Michael Gray, CPA's

April 9, 2010
© 2010 by Michael C. Gray
ISSN 1930-0387

A monthly report focusing on tax issues for the homeowner and real estate investor.

Table of Contents

• Only 6 days left in tax season!
• Extensions – and when you don't have the money to pay the tax.
• What to do when your state is holding refunds.
• First individual estimated tax payment is due April 15.
• First calendar corporation estimated tax payment is due April 15.
• Last chance to make an IRA or Roth contribution for 2009.
• Remember second California real estate tax payment is due April 10.
• First time homebuyer credit expires April 30.
• California adopts tax credits for home purchases.
• Health Care Reform includes tax changes.
• Jobs Act includes tax changes.
• Financial Insider Weekly broadcast schedule.
• Questions and Answers
• Common questions answered on our website.
• How does California calculate the gain on the dispostion of rental property?
• Follow me on Twitter, Facebook and LinkIn!
• Interested in our other newsletters?
• Check out my blog.
• Subscribe/Unsubscribe from Michael Gray, CPA's Real Estate Tax Letter

Only 6 days left in tax season! Time to think about extensions.

There isn't enough time left to give preparing tax returns the attention they deserve, but we can help a few more new clients with extensions and finish their returns later. To make an appointment, please call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Extensions - and when you don't have the money to pay the tax.

(This is a reprint from past newsletters.)

What do you do when you don't have the money to pay the tax?

My first recommendation is to file your income tax returns, certified mail, by the initial filing date. One of the nastiest penalties in the IRS's arsenal is for late filing - 5% per month to a maximum of 25%. Some people who owe money don't file their returns because they are afraid. THIS IS A HUGE MISTAKE! The best approach is to be honest about your situation and work with the tax authorities to resolve it.

When you file an extension, any balance of tax due when the tax return is filed represents an exposure for the late filing penalty.

Please don't misunderstand me. I regularly use extensions for my clients and myself as a workload "safety valve." We often don't have the information to complete a return by the due date. They just aren't appropriate when there will be a significant balance due that won't be paid by the original filing due date.

Remember the automatic extension of time to file for 2009 individual income tax returns is for six months to October 15, 2010.

Remember to state a good (high side) estimate of total tax liability for 2009 on line 4 of federal Form 4868 or the extension will be invalid. According to the Treasury regulations for the requirements to file a valid automatic extension request, "an application for extension must show the full amount properly estimated as tax for the taxable year." (Reg. § 1.6081-4(a)(4).) The regulations relating to reasonable cause for failure to file a tax return state that if a taxpayer satisfies the requirement of showing the full amount estimated as tax, the taxpayer has a reasonable cause for failure to file during the extension period provided (1) the excess of the amount of tax shown on the return over the amount of tax paid by the original filing date (including the amount paid with the extension form) is no greater than 10 percent of the amount shown on the return (restated, 90% of the tax is paid by the due date), and (2) any balance due shown on the return is paid with the return. (Reg. § 301.6651-1(c)(3).)

(For California taxpayers, the extension is paperless so the amount of the tax need not be stated. You are still required to pay at least 90% of the tax by the original due date with Form FTB 3519 to avoid the late filing penalty.)

If you have filed an income tax return for 2008, you can process your federal extension electronically (using tax return preparation software or through a tax return preparer). If you make a tax payment using a credit card, you can extend your income tax return by calling 888-729-1040 or 800-272-9829 by April 15. (For California extension payments, the extension is 1555.) Better call early to beat the rush! Mailing a paper form is still acceptable and is the only way a person who didn't file a 2008 income tax return can request an automatic extension.

You can also make a credit card payment online at www.pay1040.com or www.officialpayments.com. California also has a web payment option at www.ftb.ca.gov.

A taxpayer can still avoid the late filing penalty by demonstrating a "reasonable cause," but this can be a hassle and the taxpayer is at the mercy of the subjective judgment of a representative of the tax authority.

Should you borrow using a margin account? In most cases, this is not a good choice because of the exposure to margin calls if the market declines.

Should you use an equity advance loan, secured by your principal residence? In some cases it might be to your advantage, if you can get a favorable interest rate. Remember that interest for an equity loan not used for a home improvement is only deductible on a loan amount up to $100,000. This interest is not deductible when computing the alternative minimum tax.

Remember that IRA accounts and even other retirement accounts can be temporary sources of funds. Distributions from IRAs that aren't minimum required distributions can be rolled over to another IRA or returned to the same IRA within 60 days after a withdrawal. This exception only applies to one rollover per year. (You must wait more than one year after a rollover is completed before making another one.)¹

Certain distributions from other qualified plans can also be rolled over within a 60-day period to an IRA or another qualified plan.² Using IRAs or qualified plans as a temporary source of funds to pay taxes can be useful if the funds to complete the rollover will soon be available, such as when there is a lockout "window" that will soon be open. The cost of an error can be high, because if the rollover isn't completed before 60 days have expired, the distribution may be subject to tax as ordinary income plus a 10% early distribution penalty.³

The IRS has a form for installment agreements, Form 9465. They would prefer that you submit the form with your income tax return. You can take up to five years to pay off your tax liability. An advantage of arranging an installment agreement is the penalty for late payment of tax is reduced from 1/2% per month to 1/4% per month. In addition to penalties, interest is charged for late tax payments. The interest rate is adjusted quarterly. Recently, the rate has been eight percent.

