Michael Gray, CPA's Tax and Business Insight
February 4, 2026
© 2026 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 Valentine's Day!
- February celebrations.
- Tax season is here!
- Make your tax return preparation interview appointment now.
- Remember federal income tax returns for calendar-year S corporations and partnerships are due March 16.
- The election to be an S corporation for calendar-year corporations is generally March 15, 2026; see your tax advisor for new corporations.
- IRS form for sale of partnership interest.
- Have you received your tax preparation materials?
- File your tax return early, if you can.
- Disaster tax relief enacted.
- California wages could be wrong on Form W-2.
- Roth conversion reminder.
- Distribution election for estates and complex trusts.
- Were you age 73 or older during 2025?
- Get help for reporting tips for 2025.
- Not all overtime pay qualifies for the "no tax on overtime" deduction.
- Watch tax-deferred exchange rule changes for California.
- Watch accounting methods conformity for California.
- Watch alimony reporting conformity for California.
- Employers watch new rules for taxing employee meals benefits.
- California doesn't conform to federal business meals rules.
- Partnership debt allocation rules effective mostly 2025 forward.
- Fifth Circuit reverses Tax Court on limited partner self-employment tax.
- A wealth tax might be on California's midterm ballot.
- Do you sell products, services or software to CPAs?
- Attention CPAs-would you like help with marketing your services?
- Attention CPAs-do you need support for tax issues?
- Attention Accountants! Speed up processing your business closings!
- Please share your good experiences with Michael Gray, CPA.
- Financial Insider Weekly past episodes.
- Visit our new book review: Robert's Rules of Order, 12th Edition
- Follow me on social media!
- Check out my blogs.
- Subscribe/Remove from Michael Gray, CPA's Tax & Business Insight
Janet and me with Janet's sister, Gail Johnston and brother-in-law, Lane Johnston at the Beach House restaurant in Pacific Grove, California, January 6, 2026 Valentine's Day!
Remember to show your love and appreciation for your loved ones on Saturday, February 14. Book your reservation at your favorite restaurant now.
February celebrations.
My grandson, Clive Baker, and Thi Nguyen, CPA, who is now serving my former clients, are celebrating birthdays this month. Happy birthday Clive and Thi! My wife's sister, Gail Johnston, and her husband, Lane, are celebrating their wedding anniversary this month. Congratulations!
Tax season is here!
The IRS has announced it began accepting and processing (including efiling) 2024 individual income tax returns on January 26, 2026. Note that the final versions of some tax forms haven't been released yet and there are other reasons to delay filing 2026 individual income tax returns, including waiting to receive Schedules K-1 for partnerships and S corporations. Consult with your tax return preparer.
Make your tax return preparation interview appointment now.
Most personal interview appointments for preparing 2025 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.
Remember federal income tax returns for calendar-year S corporations and partnerships are due March 16.
(Federal income tax returns for calendar-year C corporations are due April 15.)
The election to be an S corporation for calendar-year corporations is generally March 15, 2026; see your tax advisor for new corporations.
IRS form for sale of partnership interest.
When there was a sale of a partnership interest during the year that included shares of unrealized receivables and/or appreciated inventory, the partnership must provide Form 8308 with Parts I through III completed to transferors and transferees by January 31 of the following year. Form 8308 with Parts I through IV completed must be included with the partnerships's federal income tax return. https://www.irs.gov/pub/irs-pdf/f8308.pdf https://www.irs.gov/pub/irs-pdf/i8308.pdf
Have you received your tax preparation materials?
If you haven't received a tax data organizer or instructions to submit information online and want tax return preparation service by my successor, Ms. Thi Nguyen, CPA, please contact her at thi@atl-cpa.com.
File your tax return early, if you can.
Identity theft has become a rampant problem. Scammers are filing bogus income tax returns and claiming refunds for withholding and estimated tax payments of innocent taxpayers. It can take months to straighten out a duplicate filing situation. Your easiest defense is to be the first one to file an income tax return under your Social Security Number. Individuals who have suffered from identity theft in the past can get a special identification number for electronic filing from the IRS. Meanwhile, many taxpayers must wait to receive documents like Schedule K-1 as late as September, and have to file for extension of time to file their tax returns.
