Michael Gray, CPA's Blog

Tax and financial advice from the Silicon Valley expert.

Two little words that might save your grandchild’s inheritance

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  • mike   

When my father passed away, I helped my mother rollover his traditional IRA to her own name.

I helped her designate my brother, my two sisters and myself as beneficiaries for the account, by simply listing our names.

Sadly, one of my sisters died from cancer before my mother’s death. No changes were made to the beneficiaries of my mother’s IRA after my sister’s death.

After Mother’s death, I went to her credit union to arrange for distributing the balance of the IRA. I was surprised to learn my deceased sister’s share didn’t go to her children, my two nephews. Since my sister predeceased my mother, her name was simply removed as a beneficiary and her share was divided equally by my mother’s remaining children.

Fortunately, my mother’s revocable living trust had language that preserved the share of my sister’s children for her remaining assets.

My nephews, who were adults, felt fortunate to receive any inheritance from their grandmother, and the balance of the IRA was small, so they weren’t concerned.

Their father, my brother in law, was more sensitive about his sons’ inheritances. I was embarrassed to explain that his sons wouldn’t receive a couple of thousand dollars each from the IRA. He also let the matter go.

For many families, the largest assets in a decedent’s estate are the family residence and the decedent’s retirement accounts. Making beneficiary designations for the retirement accounts is very significant, and most of us don’t consult with an estate planning attorney when making those designations. We just quickly “fill out the forms”.

Since we don’t normally think about our retirement accounts as accessible assets, they can be “invisible” assets that are even neglected by attorneys for estate planning. This is a big mistake. Whenever working on an estate plan with an attorney, remember to include your retirement accounts, including your beneficiary designations.

If my mother had included two little words after my sister’s name, her share of the IRA would have gone to my sister’s children. The words are “per stirpes”.

They are a legal phrase that roughly mean “by right of representation”. For example, for the beneficiary designation “Mary Smith, per stirpes”, if Mary predeceases the IRA owner, her share is divided equally by her children. If Mary and one or more of her children predecease the IRA owner, a deceased child’s share would be divided equally by that child’s children (Mary’s grandchildren via that child). Etc.

My understanding is “per stirpes” isn’t used when naming a spouse as a beneficiary. In that case, children, per stirpes could be named as successor beneficiaries for the contingency of the spouse’s death.

After my experience after Mother’s death, I changed the successor beneficiaries of the retirement accounts for my wife and myself, listing our children, per stirpes, as successor beneficiaries.

I recommend that you consult with an estate planning attorney to create your estate plan, including discussing your retirement accounts. While that’s in process, consider adding “per stirpes” to your beneficiary designations.

Michael Gray, CPA is the co-author of How To Use Roth & IRA Accounts To Provide A Secure Retirement, 2025 Edition. rothirainvestingbook.com

Tariff controversies after Supreme Court ruling

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  • mike   

On February 20, 2026, the Supreme Court ruled in Learning Resources v. Trump that tariffs imposed by President Donald Trump exceeded his authority under the 1977 International Emergency Economic Powers Act.

Three conservative Justices, Chief Justice John Roberts and Justices Amy Coney Barrett and Neil Gorsuch, joined the court’s three liberals in the 6-3 majority.

Chief Justice Roberts wrote in his opinion, “The President asserts the extraordinary power to unilaterally impose tariffs of unlimited amount, duration and scope. In light of the breadth, history, and constitutional context of the asserted authority, he must identify clear congressional authorization to exercise it.”

The ruling doesn’t apply to national security tariffs imposed on specific industries, including automobiles and auto parts, steel and aluminum, copper and softwood lumber.

Since the trade agreements Trump has been making with other countries involved relief from high tariffs, those agreements could be reopened.

The Court’s ruling didn’t include whether or how about $175 billion collected from the tariffs would be refunded. According to Treasury Secretary Scott Bessant, a lower court will need to decide the issue. “The Supreme Court remanded it down to a lower court. And, you know, we will follow what they say, but that could be weeks or months.”

The Tariff Refund Act of 2026 has been introduced by Democrats in the Senate and the Restoring Economic Lifelines for Independent Enterprises and Family Business Act has been introduced by Democrats in the House of Representatives, which would require refunding the tariffs plus interest, eliminating the need for individual applications or formal protests. Since the Democrats don’t have control of the Senate or the House and President Trump is unlikely to approve these proposals, they probably won’t be enacted.

