By 2018, Triggering Tax-Credit Phaseout")

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Rental deductions disallowed.

The Tax Court upheld the IRS in disallowing rental expenses, including mortgage interest and depreciation deductions, and legal and professional fees. It appears the legal fees related to the divorce proceedings for the taxpayer's son. There was no rental income for the property for several years. The court said there were insufficient records to substantiate the deductions.

(Sholes v. Commissioner, TC Memo. 2018-203, December 17, 2018.)

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Partnerships required to capitalize interest and property taxes relating to growing almond trees.

The Ninth Circuit Court of Appeals upheld the Tax Court in requiring three related partnerships to capitalize interest expenses and property taxes paid during the pre-productive period growing almond trees.

Under Internal Revenue Code Section 263A, taxpayers who produce real property are required to capitalize the direct costs of the property and the property's share of indirect costs (property taxes) which are allocable to the property. Interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.

The partnerships argued that the property taxes and interest related to the land, not the trees and they didn't produce the land.

The Ninth Circuit said the land was a production expenditure of the trees because the land was used for that purpose.

(Wasco Real Properties I, LLC v. Commissioner, Ninth Circuit decision No. 17-17810, December 5, 2018.)

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New California State Use Tax collection requirement.

In the past, retailers with no physical presence in a state weren't required to collect use tax for out of state sales. With the U.S. Supreme Court decision, Wayfair, Inc. v. South Dakota, states are permitted to collect the tax. California will require out of state retailers with no physical presence in the state to register to collect California use tax, effective April 1, 2019. The requirement will apply tax if during the preceding or current calendar year (1) The retailer's sales into the state exceed $100,000, or (2) The retailer made sales into the state in 200 or more separate transactions. The requirement applies to tangible personal property used in the district, sales or leases of vehicles or undocumented vessels located in a district, and to rentals from a lease of personal property located in a district.

Here is a link to the California Department of Tax and Fee Administration's online guide to the new requirements: http://www.cdtfa.ca.gov/industry/wayfair.htm

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New California District Use Tax collection requirement.

California is implementing a new District Use Tax collection requirement under Revenue and Taxation code section 7262 and the U.S. Supreme Court's decision in South Dakota v. Wayfair. Effective April 1, 2019, retailers registered or required to be registered to collect California sales tax are responsible for collecting and paying a district's use tax if during the preceding or current calendar year (1) The retailer's sales into the district exceed $100,000, or (2) The retailer made sales into the district in 200 or more separate transactions. The requirement applies to tangible personal property used in the district, sales or leases of vehicles or undocumented vessels located in a district, and to rentals from a lease of personal property located in a district.

Here is a link to the California Department of Tax and Fee Administration's online guide to the new requirements. http://www.cdtfa.ca.gov/industry/wayfair.htm

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Granting a life estate results in reassessment.

Two sisters each inherited 50% of a family home as tenants in common when their mother passed away. Years later, the taxpayer's sister granted the taxpayer a life estate for her 50% and a new deed was recorded. The life estate allowed the taxpayer to live in the home for the rest of her life. At her death, the surviving sister would regain her 50% ownership.

The Sixth District California Court of Appeal found granting the sister a life estate resulted in a change of ownership resulting in property tax reassessment.

(Mimi K. Karas Durante v. County of Santa Clara, California Court of Appeal, Sixth District, Case No. H041620, November 30, 2018.)

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Please share your good experiences with Michael Gray, CPA.

As you know, more and more people are going to the internet to find information about service providers. We hope you will share some good words about experiences that you have had with our firm<. Some of the sites where you can share your experiences include yelp.com and siliconvalley.citysearch.com.

We use Angie's List to assess whether we're doing a good job keeping valued customers like you happy. Please visit AngiesList.com/Review/4258970 in order to grade our quality of work and customer service.

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Financial Insider Weekly past episodes

After eight years of production, I have discontinued producing new interviews for Financial Insider Weekly. Doing the show has been a rewarding experience and I consider back episodes to be my legacy of financial literacy education to our community. Back episodes available at https://www.youtube.com/user/financialinsiderweek.

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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

For your questions about dependent exemptions, see IRS Publication 501 at www.irs.gov.

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Visit our new article!

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Follow me on Social Media!

Want to see new episodes of Financial Insider Weekly as soon as they're posted on Youtube? Want to see Michael Gray's blog posts as soon as they're live? We post them (and more) on social media!

If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.

I'm also on Facebook, LinkedIn, and Google+.

you can also follow me on other social media sites, Facebook, LinkedIn, and Google+.

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If you have employee stock options, have you subscribed to Michael Gray, CPA's Option Alert at no charge or obligation?

To learn more, visit stockoptionadvisors.com/subscribe.shtml

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Real estate investors, have you subscribed to Michael Gray, CPA’s Real Estate Tax Letter at no charge or obligation?

For details, visit www.realestatetaxletter.com

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Check out my blog.

I have also started a blog at www.michaelgraycpa.com. Check it out!

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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 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 www.taxtrimmers.com/directions.shtml.

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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
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