New Federal and California Developments on Cancellation of Indebtedness from Short Sales

On September 19, 2013, the IRS issued a Chief Council Letter where it stated that the short sale of a California principal residence converts the mortgage to a nonrecourse loan and is treated as a sale, not Cancellation of Indebtedness.  Under California law, when agreeing to a short sale, the bank may not go after the borrower for any shortfall on the debt.  The letter stated that, under the anti-deficiency provision of Code of Civ. Proc. §580e, the debt would be a nonrecourse obligation, and for federal income tax purposes the homeowner will not have COD income. Instead, the full amount of the nonrecourse indebtedness is treated as the sales price.

The California Franchise Tax Board has just updated their website to include information about mortgage debt relief for taxpayers who sold their principal residences through a short sale in 2013.  The FTB guidance confirms that California will follow this treatment.  The FTB clearly states that the IRS guidance is limited to California short sales only, and that the IRS guidance did not specifically address other types of real estate transactions, such as non-judicial foreclosures and mortgage loan modifications.

The information posted by the FTB can be found here.

Grouping Passive Activities

By Darren Morrow

If you own rental properties or have other similar passive activities that generate a loss each year and you want to be able to utilize that loss, then grouping activities may be a good option for you.

Grouping activities is the process of treating one or more passive trade or business activities, or rental activities, as a single activity, including rental real estate. This can only be done if those activities form an appropriate economic unit for measuring gain or loss under the passive activity rules. The simple definition of an economic unit is activities that are similar in nature, industry, and control. See IRS publication 925 for specific criteria regarding what constitutes and economic unit.

Grouping is important for a number of reasons. If two activities are grouped into one larger activity, you need only show that you materially participate in the activity as a whole. But if the two activities are separate, you must show that you materially participate in each one of the activities individually. This is especially beneficial if you own multiple rental properties and are trying to qualify for the material participation test or active participation test. Qualifying for these tests may allow you to potentially recognize all of the losses in the year incurred (materially participating real estate professional) or up to $25k of losses in the year incurred (active participation test). Grouping can also be important in determining whether you qualify for the 10% ownership requirement for actively participating in a rental real estate activity .

One of the downsides to look out for when grouping your activities is if you plan on disposing of one of your activities that accumulated suspended passive losses before it was grouped with other activities.  If you group two activities into one larger activity and you dispose of only one of the two activities, then you are considered to have disposed of only part of your entire interest in the activity. In this case, you are not allowed le to recognize the previously suspended passive losses of the disposed of activity since it is now considered part of the one larger activity. But if the two activities are separate and you dispose of one of them, then you are considered to have disposed of your entire interest in that activity and are able to recognize the suspended passive losses associated with the disposed of activity.

To group an activity all you need to do is file a written statement with your original income tax return for the first tax year in which two or more activities are originally grouped into a single activity. The statement must provide the names, addresses, and employer identification numbers (EIN), if applicable, for the activities being grouped as a single activity. In addition, the statement must contain a declaration that the grouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules.

Certain activities are restricted from being be grouped. They are listed below:
– Motion picture films
– Farming
– Leasing 1245 property
– Oil and Gas resources
– Geothermal deposits.

For more information about grouping passive activities and material participation please contact us at http://www.ntcpas.com or contact our offices at (714) 836-8300.

Standard Mileage Rates go Down in 2014

Via Journal of Accountancy

Optional standard mileage rates for use of a vehicle will go down by one-half cent per mile for 2014, the IRS announced on Friday (Notice 2013-80). Taxpayers can use the optional standard mileage rates to calculate the deductible costs of operating an automobile.

For business use of a car, van, pickup truck, or panel truck, the 2014 rate will be 56 cents per mile. Driving for medical or moving purposes may be deducted at 23.5 cents per mile. Both rates are one-half cent lower than for 2013.

The rate for service to a charitable organization is unchanged, set by statute (Sec. 170(i)) at 14 cents a mile.

The portion of the business standard mileage rate that is treated as depreciation will be 22 cents per mile for 2014, down one cent from the 23 cent rate in effect in 2012 and 2013.

For purposes of computing the allowance under a fixed and variable rate (FAVR) plan, the maximum standard automobile cost for 2014 is $28,200 for automobiles (not including trucks and vans) or $30,400 for trucks and vans, increases of $100 and $500, respectively, from 2013. Under a FAVR plan, a standard amount is deemed substantiated for an employer’s reimbursement to employees for expenses they incur in driving their vehicle in performing services as an employee for the employer.