Another alternative is to make an Offer in Compromise, Form 656. With this procedure, the IRS actually can reduce your tax based on your ability to pay. You don't have to wait until you have owed the tax a long time to use this procedure. I think it's best to work with an attorney, CPA or enrolled agent when making an Offer in Compromise. If the amount is large, an attorney is probably the best choice. (This may be an exercise in futility. The IRS has recently been rejecting almost all offers. You are required to make a non-refundable deposit of 20% of the compromised tax in most circumstances. It's sad, because taxpayers really need this relief.)

Although it may provide relief from your other creditors, bankruptcy doesn't offer much help for recent debts for income taxes. When you make payments on your tax bill, be sure to specify to apply the payments to taxes due. Penalties and interest are dischargeable in bankruptcy, but income taxes aren't.

It may be to your advantage to plan how to use regular tax or alternative minimum tax capital loss carryovers or minimum tax credit carryovers. You might need to generate capital gains, which can be difficult when you're in financial distress.

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What to do when your state is holding refunds.

Some states, such as Hawaii, are holding refunds due to the current cash crunch. Consider making an arrangement to apply the overpayment to next year's estimated tax and reduce your withholding at work or next year's estimated tax payments.

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First individual estimated tax payment is due April 15.

(This is a reprint from past newsletters.)

Remember to review your estimated tax situation for 2010.

There is no estimated tax penalty provided the taxpayer pays at least 90% of the tax (including AMT) on the current year's tax return through withholding and/or equal quarterly estimated tax payments.

For taxpayers who have no more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year's income tax return, there is no penalty for underpayment of estimated tax provided at least the income tax on the previous year's income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.⁴ For taxpayers who have more than $150,000 of adjusted gross income ($75,000 for married persons, filing separately) on the previous year's income tax return, there is no penalty for underpayment of estimated tax provided at least, for 2010, 110% of the income tax on the previous year's income tax return (including AMT) is paid in equal quarterly estimated tax payments plus withholding.⁵

Remember California now requires 30% of the estimated tax liability to be paid for the first quarter of 2010, 40% for the second quarter, none for the third quarter and 30% for the fourth quarter.

Taxpayers who have uneven income and deductions may also compute their estimated tax on an "annualized" basis. You multiply the year to date income and deductions to arrive at amounts for a year, compute the tax for that amount, then pay federal amounts to cumulatively pay in 1/4, 1/2, 3/4 and 100% of those amounts. You should probably get help from a professional tax return preparer to do this. (California wants cumulative amounts of 30%, 70%, 70% and 100%.)

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First calendar corporation estimated tax payment is due April 15.

Calendar-year Corporations almost always have to pay the minimum California tax payment of $800 by April 15, 2010. In addition, regular corporations have federal and California estimated tax payments due on that date. The estimated tax payments may be based on the income tax on last year's income tax returns, provided there was a tax on the return. If there was no tax, the estimated tax must be computed based on the current year's income. Corporations that had taxable income exceeding $1 million in any of the last three years may only base their first estimated tax payment on last year's income tax returns; the rest must be based on the current year's income.

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Last chance to make an IRA or Roth contribution for 2009.

Remember the final due date for IRA and Roth contributions for 2009 is April 15, 2010. We don't think making an election to have a tax overpayment deposited to an IRA or Roth account is a good idea for income tax returns filed during the last two weeks of tax season. It's too easy for a refund to be delayed past the due date.

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Remember second California real estate tax payment is due April 10.

With the income tax deadline, most of us are focused on April 15, but the second California real estate tax payment is due April 10, and there is a nasty penalty for a late payment. Consider yourself reminded!

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First time homebuyer credit expires April 30.

Remember that the federal First-Time Homebuyer Credit is scheduled to expire April 30, 2010. The credit actually applies to a closing date of June 30, 2010 provided the contract of sale is in place by April 30. Individuals who owned a home for five of the last eight years are also eligible for a credit. For details go to www.realestateinvestingtax.com/first.shtml.

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California adopts tax credits for home purchases.

California has enacted AB 183, which includes tax credits for first-time homebuyers and taxpayers buying homes that have never been occupied. The credits are the lesser of 5% of the purchase price or $10,000. The credit applies for taxpayers who purchase a "qualified principal residence" on or after May 1, 2010 and before January 1, 2011. The credit will also apply if a contract is in effect on or after May 1, 2010 and before January 1, 2011, provided the sale is completed by August 1, 2011.

It's possible for both the federal credit and a California credit to apply to the same home purchase.

The credit applies over a three-year period, beginning with the year in which the qualified principal residence is purchased.

Each credit has a $100 million limit for the state, and will be awarded to taxpayers on a first-come, first-served basis. (You have to apply for the credit before you file your income tax returns.)

The credits are not refundable, do not reduce AMT, and can't be carried over.

(Spidell Publishing Flash E-Mail March 24, 2010.)