Meanwhile, about 1,000 companies have filed protective refund lawsuits, including Costco. FedEx filed for a refund on February 23. Maybe there will be a class action lawsuit to reduce legal expenses of recovering tariffs paid?

President Trump is furious with the Supreme Court’s ruling. “The Supreme Court’s ruling on tariffs is deeply disappointing, and I’m ashamed of certain members of the Court — absolutely ashamed — for not having the courage to do what’s right for our country.”

President Trump believes the Supreme Court has left the possibility of using alternative theories to continue broadly imposing tariffs. Trump and his team had a “Plan B” ready to implement.

Immediately after the Supreme Court ruling on February 20, President Trump signed an Executive Order imposing a 10% tariff on worldwide imports to the United States under Section 122 of the Trade Act of 1974, effective February 24, 2026. Less than 24 hours later, he announced the tariff to be increased to 15%, the maximum under Section 122. Under Section 122, the tariff may be imposed for up to 150 days, unless Congress agrees to extend it. Since Section 122 has never been invoked before, it’s unknown if Trump could invoke it again after the 150 days expires.

Exemptions apply for the 15% tariff that are similar to those that were invalidated by the Supreme Court, with carve outs for specific products within sectors such as energy, pharmaceuticals, autos, and aerospace, and shielding goods from North American neighbors under the U.S. Mexico-Canada Agreement, which was signed by President Trump during his first term.

It isn’t clear that President Trump has the authority to impose tariffs under Section 122 of the Trade Act of 1974. The tariffs were meant to be imposed when the United States faces “fundamental international payments problems” requiring emergency action. The legislation was enacted when the United States suffered a balance of payments problem under fixed currency exchange rates that were later replaced with floating currency exchange rates.

Three circumstances qualify for the temporary surcharge: (1) dealing with “large and serious United States balance-of-payments deficits”; (2) preventing “an imminent and significant depreciation of the dollar in foreign exchange markets”; or (3) cooperating with other countries “in correcting an imbalance in international payments.”

Note that trade deficits aren’t included on the list.

Section 122 was written for something specific: a crisis where a country is running out of the foreign exchange or gold reserves needed to honor it’s international obligations. That was the world scenario during 1971.

According Bill Riley, director of the Free Trade Initiative, “Section 122 only makes sense under a fixed exchange rate, which hasn’t existed in the U.S. in more than 50 years.” The economic conditions for Section 122 can’t arise under the current monetary system.

It seems likely the 15% tariff will be litigated and, in light of the Supreme Court’s ruling in Learning Resources v. Trump, could be subjected to emergency court injunctions.

Make your Section 83(b) election online

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  • mike   

Employees or service providers who receive restricted or unvested property, such as employer stock, as compensation should consider making a Section 83(b) election online. A Section 83(b) election is used to accelerate the taxation for unvested property received as compensation.

The most common situation where we see it in Silicon Valley is when a nonqualified stock option has an early exercise privilege (isn’t vested). For example, when an employee exercises a nonqualified stock option that has an early exercise privilege doesn’t work a certain number of years, the unvested stock is forfeited back to the employer.

When a vested nonqualified stock option is exercised, the excess of the fair market value of the stock over the option price is taxed as ordinary compensation income. When a nonvested nonqualified stock option is exercised, the ordinary income event is when the stock vests. When a Section 83(b) election is made, the exercise is treated “as if” the stock was vested. The option holder makes the election because he or she expects the price of the stock to grow in the future.

Similar rules apply for restricted/nonvested stock grants, but not for restricted stock units (RSUs).

In addition, the holding period for the stock for qualification for long-term capital gains is generally measured from the later of the exercise date or the vesting date. Since a Section 83(b) election results in vesting being disregarded, the holding period when the election is made starts on the exercise date.

For incentive stock options, a Section 83(b) election is only effective for the alternative minimum tax. Incentive stock option benefits from holding the stock more than two years after the grant date and more than one year after exercise only apply for regular tax reporting, and the incentive stock option rules superscede Section 83 when an incentive stock option is exercised.

During April, 2025, the IRS issued new Form 15620 for making a Section 83(b) election. The election can still be made with alternative written election language.

According to the instructions for the paper Form 15620, the employee or service provider should “Submit this completed and signed Form 15620 to the IRS via mail with the IRS office with which the person who performs the services files a federal income tax return.”