Deadline Approaching for 100% Qualified Small Business Stock Gain Exclusion

Via Journal of Accountancy

Taxpayers have a short window in which to act if they want to take advantage of the Sec. 1202 provision that allows exclusion of 100% of the gain realized on the sale or exchange of qualified small business stock (QSBS). Unless the law is amended, for QSBS acquired after Dec. 31, 2013, the Sec. 1202 exclusion percentage will fall to 50%, and an alternative minimum tax (AMT) preference will further erode the exclusion’s advantages.

Currently, Sec. 1202 allows exclusion of 100% of the gain realized on the sale or exchange of QSBS for stock that is acquired after Sept. 27, 2010, and before Jan. 1, 2014, and held for more than five years. The exclusion applies to non-corporate taxpayers within certain tax-year limits.

In addition, the Sec. 57(a)(7) AMT preference for a portion of the gain excluded under Sec. 1202 does not apply to QSBS purchased within this period (Sec. 1202(a)(4)). Because the deadline for acquiring stock that will qualify for the more favorable treatment is rapidly approaching, investors should plan to complete any purchases of stock that could qualify as QSBS before the end of the year. 

If you have any questions regarding this article or any other matter, please contact our office at (714) 836-8300.

Governor Signs Cutler Bills

Via Spidell Publishing

On October 4, 2013, Governor Brown signed both AB 1412 and SB 209. Because the Governor signed AB 1412 last, it will become operative.

This means that for taxable years 2008 through 2012, taxpayers may exclude 50% of the gain on the sale of small business stock.

The bill not only reinstates the exclusion on the gain of small business stock deemed unconstitutional in Cutler, but it also generally allows taxpayers who claimed the small business exclusion on the federal return to also claim an exclusion on the California return for all open years. This is because AB 1412 removes the 80% payroll and property in California requirements.

Among other things, the bill allows taxpayers 180 days from the date of enactment to file a claim for refund for the 2008 year.

No California Principle Residence COD Exclusion for 2013

Via Spidell Publishing

The California Legislature did not extend the COD exclusion for canceled qualified principal residence debt when SB 416 was defeated.  This means that a homeowner who loses a home to foreclosure in 2013 may not use the principal residence exclusion to exclude COD income on his or her California return.

An individual who has COD income in this situation should:

• See if the insolvency exclusion will exclude income; or
• Plan for a California tax liability in 2013.

Federal law extended the exclusion through 2013.

Installment Sale Basics

By Darren Morrow, CPA

Ever heard of an installment sale?  This article will help you understand the basics of installment sales, including what you need to know to help you make the best decisions when selling property.

An installment sale is the sale of a property where both parties have agreed to terms where the payments will be made over a number of years instead of receiving the entire purchase price at the time of sale. For instance, a person may choose to sell their home to someone and receive payments over a ten year period. The technical definition of an installment sale for tax purposes requires that payments must be made in at least two separate tax years.

Calculating the taxable income to be recognized under an installment sale is quite simple. The first step is to calculate the gain on sale as you normally would (sales price less tax basis). Then a percentage is calculated taking the principal portion of payments received in the current year divided that by the total sales price.  Taxable income for the current year must include this percentage of the overall gain on the sale of the property.

There are some benefits to taxation under the installment sale rules.  One of the most obvious benefits is the deferral of capital gains taxes. Since you are only recognizing a portion of the gain in the current year you are only taxed on that amount.  The additional tax due from the sale is deferred to future years. Another benefit that is not quite as obvious is that you could possibly be in a lower tax bracket each year since you are not recognizing a large amount of income in one year. Additionally, an often overlooked benefit of the transaction is the additional interest income that can be structured into the sale. Generally sellers will receive a higher rate of interest on the deferred funds than can be realized elsewhere, and the note receivable is secured by the real property. 

Installment sales are not always an option for every transaction. Installment sales cannot be used (for tax calculation purposes) if your sale results in a loss (sales price exceeds your basis), or if it is a sale of inventory, stocks, or securities traded on an established securities market. Additionally, if you choose to do an installment sale and defer your capital gains into future years and the tax rate on capital gains goes up, you could potentially pay a higher amount of tax in the future.

Knowing how installment sales work and how to use them to your advantage is a great tool when negotiating a sale. It will let you have more control over your income and may even earn you a little extra interest income along the way. For more information about installment sales please contact us at http://www.ntcpas.com or contact our office at (714) 836-8300.