Another way to protect yourself is to get an Identity Protection Personal Identification Number (IP PIN) from the IRS. Here is a link to an IRS explanation. https://www.irs.gov/identity-theft-fraud-scams/get-an-identity-protection-pin. A new IP-PIN is generated for each year that your file an income tax return.
Another reason to file early is some taxpayers might have tax refunds because certain tax benefits, like the Senior deduction, "no tax on tips", "no tax on overtime" and increased deduction for state taxes were enacted in the One Big Beautiful Bill Act while federal income tax withholding wasn't adjusted.
Disaster tax relief enacted.
President Trump signed the Disaster Related Extension of Deadlines Act (HR 1491).
The act:
- Extends the statute of limitation period for disaster victims to file a refund claim; and
- Prohibits the IRS from mailing a payment due notice to disaster victims until 60 days after the disaster postponement period.
Before the change, disaster postponements were not treated as an "extension", so even though taxpayers were granted postponements to pay the tax, the lookback period was not extended to include the disaster postponement period.
Under the Act, the deadline for filing a refund claim is three years plus the period of any extension, including the disaster postponements.
(Spidell's Flash E-Mail, January 5, 2026, "More disaster tax relief legislation enacted.")
California wages could be wrong on Form W-2.
Since many people who work for California employers are working remotely, some of them have chosen to move out of state. If the move is permanent, they are no longer residents of California and the wages earned after moving probably aren't California wages. If they haven't notified their employer, the employer would have continued reporting the wages as California wages and done so on Form W-2.
(Note that California residents report total wages on their California income tax return and might qualify for state tax credits for income taxes paid to other states to reduce double taxation.)
There are exceptions for employment taxes like California unemployment insurance, employment training tax and state disability insurance when most of the services are performed in California, when some services are performed in California and the individual's base of operations is in California, or if some services are performed in California and the place from which the employer exercises general direction and control over the employee's services is in California.
The liability for personal income tax withholding is based on where the work is done.
Ideally, the employee should notify the employer of any error in sourcing wages and a corrected Form W-2 should be issued.
If the employer refuses, the employee should report the corrected information on his or her California income tax return with an explanation. This is one situation when the tax return should be paper filed, not efiled.
There could be a conflict because some employers have said they would reduce the pay scale for employees who move out of California.
Any taxpayer who hires a professional tax return preparer should tell them when remote work for a California employer is performed remotely out of the state.
Roth conversion reminder.
Taxable Roth conversions of IRA accounts are still allowed. Under the One Big Beautiful Bill Act, federal income tax rates are "on sale" and generating federal deficits. It seems likely federal income tax rates will increase in the future. Making a taxable Roth conversion during 2026 might be a wise tax planning move.
Distribution election for estates and complex trusts.
The maximum 37% federal income tax rate and the 3.8% tax on net investment income hit estates and trusts especially hard. For 2025, they apply when the undistributed estate or trust income exceeds $15,650. Distributions by the estate or complex trust shifts the taxation of income to the beneficiaries. An election is available to treat distributions made during the first 65 days of the following year (for example, January 31, 2025) as distributed for a taxable year (for example 2026).
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.
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.
Were you age 73 or older during 2025?
Required minimum distributions apply for traditional IRAs and employer retirement accounts (with some exceptions) for the year the plan participant reaches age 73. The first payment must be made by April 1 of the following year. Thereafter, the payment must be made by December 31, so there could be two payments required during the year following the year the plan participant reaches age 73. The two payments could throw you into a higher tax bracket or make qualified dividends or long-term capital gains subject to a higher tax rate. Calendar taking care of this. Consider scheduling automatic payments with the plan custodian. See your tax advisor.
Get help for reporting tips for 2025.
The "no tax on tips" deduction is rather complicated. Not all tips qualify for the deduction. The IRS has issued Notice 2025-69 with some guidance for 2025 at Section III A. https://www.irs.gov/pub/irs-drop/n-25-69.pdf The IRS is relaxing some rules relating to a "specified service trade or business" until the year after it issues final regulations for this new tax benefit, so the waiver applies for 2025 and 2026.
The IRS has also issued a list of occupations where employees receive tips that might qualify for the "no tax on tips" deduction. https://public-inspection.federalregister.gov/2025-18278.pdf
When an employer doesn't include tips in the total wages on Form W-2, an employee should report them using Form 4137. https://www.irs.gov/pub/irs-pdf/f4137.pdf The tips must be reported as income in order to claim the related tips deduction. Tips received by employees are still subject to federal employment taxes.