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Health Care Reform includes tax changes.

As you know, Congress has passed and President Obama has approved significant health care reform legislation. There are a number of tax provisions in the legislation that I don't have time to discuss in detail.

• One is an increase of the Medicare tax on high-income taxpayers, including a tax on investment income! The 3.8% tax won't take effect until 2013. It applies to individuals with adjusted gross income of $200,000 for singles, $250,000 for married filing joint returns. A 0.8% additional Medicare payroll tax will also apply. For details see my blog post at michaelgraycpa.com/2010/03/29/health-care-act-includes-big-medicare-taxes-for-high-income-taxpayers/.
• For 2010 through 2013, eligible employers may qualify for a sliding-scale tax credit of up to 35% of their contribution to employees' health insurance premium. Eligible small employers have no more than 25 employees and average annual wages of less than $50,000. For 2014 and beyond, eligible employers who purchase coverage through an insurance exchange may qualify for a credit for two years of up to 50% of their contribution. Salary reduction contributions are not counted.
• Cafeteria plan rules are relaxed to encourage more small employers to offer tax-free benefits to employees.
• Beginning in 2018, a 40% nondeductible excise tax will be imposed on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of an inflation-adjusted $10,200 for individuals and inflation adjusted $27,500 for families. The tax will apply to the amount in excess of the thresholds.
• Effective for tax years beginning after December 31, 2012, the threshold for the regular tax itemized medical deductions will be increased to the same as for the alternative minimum tax from 7.5% to 10%. The threshold increase will be postponed for individuals age 65 and older and their spouses until after 2016.
• The exclusion for family health care benefits will apply to adult children under age 27. The deduction for health insurance for self-employed individuals will also apply to this coverage.
• Starting in 2014, monthly penalties will apply to individuals not eligible for Medicaid, Medicare, other government-sponsored coverage or other exemptions who don't have health insurance coverage.

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Jobs Act includes tax changes.

President Obama signed the Hiring Incentives to Restore Employment Act on March 18. The Act includes some important tax incentives.

• The employer's part of Social Security tax of 6.2% of an employee's taxable wages up to $106,800 is waived for covered workers on the employer's payroll after March 18, 2010 and before January 1, 2011. The covered employee must begin employment after February 3, 2010 and before January 1, 2011. The covered employee can't be hired to replace another employee of the qualified employer, unless the other employee voluntarily quit or was terminated for cause. The covered employee may not be related to the employer. Household employers are ineligible for the credit. In order to qualify, the employees must certify they were unemployed during the 60 days before beginning work, or that they worked fewer than a total of 40 hours for another employer during the 60 day period. The IRS is developing a form for employers to use for the certification. Remember, Medicare tax still applies!
• The increased $250,000 expense election limit, which had expired at the end of 2009, has been extended through December 31, 2010. The investment limitation up to $800,000 before the expense election is phased out has also been extended.

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Financial Insider Weekly broadcast schedule for April and May.

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 4:30 p.m., Pacific Time. You can watch it on Comcast channel 15 for those cities. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for April and May:

April 14, Lori Greymont of Summit Solutions Team Corp., "Real estate investment strategies I"

April 21, Lori Greymont of Summit Solutions Team Corp, "Real estate investment strategies II"

April 28, James Quillinan, Esq. of Hopkins & Carley, "Tax planning and compliance issues of federal estate tax repeal for 2010".(Note schedule change!)

May 5, James Quillinan, Esq. of Hopkins & Carley, "California real estate change of ownership rules in estate and business planning"

May 12, Don Pollard of Advanced Professionals, "What Federal Health Care Reform means for you"

May 19, Don Pollard of Advanced Professionals, "Medical insurance alternatives"

May 25, To be announced

Financial Insider Weekly is also broadcast as follows:

• Sunday at 5 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California
• Monday at 7:30 p.m. on Comcast channel 15 in Saratoga
• Thursday at 5:30 p.m. on Comcast channel 27 in Santa Cruz County and Charter Communications channel 73 in Capitola and Watsonville
• Thursday at 7 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County
• Thursday at 10 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California
• Friday at 4 p.m. on cable channel 15 in Cupertino, Los Altos and Mountain View
• Friday at 4:30 p.m. on Comcast channel 15 in Los Gatos

Back episodes available at https://www.youtube.com/user/financialinsiderweek.

Let me know any ideas that you have for topics or guests. Guests will usually have to be located in or near the Silicon Valley in California.

Hope you can watch or record the show. Please tell your friends about it!

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Questions and Answers

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

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.

Many other questions relate to short sales and foreclosures. See our article on that subject at www.realestateinvestingtax.com/shortsale.shtml.

Question

Does California calculate the gain on the disposition of a rental property the same way as on the federal income tax return? Are certain costs disallowed?

My tax software is not including adjustments to basis which includes the land and the other costs associated with previous refinancing that could not be previously deducted?

Answer

You might be having some difficulty with the details of handling state reporting with your software. There are occasionally some differences for items like depreciation methods between federal and California reporting, depending on when the property was acquired, but mostly the information is usually the same.

I suggest that you call technical support at the software company for help.

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