The IRS also (quietly) allows Form 15620 to be submitted online using its idME portal. According to the instructions on the idME site, Form 15620 may be submitted “either online (preferred), or by mail, but not both.” The Section 83(b) election may only be submitted using Form 15620 when it is submitted online using the idME portal.

To my knowledge, the IRS has made no public announcement of this alternative.

Here is a link for the IRS’s “mobile-friendly form”. https://tinyurl.com/83online

You need an IRS idME online account to file the form online and you can do it using the above URL if you don’t already have one.

An advantage of filing online is you are assured the IRS has received it and shouldn’t misplace it.

The IRS prefers electronic filing because it’s far more efficient for the IRS to process electronic forms. They call paper forms “kryptonite”.

To be effective, a Section 83(b) election must be filed within 30 days after the option is exercised or restricted/unvested stock is granted.

A signed copy of the election must also be submitted to the transferee of the property and the person/company for whom services were performed.

A Section 83(b) election is generally irrevocable — you can’t change your mind later.

Employees or service providers who receive a nonqualified stock option with an early exercise privilege or a restricted stock grant should consult with a tax advisor who knows these rules.

Tax advisors should alert their clients who issue or receive stock-based compensation of this choice for making a Section 83(b) election.

Take mailed estimated tax payments to a USPS retail counter

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  • mike   

On November 24, 2025, the U.S. Postal Service published a notice in the Federal Register clarifying its postmark policies, effective December 24, 2025. https://www.federalregister.gov/documents/2025/11/24/2025-20740/postmarks-and-postal-possession

The new policy is also explained in this article from the USPS Newsroom. https://about.usps.com/newsroom/statements/010226-postmarking-myths-and-facts.htm

Instead of dating the postmark when an item of mail is accepted by the USPS, the postmark is generally dated when the item is processed at its automated processing facility, which might be several days after its accepted.

This might cause an issue for items mailed, but not postmarked, by a critical due date, such as a tax filing due date or voting day for a mail-in ballot.

Here are three ways to ensure a postmark showing the date of delivery:

  1. Request a Manual Postmark. Take the mailpiece to a USPS retail counter and request a “manual (local) postmark”. The postmark will be applied when the item is accepted. There is no additional charge for this service.
  2. Postage Validation Imprint (PVI). When postage is purchased at a retail counter and a PVI label is printed, the label will indicate the date of acceptance.
  3. Certificates of Mailing. A customer may purchase a Certificate of Mailing, or use Registered or Certified Mail, to get a receipt serving as evidence of the date the item was presented for mailing.

Note that the date on customer-applied pre-printed labels, such as from self-service kiosks, Click-N-Ship, or postage meters is not evidence of the mailing date or when the USPS accepted the item.

So, when you’re mailing a tax form, such as the next estimated tax payment due on January 15, 2026, or sending a mail-in ballot close to the deadline, take the item to a USPS retail counter and request a manual postmark, a Postage Validation Imprint, or a Certificate of Mailing.

Very high-income taxpayers should probably accelerate donations to 2025

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  • mike   

Not all of the tax law changes in the One Big Beautiful Bill Act (OBBBA) enacted July 4, 2025 favor high-income taxpayers.

For example, effective for tax years beginning after 2025, under Section 70425 of the Act, the charitable contributions tax deduction for individuals is reduced by 0.5% of the taxpayer’s contribution base for the taxable year.

The contribution base is the taxpayer’s adjusted gross income, computed without regard to any net operating loss carryback to the taxable year.

For most taxpayers, this reduction might not seem significant. For example, if John has adjusted gross income of $1,000,000, the reduction would be $5,000.

Taxpayers with much higher income are hit harder. For example, if Jane has adjusted gross income of $20 million, the reduction would be $100,000. Jane would be in the 37% marginal federal income tax bracket plus 3.8% for the net investment income tax, or 40.8%, so this tax law change could increase Jane’s federal income tax liability by $40,800 for 2026 compared to 2025. If Jane makes $100,000 of charitable contributions each year, she should consider accelerating the contributions she would normally make during 2026 to 2025.