When tips aren't reported on Form 1099-NEC or 1099-MISC, an independent contractor may substantiate the tips with other documentation. Then the tips can be included in taxable income with an offsetting tips deduction.
Remember the "no tax on tips" deduction is limited to $25,000 and is phased out when the taxpayer's modified adjusted gross income exceeds $150,000, or $300,000 for married persons filing a joint return. (Married persons may only claim the deduction when they file a joint return.)
If you have questions relating to claiming the "no tax on tips" deduction, get professional tax advice.
Not all overtime pay qualifies for the "no tax on overtime" deduction.
Determining which taxable wages qualify for the overtime deduction also isn't straightforward. The IRS has issued Notice 2025-69 with some guidance for 2025 at Section III B. https://www.irs.gov/pub/irs-drop/n-25-69.pdf
Overtime wages aren't separately disclosed on 2025 Form W-2. Employees should ask their employers for this information.
Only overtime required under Federal Labor Standards Act of 1938 (FLSA) qualifies. Under the FLSA, overtime is required to be paid for work exceeding 40 hours per week. Some states require overtime to be paid when an employee works more than 8 hours per day. The rate for overtime is 150% of the employee's standard hourly rate. Some states, unions, or employer policies require more than 150%.
"Exempt" employees who aren't eligible for overtime under the FLSA also don't qualify for the "no tax on overtime" deduction.
Only the portion of wages paid for overtime over the employee's standard hourly rate qualifies for the deduction.
The maximum amount of overtime that qualifies for the deduction is $12,500, or $25,000 for taxpayers filing a joint return.
The deduction is phased out when a taxpayer's modified gross income exceeds $150,000, or $300,000 for a married, filing joint return. Married taxpayers must file a joint return to claim the deduction.
If you have questions relating to claiming the "no tax on overtime" deduction, get professional advice.
Watch tax-deferred exchange rule changes for California.
During 2025, California adopted federal conformity legislation, SB 711. The new conformity date under the California Revenue and Taxation Code is updated from January 1, 2015 to January 1, 2025. Note the One Big Beautiful Bill Act was enacted AFTER January 1, 2025.
An important conformity item was changing California's Section 1031 Like Kind Exchange rules to conform to the Tax Cuts and Jobs Act of 2017, effective January 1, 2025. That means personal property no longer qualifies for like kind exchanges and only real estate continues to qualify.
Watch accounting methods conformity for California.
California also conformed to federal Internal Revenue Code §§451(b) and (c) as of January 1, 2025. §451(b) conforms tax accounting to financial statement reporting for certain items for publicly traded corporations and certain other audited financial statements. §451(c) required taxpayers that use the accrual method of accounting to include advance payments received in taxable income no later than the year after it was received.
Watch alimony reporting conformity for California.
California has conformed to the federal reporting rules for alimony (spousal support) effective for divorce or separation agreements entered into after 2025. For federal reporting, there is no deduction for the payor spouse and no income for the recipient spouse effective for divorce or separation instruments executed after December 31, 2018.
(Spidell's California Taxletter, January, 2026, P. 3, "Top 10 'must knows' for filing 2025 Form 540".)
Employers watch new rules for taxing employee meals benefits.
Under the Tax Cuts and Jobs Act of 2017, employer deductions are eliminated after 2025 for employer-provided meals that are excludable from an employee's income or are de minimis fringe benefits. (Internal Revenue Code §274(o).)
See Publication 15-B, page 19. For amounts incurred or paid after 2025, an employer can no longer deduct expenses associated with providing food and beverages to employees through an eating facility (cafeteria or executive dining room) that meets the requirements for de minimis fringe benefits or the convenience of the employer. https://www.irs.gov/pub/irs-pdf/p15b.pdf (There is an exception for meals provided to crews of certain commercial vessels, oil platforms and fishing boats.)
It may be that expenses for snacks and beverages provided to employees are also no longer tax deductible for employers.
De minimis fringe benefits are still not taxable for employees.
Food and beverage expenses related to employee recreation, such as holiday parties or annual picnics, are still 100% deductible when they are primarily for the benefit of employees other than employees who are officers, shareholders or other owners who own 10% or more of the business.
