It should come as no surprise that Uncle Sam wants taxes paid in full during the course of the year. Avoiding the penalties associated with guessing wrong about those estimated tax payments is easy. Anyone, including any snow and ice management businesses, large or small, can usually avoid penalties by basing their estimated tax payments on the previous year’s tax bill.
Unfortunately, if the coming year turns out to be a bad one financially, basing estimated tax payments on the previous year can mean the government, not the business, gets use of those funds, interest free, for up to a year. If the coming year turns out to be a good one, basing estimated tax payments on the previous year may mean no penalty but a whopping tax bill when the tax return is filed – along with the first estimated tax installment for the upcoming tax year.
Estimating the income – and the tax bill – of any snow or ice management business can be a nightmare especially when compounded by the economy, our battling lawmakers, and the uncertainty over Obamacare and tax reform. While most self-employed snow removal professionals and businesses have software programs or a professional to help with estimated tax payments, few are aware of how to anticipate – or handle – changes.
Think of estimated taxes as a “pay-as-you-go” tax. Four times a year (quarterly), every snow and ice management professional is required to send Uncle Sam enough of his or her revenue to cover income tax as well as their self-employment tax (Social Security and Medicare) obligations.
If enough taxes are not paid throughout the year, either through payroll withholding or estimated tax payments, a professional and/or his or her business may face a penalty for underpayment of estimated tax. However, the IRS knows that calculating earnings isn’t easy, so it offers safe harbors – paying at least as much as the previous year’s liability or paying within 90 percent of the actual liability, means no penalty for underpayment.
PAYING ESTIMATED TAXES
Anyone filing as a sole proprietor, partner, S corporation shareholder, and/or as self-employed is generally required to make estimated tax payments if they expect to owe $1,000 or more in taxes. If it’s not through withholding, then it must be done with quarterly estimated taxes. If the snow and ice management operation is structured as a corporation, estimated tax payments are required if the incorporated business’s final tax bill is anticipated to be $500 or more.
For estimated tax purposes, the year is divided into four payment periods with each period having a specific payment due date. If not enough estimated tax is paid at the end of each payment period, a penalty may be charged – even if a refund results at year’s end.
That underpayment penalty usually consists of a non-deductible interest charge – currently the federal short-term interest rate plus 3 percent – accruing from the date the payment was due.
ALMOST INEVITABLE UNDERPAYMENTS
Paying estimated taxes weekly, bi-weekly, monthly, etc. is permitted, so long as enough tax is paid in by the end of the quarter. If sufficient estimated tax was not paid throughout the year, either through withholding or by making estimated tax payments, a penalty for underpayment of estimated tax is almost inevitable.
Fortunately, if income is received unevenly during the year, penalties can be avoided or lowered by “annualizing” income and making unequal payments. The annualized income installment method annualizes tax at the end of each period based on a reasonable estimate of income, deductions and other items relating to events that occurred from the beginning of the tax year through the end of the period. Form 2110, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, is used.
The penalty may also be waived if:
The failure to make estimated payments was caused by a casualty, disaster or other unusual circumstance, and it would be inequitable to impose the penalty, or
If the business owner retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required or there was a reasonable cause for the underpayment and it was from not willful neglect.
Those filing as a sole proprietor, partner, S corporation shareholder and/or as self-employed, should use Form 1040-ES, Estimated Tax for Individuals, to both figure and pay estimated tax. As mentioned, incorporated snow removal businesses are also required to pay their estimated income tax bill in quarterly installments.
When filing as a corporation, Form 1120-W, Estimated Tax for Corporations, is used to figure the estimated tax. In general, each quarterly federal tax payment is 25 percent of the corporation’s “required annual payment,” which is the lesser of two amounts:
Current-year tax liability – 100 percent of the federal income tax reported on the return for the year of the payment
Prior-year safe harbor – 100 percent of a corporation’s federal income tax reported on the return for the preceding year.
Corporations with no tax liability in the preceding year obviously cannot use the 100 percent prior-year safe harbor amount to determine their required estimated tax payment. And certain “large corporations” – those with taxable income of $1 million or more in any of the three preceding tax years –- can only use the prior-year safe harbor amount when calculating their first-quarter payment.
Should an incorporated snow and ice management business figure and deposit its estimated tax only to discover its tax liability for the year will be more or less than originally estimated, it may have to refigure the required installments. An immediate catchup payment should be made to reduce any penalty that might result from underpaying an earlier installment.
All incorporated snow and ice management businesses are required to use the Electronic Federal Tax Pay System (EFTPS) for tax payments, while Form 2220, Underpayment of Estimated Tax by Corporations, is used to determine whether an incorporated business is subject to estimated tax underpayment penalties and to compute the amount of the penalty.
ESTIMATED TAX REFUNDS
Much like individuals, a corporation that does not pay one of its required estimated tax installment by its due date, may be subject to a penalty. That penalty is figured separately for each installment due date. In fact, again as is the case for an individual taxpayer, the corporation may owe an underpayment penalty even if it paid enough tax later to make up the underpayment. This is true even if the corporation is due a refund when its tax return is filed.
An incorporated snow and ice management business that has overpaid its estimated tax for the year may be able to apply for a special “Quick Refund” simply by using Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax. A corporation can apply for a quick refund if the overpayment is at least $500 and at least 10 percent of the operation’s expected tax liability.
In general, incorporated snow and ice management businesses estimate their annual depreciation deductions, taking into account all equipment and business property purchased, sales or other dispositions, changes in use, additional first-year depreciation and similar events as of the last day of the quarter. The tax regulations do, however, contain two safe harbor methods that can be used when determining an incorporated business’s estimated tax depreciation deduction: a proportionate depreciation allowance or 90 percent of the preceding year’s depreciation write-off.
Under the proportionate depreciation allowance method, corporations estimate their depreciation deduction based on assets placed in service by the end of the previous year and by the end of the installment period. Using 90 percent of the preceding year’s depreciation to calculate estimated tax payments may provide a tremendous benefit to taxpayers taking advantage of the substantial depreciation write-off with “bonus” depreciation.