Charitable contributions disallowed because of the 0.5% of contribution base reduction are added to the charitable contributions carryover amount that might be deductible during the 5 subsequent tax years. They are only added to the charitable contributions carryover if the deduction ceiling amount is exceeded, such as 60% of the contribution base for cash contributions to qualifying charities. Otherwise, the deduction for the disallowed charitable contributions are lost. In the example above, if Jane made $100,000 of charitable contributions for 2026, the 60% limitation would be $12 million, so the tax deduction for $100,000 would not be added to the charitable contributions carryover and would be lost.

Another OBBBA change effective after 2025 reduces the tax benefit of itemized deductions by 2/37 (about 5.4%) of the lesser of (1) itemized deductions before the “haircut”, or (2) the taxable income of the the taxpayer, before itemized deductions, that exceeds the threshold for the 37% tax bracket. Note this “haircut” applies to itemized deductions after the 0.5% reduction of charitable contributions.

For example, Jane has taxable income for 2026, before itemized deductions, of $20 million, and itemized deductions before the “haircut” of $1,000,000. The 2026 threshold for the 37% tax bracket for a single person is $640,600. The taxable income, before itemized deductions, exceeding the threshold is $20 million – $640,600 = $19,359,400. The “haircut” would be $1,000,000 X 2/37 = $54,054.

Note that taxpayers age 70 1/2 or older may make qualified charitable distributions (QCDs) from a traditional IRA of up to $108,000 for 2025 and $111,000 for 2026. QCDs aren’t taxable and aren’t subject to the contribution base limits that apply for other charitable contributions. QCDs also “count” for satisfying required minimum distribution (RMD) requirements for traditional IRAs that currently apply for taxpayers who reached age 73 during 2025 or the ages when RMDs applied for earlier years.

Taxpayers who haven’t decided where to donate their charitable contributions yet can “park” the funds in a donor advised fund, community foundation or a private foundation. Lower maximum deduction thresholds might apply.

The 0.5% reduction of the charitable contributions deduction and the 2/37 “haircut” of itemized deductions are only two of the significant changes in OBBBA that are making tax planning more complicated, with many different effective dates and thresholds. Taxpayers should consult with tax advisors who work with tax planning software that incorporates these changes and understand the rules for charitable planning.

Should a parent or the student claim the American Opportunity Tax Credit?

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  • mike   

Did you know the American Opportunity Tax Credit (AOTC) can be claimed either on the income tax return of a parent or the student who is their dependent?

The AOTC is an important tax benefit to help defray education expenses of full-time college students.

The IRS has provided an explanation of Tax Benefits for Education in Publication 970, available at the IRS web site, www.irs.gov.

The credit is for the first $2,000 of qualified education expenses, plus 25% of the next $2,000 of expenses, or a maximum of $2,500 per year for the first four years of qualified post-secondary education. (The credit can’t be claimed for more than four tax years.)

The student must be enrolled at least half-time for at least one academic period that begins during the tax year, or the first three months of the next tax year when qualified expenses were paid during the previous tax year. The student must also be enrolled in a program that leads to a degree, certificate, or other recognized academic credential.

Only tuition and certain related expenses, including books, supplies and equipment needed for a course of study, are included in qualified education expenses for the credit. Room and board don’t qualify for the credit.

When a parent claims the AOTC, amounts paid by the student can be included to compute the credit on the parent’s income tax return. When a dependent child claims the AOTC, amounts paid by parent(s) can be included to compute the credit on the child’s income tax return.

Amounts reimbursed using tax-free funds, such as employer-paid expenses, tax-free scholarships, or tax-free distributions from Section 529 plans (qualified tuition arrangements), don’t qualify for the credit.

The AOTC is phased out when the taxpayer’s modified adjusted gross income (MAGI) is between $80,000 and $90,000 for single persons, or $160,000 and $180,000 for married taxpayers filing a joint return. Married persons who file a separate return and individuals claimed as a dependent by another taxpayer aren’t eligible for the credit.

The income of the parents might exceed the phaseout limitation, or a parent might file a separate return, so the parents might get no tax benefit from the credit. In that case, the student can claim the credit. (IRC Section 25A(f)(1)(A)(iii), Pub. 970, page 20.) The parent(s) may not claim the student as a dependent on their income tax return when the student claims the credit.

Since dependent exemptions have been repealed by the One, Big, Beautiful Bill Act (OBBBA), the main impact on the parents’ income tax return may be whether they can claim the child credit or the credit for other dependents. Since a child must be under age 17 to qualify for the child credit, it won’t apply for most college students. The credit for other dependents is $500 and phases out for married taxpayers who file a joint return with adjusted gross income exceeding $400,000 and other taxpayers with adjusted gross income exceeding $200,000.

