New Estimated Tax Rules Give Small Business Owners a Break

Taxpayers, including small business owners, are required to prepay their taxes for the year through withholding or by making estimated tax payments.  Due to the lack of a withholding source, small business owners are most frequently affected by this requirement.

When a taxpayer fails to prepay enough, he or she can be subject to a nondeductible penalty for underpayment of estimated taxes.  The problem for small business owners is that they cannot always accurately predict their profits for the year, especially in this troubled economy.  This leaves them with only two options: (1) determine their profits through each quarter and base their estimated tax on those profits projected through the end of year, or (2) base their estimates on one of the available safe harbor estimates. 

Although there are several exceptions that can avoid or mitigate the imposition of underpayment of estimated tax penalties, only the ones based on the prior year’s tax liability provide safe harbor payments.  Prior to the passage of the “American Recovery and Reinvestment Act of 2009” last February, there were only two “safe harbor” payment amounts, both predicated on the taxpayer’s AGI for the year – 100% of the prior year’s tax liability if the taxpayer’s AGI for the prior year is $150,000 or less or 110% of the prior year’s tax liability if the taxpayer’s prior year AGI is over $150,000.  This left many taxpayers with only the option of paying 110% of the prior year’s tax.

Thanks to the new tax law, many small business taxpayers can now base their safe harbor estimates on 90% of the prior year’s tax.  This provides them with a substantial reduction in the amount that needs to be prepaid, and possibly avoids substantial overpayments at a time when money is tight for most small business owners.  However, like all things taxable, there are qualifications and limitations associated with this new safe-harbor.   First, at least 50% of the prior year’s gross income must be attributable to a small trade or business (one, that on average, employs no more than 500 people), and second, the taxpayer’s AGI must be less than $500,000 ($250,000 if married filing separately) on the prior year’s return. 

Each installment payment must be equal to 25 percent of the safe-harbor amount, whether it is based on 90%, 100% or 110% of the preceding year’s tax. Failing to pay the required installment amount, or paying it late, could void the safe harbor provision, and expose the taxpayer to the underpayment of estimated tax penalty.

There are special rules for farmers and fishermen that allow them to pay their entire estimated tax by January 15 of the subsequent year or file their return and pay their total tax liability by March 1 of the subsequent year. 

If you need help with your estimated payments or wish to adjust them, please contact this office. 

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