Tax Season Toolkit: everything you need to navigate through the busy season.

As the holiday season turns into tax season, bringing the promise of constant, adrenaline-fueled deadlines, CPAs can be excused for turning a sentimental eye to winter. But never fear! CalCPA's annual Tax Season Toolkit is here to help.

As you meet with clients, research what's new in the tax codes and update your software to provide the best service you can, spring ahead and confidently meet the only season that's never late or early--tax season.

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California Tax Tips

No Conformity Bill Means More CA Differences

Some of the new non-conforming items as a result of the lack of a conformity bill this year include:

1. Charitable contributions fail to conform, but this is virtually immaterial because the Federal requirements set the higher standard. Federal law requires receipts or cancelled checks for all charitable contributions for 2007; California only requires taxpayers to meet the pre-2007 law.

2. California doesn't allow a deduction for mortgage insurance premiums as a mortgage interest expense.

3. HSA, FSA and IRAs. California doesn't allow tax free rollovers of HSA or FSA accounts into IRAs, creating taxable income and possibly an early withdrawal penalty. Indeed, California doesn't conform to health savings accounts at all.

4. California doesn't conform to the indexing of AGI requirements for IRAs (Spidell's CA Taxletter, Page 147, October 2007). Consequently, the taxpayer may have a different deductible amount for Federal income tax purposes than for California income tax purposes. However, this isn't new. There were different upper limits in the early days of IRAs and Keoghs.

5. Kiddie tax differences. The Internal Revenue Code applies the kiddie tax under age 18 for 2007, and under age 24 for students in 2008. California's limit remains at age 14.

6. California still doesn't permit the unlimited deduction of rental losses of real estate professionals.

Other Tax Legislation Enacted, A Partial List

SB 87: California has repealed the Teacher Retention Tax Credit

AB 897: This act eliminates the requirements for certain federally tax-exempt entities to apply for California income tax exemption by allowing 501c(3) organizations to submit a copy of the IRS tax exemption notice to the FTB to establish California income tax exemption. 501c(3) organizations would no longer be required to file an exemption application with FTB or submit a $25 filing fee.

Filing individual taxpayers as married filing separately

There's generally no advantage to filing married individuals as married-filing-separately because of the community income, deductions and credits that must be reported on each separate return.

However, there has been an added impetus to computing the taxes both ways because of the 1 percent surtax (called the Mental Health Services Tax) on taxable incomes of more than $1 million because a taxable income of, for example $1.6 million on a joint return turns into only $800,000 on each of MFS returns.

Oftentimes, though, since whatever filing status is used on the Federal Form 1040 must also be used on the California Form 540, with few exceptions, the additional taxes paid on the Federal return exceed the savings from filing MFS for California.

The only way to know for sure it do the return both ways. Computer programs are capable of doing that if the input is coded correctly.

Reminders of Protective Claims/Amended returns to be filed

1. Tax practitioners have been filing protective claims requesting refunds of the gross receipts LLC "fee" (but not the $800 annual tax), pending the outcomes of the Yentas and Northwest cases in the California courts. The California Legislature is attempting to circumvent these claims via AB 198, which would not allow full refunds if the current LLC fee provision is ruled unconstitutional. As of press time, the fate of AB 198 is unknown.

2. The other matter necessitating protective claims is the California provision that otherwise tax-free state and municipal bond interest is taxable to California residents when the source of the interest is a non-California instrument. This matter is on appeal to the U.S. Supreme Court in the case of Commonwealth of KY vs. George W. Davis et aux.

3. Protective claims for both matters for the year 2003 must be filed by April 15, 2008.

Federal Tax Tips

2007 SMALL BUSINESS & WORK OPPORTUNITIES TAX ACT Preparer Penalties Expanded and Increased

The definition of "preparer" is broadened to include preparers of gift, estate, employment, excise and exempt organization returns.