40% of the AOTC is a refundable credit. Taxpayers who are subject to the “kiddie tax” aren’t eligible for the refundable credit, so most students who claim the credit on their income tax returns won’t get the refundable credit. (Mostly this applies when the student doesn’t provide more than half of his or her support. See the Instructions for Form 8615.)

Here are some additional rules to be aware of.

A person who qualifies as a dependent of someone else can’t claim himself or herself as a dependent. (A dependent student can’t claim himself or herself as a dependent, even when a parent doesn’t claim them as a dependent.) (IRC Section 152(b)(1).)

Accident and Health plans and HSAs are allowed for medical expenses of individuals qualifying as dependents, not based on whether the dependent exemption was claimed. (IRC Sections 105(b) and 223(d)(2)(A).)

The Kiddie Tax on unearned income of dependents still applies, because a parent is living. (Section 1(g).)

The standard deduction for 2025 is limited for a single person eligible to be claimed as a dependent to the greater of $500 or the sum of $250 plus the individual’s earned income, limited to $15,750. (IRC Section 63(c)(2) and (5).)

There might be state income tax considerations not discussed here for deciding whether to claim the AOTC on the federal income tax return of the parent or the student.

Families should determine whether claiming the AOTC on the federal income tax return of the parent(s) or the student provides the maximum tax benefit. Tax planning computations have become much more complicated under OBBBA. Consider using tax projection software that has been updated for the new tax law.

IRS issues rules for Roth 401(k) catch-up requirement

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  • mike   

On September 16, 2025, the IRS published final regulations relating to catch-up contributions to 401(k) and other elective contribution employer accounts. IR-2025-91. https://www.irs.gov/newsroom/treasury-irs-issue-final-regulations-on-new-roth-catch-up-rule-other-secure-2point0-act-provisions

The SECURE 2.0 Act of 2022 included some important changes for catch-up contributions to 401(k) accounts and other elective contribution employer accounts.

Effective for taxable years beginning after December 31, 2023, catch-up contributions by individuals who have $145,000 (subject to cost of living adjustments) or more of wages for the prior year could only be made to a Roth account, disallowing the exclusion from federal income taxes for that contribution.

In August, 2023, the IRS issued Notice 2023-62, which postponed the effective date for two years, until taxable years beginning after December 31, 2025.

The final regulations include the requirement that catch-up contributions for 401(k) plans must be designated as Roth contributions. Although the final regulations aren’t effective until taxable years beginning after December 31, 2026, the requirement in the tax law hasn’t been further postponed, so the requirement also applies for 2026.

Also note Roth contributions can’t be made unless the plan provides for them, so employees of companies whose plans don’t provide for Roth contributions can’t make catch-up contributions.

The catch-up contribution for employees who reach age 50 by the end of the tax year is generally limited to $7,500 for 2025, to be adjusted for inflation for future years. For taxable years beginning after 2024, plan participants who attain ages 60 through 63 have a higher catch-up contribution limit of 150% of the limit for other employees, or $11,250 for 2025, to be adjusted for inflation in future years.

The final regulations also include rules for other retirement plans, such as SIMPLE plans.

Employers and their plan administrators should meet with their tax advisors and legal counsel about updating their retirement plans for the new final regulations.

Do you qualify for the new federal tips deduction?

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  • mike   

The IRS has issued proposed regulations for what tips qualify for the new federal tips deduction. (IR-2025-92, Prop. Reg. 110032-25, published September 22, 2025. https://www.federalregister.gov/documents/2025/09/22/2025-18278/occupations-that-customarily-and-regularly-received-tips-definition-of-qualified-tips

The deduction is up to $25,000 of qualifying tips received by an individual or a married couple. It’s not an itemized deduction. The social security number of the individual or individuals claiming the deduction must be reported on the income tax return. Married persons must file a joint return to claim the deduction.

The deduction for qualified tips phases out by $100 for each $1,000 over $150,000 of modified adjusted gross income ($300,000 for joint returns.)

The deduction applies for 2025 through 2028.

The deduction applies for employees who receive Form W-2, independent contractors receiving Forms 1099-K or 1099-NEC, and certain business owners.