Enterprise Zone Bill Waiting for Governor’s Signature 7/11/13 UPDATE: BILL SIGNED

The Senate and State Assembly have passed AB 93, which makes major changes to the Enterprise Zone program.  The bill is now awaiting the Governor’s signature.  The Governor has been a supporter of the changes to the Enterprise Zone program, so his signature is essentially guaranteed.  UPDATE: ON JULY 11, 2013, AS EXPECTED, GOVERNOR BROWN SIGNED SB 90 AND AB 93.

The bill eliminates the current Enterprise Zone Hiring Credit for employees hired on or after January 1, 2014. Employees hired and vouchered prior to January 1, 2014 will continue generating credit for their first 60 months of employment. The bill gives taxpayers a 10-year carryforward period to use these credits.

The bill also provides a new sales and use tax exemption for manufacturing equipment beginning in 2014. This benefit will apply for tax years through July 1, 2019 (2021 for taxpayers in certain areas).

A new credit will be available for taxable years beginning on or after January 1, 2014, and ending before January 1, 2021. The new credit applies to fewer employees than the current credit, and certain industries are specifically excluded.

Nienow & Tierney, LLP will continue to keep you updated on the status of AB 93 and other tax laws affecting you and your business.  If you have any questions, please contact our office at (714) 836-8300.

Research and Development Credit – The Basics

As an incentive for businesses to engage in research and development, the Internal Revenue Code provides for the Incremental Research Expenses Credit, also known as the Research and Development Credit (R&D Credit).  This credit may be claimed by a business as one of the general business credits. This credit is intended to benefit those who spend resources on bettering their technology with the intention to develop or improve a business component – especially in the manufacturing and distribution field. The expenditures must have a functional purpose.  They must relate to new or improved function or increase performance, reliability or quality.

The Research and Development Credit may be calculated using one of two methods. Under the general method, 20% of the increases in qualified research expenses over a base year are allowed as a credit against tax. The base period amount is a result of fixed-base percentage and average annual gross receipts for four years preceding the credit. The fixed-base percentage of qualified research expenses may not exceed 16% of gross receipts for the preceding four years. The base amount may not be less than 50% of the qualified research expenses for the credit year.

The Alternative Simplified Credit Method may also be used to calculate the increased research activities credit. Under the Alternative Simplified Credit Method, the credit is generally calculated as 14% of the amount of current year qualifying expenses in excess of 50% of the average of qualifying expenses over the three years preceding.

Expenses qualifying for the Research and Development Credit are generally all in-house expenses dedicated directly for research – wages, supplies, rent of a qualified facility and computer charges, as well as 65% of amounts paid or incurred for research done by someone other than an employee, or 75% if using a qualified research consortium.

The credit is subject to general business credit tax liability limitation and carryover rules. Additionally, the amount of credit will also reduce the deduction for research expenses unless otherwise elected.

Generally, it is preferential to take the credit and lower the corresponding deduction because there is a dollar for dollar tax benefit for expenditures resulting in a credit, as compared to a partial tax benefit for expenses treated as a tax deduction.

This information is intended to provide a basic understanding of the R&D Credit.  Please contact our office to better understand the details, and to explore taking advantage of this great credit.

Author: Sid Siddiqui

CPA Day at the Capital

 

On January 23rd, CPA’s from all around the State of California converged on our state capital in Sacramento as a part of the annual CPA Day at the Capital.

Meetings were scheduled with each state Senator and Assemblymen/women.  It was an opportunity for the CPA profession to voice a united opinion on the topics which affect our profession and also the taxpayers for whom we prepare tax returns and financial statements.

This year, Stephen Tierney took part in this opportunity to share with our state legislature the issues which we feel are important to clients such as yourself.

We specifically called upon the legislature to forego any effort to impose sales tax on service organizations.  As a profession, we feel that this tax would provide an unfair advantage to service based business owners located outside of the state.  This additional tax would also cause increased costs to our clients for tax preparation services.

As we met with the state representatives, we also promoted a financial literacy program which is sponsored by the California Society of CPA’s.  This program is designed to educate individuals on basic financial issues such as maintaining a budget and how to save for future expenses.  These programs are provided free of charge by CPA’s around the State of California.

Stephen loved the opportunity to meet with our state representatives and participate in helping promote issues for our clients and our profession.  He looks forward to participating in this event in future years.