This Act also alters the standards of conduct that must be met to avoid penalties for preparing a return which has a tax understatement. The realistic possibility standard for undisclosed positions is replaced with a requirement that there be a "reasonable belief" that the tax treatment of the position was more likely than not the proper treatment.

The "not-frivolous" standard, accompanied by disclosure, is replaced with the requirement that there must be a "reasonable basis" for the position's tax treatment accompanied by disclosure.

In addition, the first-tier penalty is increased from $250 to the greater of $1,000 or 50 percent of the income derived, or to be derived, by the preparer from preparing the return or claim with respect to which the penalty is imposed.

The second-tier penalty also is increased from $1,000 to the greater of $5,000 or 50 percent of the income derived, or to be derived, by the preparer.

These new rules are effective for tax returns prepared after May 25, 2007. However, IRS Notice 2007-54 (IRB-2007, 7/2/07) relaxes this effective date for:

1. All returns, amended returns and refund claims due (with extensions) before 2008;

2. 2007 estimated tax returns (vouchers) due by Jan. 15, 2008; and

3. 2007 employment and excise tax returns due by Jan. 31, 2008.

The U.S. Treasury proposed regulations (REG-138637-07), Sept. 25, 2007, to conform the professional standards in Circular 230, Section 10.34 with these new preparer penalties. These regulations are proposed to be effective for returns filed or advice provided on or after the date that final regulations are published in the Federal Register, but not earlier than Jan. 1, 2008.

Erroneous Refund Claims

A new penalty is imposed on any taxpayer filing an erroneous claim for refund or credit. This penalty is 20 percent of the disallowed portion of the claim if there is no reasonable basis for the claimed tax treatment.

The penalty does not apply to the earned income credit (which has its own compliance rules). It also does not apply to any part of the disallowed portion of the claim that is subject to accuracy-related or fraud penalties.

Effective Date: Claims filed after May 25, 2007.

Kiddie Tax

The kiddie tax is expanded to apply to children who are 18 years old or who are full-time students over age 18, but under age 24. The expanded provision applies only to children whose earned income does not exceed one-half of the amount of their support.

Effective Date: Tax years beginning after May 25, 2007 (e.g., calendar year 2008).

Increased and Extended Sec. 179 Deduction

Old Law: Generally, the maximum amount that a taxpayer may elect to expense for tax years 2003-09 was $100,000 of the cost of qualifying property placed in service during the tax year.

Qualifying property was generally defined as new or used depreciable tangible personal property purchased for use in the active conduct of a trade or business. Off-the-shelf computer software placed in service in tax years beginning before 2010 was treated as qualifying property.

The $100,000 amount was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeded $400,000.

The $100,000 and $400,000 amounts were indexed for inflation for tax years beginning after 2003 and before 2010. For tax years beginning in 2007, the inflation adjusted amounts were $112,000 and $450,000, respectively.

Taxpayers could make or revoke Sec. 179 expense deduction elections on amended returns without IRS consent for tax years beginning after 2002 and before 2010. Any such revocation was irrevocable. New Law: The $100,000 and $400,000 amounts are increased to $125,000 and $500,000, respectively, for tax years 2007-2010. These amounts will be indexed for inflation in tax years beginning after 2007 and before 2011.

In addition, the new law extends for one year the increased amount that a taxpayer may deduct and the other Sec. 179 rules applicable in tax years beginning before 2010. Thus, these rules continue in effect for tax years beginning after 2009 and before 2011.

Effective Date: Tax years beginning after 2006.

S Corporation's Capital Gains No Longer Passive Investment Income

Old Law: An S corporation was subject to corporate level tax, at the highest corporate tax rate, on its excess net passive income if the corporation had:

* Accumulated earnings and profits (AE & P) at the end of the tax year; and

* Gross receipts more than 25 percent of which were passive investment income.

Also, an S election was terminated if the corporation had AE & P at the close of each of three consecutive tax years and had gross receipts for each of those years, more than 25 percent of which were passive investment income.