Qualifying tips must be voluntary and determined by the payor. For example, an automatic tip specified by a restaurant without expressly providing an option to disregard or modify the amount doesn’t qualify for the deduction. Any tip paid in excess of the automatic amount qualifies for the deduction. (Some restaurants might have to segregate accounting for tips that qualify and those that don’t.) When a customer must choose from a list of tip percentages that doesn’t include “no tip”, that tip doesn’t qualify for the deduction.

The proposed regulations include a list of occupations that might qualify for the deduction.

One of the listed occupations is “digital content creator”, so a person who produces a video podcast might qualify to claim the tips deduction.

The services may not be performed in a “specified service trade or business”, as defined for the Qualified Business Income Deduction at Internal Revenue Code Section 199A(d)(2). For a self-employed person, the “specified service trade or business test” is determined based on that person’s occupation. For an employee, the “specified service trade or business test” is determined based on the business of the employer.

For example, a self-employed comedian who receives tips for performing doesn’t qualify for the tips deduction, despite being on the list of qualifying occupations, because “performing arts” is a specified service trade or business.

A pianist who receives tips as an employee of a hotel when playing in the hotel lobby does qualify for the tips deduction, because a hotel isn’t a specified service trade or business.

The IRS has issued a draft Form 1-A for claiming the tips deduction. https://www.irs.gov/pub/irs-dft/f1040s1a–dft.pdf

Remember, the income tax laws of many states, such as California’s, haven’t conformed to this new tax law.

There are many deductions with different phaseouts under the One Big Beautiful Bill Act as well as other limitations under the Internal Revenue Code. I suggest that tax planning computations be made by a tax consultant who is familiar with the new rules using tax planning software that has been updated for recent tax law changes.

Research expensing and 2024 income tax returns

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  • mike   

Technology companies have finally achieved tax relief for domestic research and experimentation (R & E) expenses. Certain “small businesses” can elect to currently deduct them on their extended or superseding 2024 income tax returns and amending or filing an administrative adjustment request for their 2022 – 2023 return.

In order to achieve budget goals, the Tax Cuts and Jobs Act of 2017 included a provision requiring that research and experimental expenses incurred after December 31, 2021 be capitalized and amortized over a 60-month period. The plan was for the amortization requirement to be repealed before it became effective. From that time, technology companies have been lobbying Congress to restore the election to currently expense R & E expenses.

Finally, the expense election was restored for domestic R & E expenses by Section 70302 of the One Big, Beautiful Bill Act of 2025 (OBBBA), effective for tax years beginning after December 31, 2024. https://www.congress.gov/bill/119th-congress/house-bill/1

Most corporations may elect to deduct the unamortized balance of domestic R & E expenses that were previously capitalized for 2022 through 2024 over a one- or two-year period, starting for 2025. (OBBBA Section 70302(f)(2).)

Alternatively, certain small businesses that have average gross receipts of $31,000,000 or less for a taxable year beginning in 2025 may elect to amend their tax returns for 2022 – 2024 and currently deduct amounts that were previously capitalized and amortized. The election must be made by Monday, July 6, 2026. (Note the due date for filing an amended return supersedes that date. For example, a corporation that timely filed its 2022 income tax return, with no extension filed, on April 15, 2023 may not file an amended income tax return after April 15, 2026.) (OBBBA Section 70302(f)(1), Revenue Procedure 2025-28, Sections 3.02(1) and 3.03(3).) (Instead of filing amended income tax returns, partnerships file administrative adjustment requests (AARs).)

According to OBBBA Section 70302(f)(1)(A), the small business expense election should be made on an amended income tax return or an AAR. Many corporations still haven’t filed their 2024 income tax returns, with an extended due date of October 15, 2025. The American Institute of Certified Public Accountants and technology companies asked the IRS to allow them to make the election for 2024 on an originally-filed income tax return.

On August 28, 2025, the IRS issued Revenue Procedure 2025-28. https://www.irs.gov/pub/irs-drop/rp-25-28.pdf According to the Revenue Procedure, certain small business taxpayers may make the election to currently deduct R & E expenses on an originally-filed income tax return. (Rev. Proc. 2025-28, Section 3.03.) In addition, the IRS said that a six-month automatic extension of time to file is granted to any business that didn’t previously request one, and a business that previously filed a 2024 income tax return without electing to currently deduct R & E expenses may make the election by timely filing a superseding income tax return that includes the election. (Rev. Proc. 2025-28, Section 8.)