California doesn't conform to federal business meals rules.
California doesn't conform to the Tax Cuts and Jobs Act of 2017 and One Big Beautiful Bill Act of 2025 amendments that:
- Eliminate the deduction for entertainment expenses;
- Limit the employer's deduction for meals provided for the convenience of the employer to 50% of expenses for 2018 - 2025 tax years and make them nondeductible after 2025; and
- Repeal the deduction for qualified transportation fringe benefits provided to employees.
This means expenses for client meals and entertainment are not deductible for federal reporting, but are 50% deductible for California.
Meals provided for the convenience of the employer are 50% deductible for federal reporting through December 31, 2025 and not deductible after that date, except as noted above. Meals provided for the convenience of the employer that qualify as de minimis fringe benefits are 100% tax deductible and those not qualifying as de minimis fringe benefits are 50% tax deductible for California reporting.
(Spidell's California Taxletter Podcasts, January 4, 2026, "California nonconformity to business meals deductibility".)
Partnership debt allocation rules effective mostly 2025 forward.
The IRS issued final partnership debt allocation rules on December 2, 2024. The rules became effective for any liability incurred or assumed by a partnership on or after December 2, 2024, other than a liability incurred or assumed by a partnership pursuant to a written binding contract in effect prior to that date.
These rules are important to determine a partner's tax basis and at-risk amounts that are limitations for deducting losses from the partnership interest.
Shares of debt that is guaranteed by partners can't be allocated to more than one partner. Being allocated a share of debt means the partner is liable to repay it if the partnership defaults on paying the debt.
(T.D. 10014, December 2, 2024.)
Fifth Circuit reverses Tax Court on limited partner self-employment tax.
The Fifth Circuit Court of Appeals reversed the Tax Court decision for Sirius Solutions LLLP, finding the definition of "limited partner" for federal self-employment tax exemption purposes is defined by limited liability under state law. The Tax Court relied on its previous decision in Soroban Capital Partners, LP (161 T.C. 310 (2023) which required a partner to be a passive investor to be a limited partner for federal self-employment tax exemption purposes.
We will be seeing more litigation on this issue unless Congress makes a legislative solution.
(Sirius Solutions, L.L.L.P., Fifth Circuit Court of Appeals No. 24-60240, January 16, 2026.)
A wealth tax might be on California's midterm ballot.
The Service Employees International Union is promoting an initiative to impose a one-time 5% excise tax on the worldwide net worth of California residences who have a net worth more than $1 billion.
The tax would apply to individuals who were California residents as of January 1, 2026.
The tax would apply to the taxpayer's tangible and intangible property, including stocks, other business ownerships, bonds and collectibles. Real estate and certain pension and retirement accounts would be excluded from the tax base and so would personal property located outside California for more than 270 days in 2026.
Most of the revenue raised by the tax would be dedicated to the state's increased health care costs resulting from the federal government's cuts to Medicaid and other health care programs.
The tax would be due in 2027, but taxpayers subject to the tax could elect to pay the tax plus interest over five years.
This tax could be a windfall for appraisers to value personal property (like yachts, collectible cars, jet aircrafts and stock that isn't publicly traded).
(Spidell's California Taxletter, January, 2026, p. 9. "Initiative battles begin around the 'wealth tax'.")
Do you sell products, services or software to CPAs?
Maybe I can help with writing promotional material and marketing ideas. Call me, Michael Gray, at 408-918-3161 or email mgray@taxtrimmers.com.
Attention CPAs-would you like help with marketing your services?
Maybe I can help with writing promotional material and marketing ideas, including encouraging referrals from your current clients. Call me, Michael Gray, at 408-918-3161 or email mgray@profitadvisors.com.
Attention CPAs-do you need support for tax issues?
Michael Gray, CPA can help you with research and guidance on complex tax planning and tax return reporting issues. mgray@taxtrimmers.com.
Attention Accountants! Speed up processing your 2019 business closings!
Do you still have 2019 business income tax returns on extension that need to be done? Check out this trial balance software, EZ Trial Balance, that's super-easy to set up and use. There is a desktop version and an online version. The online version includes consolidations and ratio analysis for analytical review. http://www.eztrialbalance.com
Please share your good experiences with Michael Gray, CPA.
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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.
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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