A business that deducts domestic R & E expenses on an original federal income tax return and complies with the requirements of Rev. Proc. 2025-28, Section 3.03 for all other applicable tax years will be deemed to have made a current-expense election. (Rev. Proc. 2025-28, Section 3.03(4).)

Instead of filing a change of accounting Form 3115, the taxpayer should attach a statement to the income tax return with similar information specified in the Revenue Procedure. (Rev. Proc. 2025-28, Sections 3.03(2) and 3.04.)

Taxpayers should consider the cost of preparing amended income tax returns and AARs, and that the IRS takes about a year to process them, when making the decision whether take to amended return/AAR route, including deducting the expenses currently on the 2024 income tax return, or simply deducting unamortized domestic R & E expenses on their 2025, or 2025 and 2026, income tax returns.

I highly recommend consulting with a qualified tax return preparer when implementing this change.

Small business stock gain exclusion planning

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  • mike   

Entrepreneurs creating new businesses have had an important benefit enhanced by the One Big Beautiful Bill Act of 2025 (OBBBA, H.R. 1, P.L. 119-21) – the Section 1202 Small Business Stock capital gain exclusion.  There are many tax planning considerations, including the choice of form of entity for the business, and employee stock option considerations.

Qualified Small Business Stock gain exclusion. 

Before the adoption of OBBBA, noncorporate taxpayers could exclude from taxable income capital gains from the sale or exchange of qualified small business stock held for more than five years.

Before the change, the exclusion was (still applies for qualified stock acquired before July 5, 2025):

  • 100% of the gain for qualified stock acquired after September 27, 2010;
  • 75% of the gain for qualified stock acquired after February 17, 2009 and before September 28, 2010; and
  • 50% of the gain for qualified stock acquired before February 18, 2009 (increased to 60% of the gain attributable to periods before 2019 if the stock was issued by a corporation in an empowerment zone and acquired after December 21, 2000.)

For stock acquired before September 28, 2010, 7% of the excluded gain is a tax preference item for alternative minimum tax reporting.

Excludable gain on dispositions of qualified stock from any single issuer for a tax year is limited to the greater of (1) $10 million, reduced by the aggregate amount excluded for the issuer’s stock in prior years ($5 million for married, filing separately); or (2) 10 times the taxpayer’s adjusted basis in all of the issuer’s stock disposed of during the tax years.

Gains on dispositions of qualified stock held by a pass-through entity for more than five years is passed through to partners, shareholders and participants who held interests in the entity when it acquired the stock and at all times thereafter.  The exclusion can’t reflect any increase in the person’s share of the entity after the entity acquired the stock.

In addition to the exclusion, taxable gains from sales of qualified stock may be deferred under Internal Revenue Codes Section 1045 by reinvesting the sale proceeds in stock of another qualified small business within 60 days after the sale.

Qualified small business stock is stock issued after August 10, 1993, and acquired by the taxpayer at the original issue, directly or through an underwriter, in exchange for money or property, or as compensation for services provided to the corporation.  The issuing corporation must be a domestic C corporation other than a regulated investment company, cooperative, or other pass-through corporation.

Both before and immediately after the qualified stock is issued, the corporation’s aggregate gross assets must not exceed $50 million, with parent-subsidiary controlled groups treated as one corporation.  During substantially all of the taxpayer’s holding period, at least 80% of the value of the corporation’s assets must be used in the active conduct of qualified trades or businesses.

A qualified business does not include the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business if its principal asset is the reputation or skill of employees.  Hospitality, farming, insurance, finance and mineral extraction also are not qualified businesses.

Note that retail, manufacturing, and research to develop a product are qualifying businesses.

How OBBBA changes the thresholds.

OBBBA changes the gain exclusion by creating tiers, effective for stock issued or acquired and to tax years commencing after July 4, 2025.  The exclusion ratios are 50% after three years, 75% after four years, and 100% after five years.  The per-issue dollar cap for post-enactment shares is increased from $10 million to $15 million reduced by the aggregate amount excluded for the issuer’s stock in prior years ($7.5 million for married persons filing separately), indexed for inflation after 2026.  The post-enactment aggregate-asset ceiling is increased from $50 million to $75 million, indexed for inflation after 2026. 

There is no alternative minimum tax preference for the excluded gains for these shares. 

The higher asset ceiling means the stock of more corporations will qualify for the exclusion. 

Shareholders who have capital gains from sales of qualified small business stock will be eligible to exclude more of their gains from taxable income.

The holding period requirement to qualify for a partial exclusion has been relaxed, so more sales of qualified small business stock will qualify for some exclusion from taxable income.

In the past, the thresholds haven’t been indexed for inflation.  Under OBBA, the thresholds will be automatically increased for inflation after 2026.

Family tax planning tip.

Giving family members cash to purchase qualified small business stock can increase the exclusion threshold for the family.  (Up to $15 million per family member.)

Choice of entity considerations.

Making a decision about what form a business should be requires having a long-term horizon and a crystal ball.

According to a Bureau of Labor Statistics report in 2024, about 20% of startups that opened for business in 2013 failed during the first year.  About 39% of startups failed within the first three years.  About 50% of startups failed within the first five years.  About 65% failed within the first ten years.  It seems the odds are against realizing a gain from the sale of startup stock.  Only a handful of shareholders do.

To qualify for small business stock to qualify for the exclusion, it must be issued by a corporation that qualifies when the stock is issued.  The corporation that issues the stock must be a regular “C” corporation (including an LLC that elects to be taxed as a C corporation – most don’t.)  Stock issued by an “S” (passthrough entity) corporation doesn’t qualify, but stock issued by a former S corporation after terminating its S election and becoming a C corporation can qualify.

Why is this important?

Business startups typically generate losses during their first few years.  Losses of a C corporation are “locked” in the business and aren’t deductible for its owners.  Losses of passthrough entities are eligible to be deducted on the income tax returns of their owners, subject to limitations like basis limitations, passive activity loss limitations, and at risk limitations.

Owners of general partnerships and sole proprietorships include their shares of “at risk” debt in their investment for the limitation for deducting business losses.  (If the business fails, they are liable for the debt.)

Passthrough entities aren’t subject to double taxation, like C corporations.  The owners pay income taxes on the entity’s taxable income and add that income to their tax basis (cost for computing taxable gain) for the sale of their ownership interest.

Partnerships and sole proprietorships have an advantage of being able to possibly liquidate by distributing their assets tax-free.

For businesses whose business plans don’t include having a public offering of their shares or selling the business at a multiple asset value for the foreseeable future, these are good reasons to choose passthrough structures, not C corporations.

For businesses that are adequately capitalized and are developing significant intellectual property or significant net income for a high multiple valuation that is expected to be sold soon after five years, or that plan to make a public offering of their shares, C corporations look more attractive.

Employee Stock Options and the Qualified Small Business Stock Capital Gain Exclusion.

The Ninth Circuit Court of Appeals has confirmed the Tax Court in holding employee stock options don’t qualify as stock for the Small Business Stock Capital Gain Exclusion.  The court also ruled the holding period of employee stock options before exercising them isn’t included for the 5-year holding period requirement.  The shares must be owned to start the clock.[1]

Any ordinary income for stock acquired by exercising an employee stock option isn’t eligible for the Small Business Stock Capital Gain Exclusion.

As explained below, determining when the holding period begins becomes complicated when employee stock options have a vesting schedule and the employer or other option granter permits an early exercise of employee stock options.  For nonqualified stock options, the employee may elect under Section 83(b) to treat the early exercise as taxable for regular tax and alternative minimum tax reporting.  When that election is made, the holding period starts on the date of exercise.  When that election isn’t made, the holding period starts on the later of the vesting date or the date of exercise.

For incentive stock options, the regular tax holding period starts on the date of exercise, regardless of vesting.  The Section 83(b) election to treat the early exercise as taxable only applies for the alternative minimum tax and the option is treated as a nonqualified option for alternative minimum tax reporting.  (The holding period might start on different dates for regular tax and AMT reporting.  Note there is no AMT adjustment relating to most Small Business Stock Capital Gain Exclusions.  For stock acquired before September 28, 2010, 7% of the excluded gain is a tax preference item for alternative minimum tax reporting.)

[1]Natkunanathan v. Commissioner, 110 AFTR 2d 2012-5193, July 12, 2012.

Michael Gray, CPA's Blog

Tax and financial advice from the Silicon Valley expert.