Effective tax planning can significantly reduce the “triple-whammy” of tax payments all simultaneously due on July 15: for 2019 taxes, 2020 first quarter estimated taxes, and 2020 second quarter estimated taxes. By reducing those payments, business owners can preserve cash that may be vital for their ongoing business operations. TLS has been doing this for thousands of business owner clients for 15 years.
In Aesop’s Fable, The Ant and the Grasshopper, it is the ant who amasses food during the summer in anticipation of its scarcity during the winter. Subsequently, while the grasshopper is starving because he has no food stores for the winter, the ant is able to survive as a result of his prudent pre-planning. Although there have been many adaptations and interpretations of this story since it was written approximately 2,500 years ago—including scores of condemnations of the ant’s callous refusal to help the grasshopper and alternate “happy” endings that promote thinly-veiled wealth redistribution themes—the enduring lesson on the perils of improvidence are particularly relevant to the summer of 2020.
For successful business owners, prudently preparing for the ebbs and flows of normal business revenue cycles becomes virtually reflexive behavior. The current pervasive economic uncertainty caused by government-induced shutdowns and widespread violent social unrest has undoubtedly amplified this instinct by orders of magnitude. Clearly, this heightened awareness has led many small to mid-sized business owners to focus on accumulating cash reserves in anticipation of potentially lean times ahead. As a consequence, measures that create the efficiency required to improve a businesses’ bottom-line savings or simply defer ‘cash burn’ have become highly coveted indeed. In furtherance of those objectives, in addition to re-examining internal operational costs, many business owners have been compelled to self-educate on the minutiae of recent (and predictably acronymic) government stimuli—both monetary and fiscal—in an effort to maximize their downside protection.
One such ostensibly welcome fiscal stimulus is the extension of federal estimated tax payment due dates. Estimated taxes are traditionally paid in four equal installments—one installment for each quarter of the year. Effective for 2020, the IRS has merged the deadlines for the first two installments from April 15 and June 15, respectively, to July 15, 2020. Coincidentally, July 15th is also the new deadline for filing 2019 taxes and for paying any outstanding balance owed for last year. However, as of today, the subsequent two estimated tax payment due dates for 2020 remain unaltered. Accordingly, the third estimated tax payment must be made on September 15th and the final payment will still be due on January 15, 2021. (see chart below for further detail)
|Payment Number||When Income Earned in 2020||Date Due|
|1st Payment||January 1st to March 31st||July 15, 2020|
|2nd Payment||April 1st to May 31st||July 15, 2020|
|3rd Payment||June 1st to August 31st||September 15, 2020|
|4th Payment||September 1st to December 31st||January 15, 2021|
At the time you are required to file, if you have not paid sufficient income tax through withholding or quarterly estimated payments, you will owe a penalty for underpayment. The underpayment penalty is not a fixed amount, but rather an interest charge on the underpaid amount for any given quarter. As such, a taxpayer who chronically underpays his or her taxes could have up to four separate and distinct penalties on an annual basis. For example, if you underpaid the September 15th installment but overpaid the January 15th installment in an effort to make up the September underpayment, you would still owe a penalty for underpaying September when it was due. This applies regardless of whether you are owed a refund when you file your tax return. There is one minor concession accorded taxpayers in the context of this rigid scheme—if you file your 2020 tax return by February 1, 2021 and pay the entire balance of the final quarterly estimate due with your return, you don’t have to make the payment due on January 15, 2021. Not exactly a “loophole”…
Under the Internal Revenue Code, the underpayment penalty amount is based on an interest rate that is re-calculated on a quarterly basis. For taxpayers other than corporations, the underpayment rate is the federal short-term rate (“AFR”) plus five (5) percent (for corps., it is AFR plus 3%). That rate—a steep one given today’s interest rate environment—is a clear disincentive to most who might be tempted to “float” the payment in hopes of a positive arbitrage on their retained funds. And, as alluded to above, that interest (i.e., penalty) begins to accrue immediately after each respective estimated tax due date.
Thankfully, there are two ways to avoid the penalty even when an estimated payment is not made according to schedule. First, if the aggregate sum of federal income tax withholding (typically from wages) and estimated tax payment amounts is at least 90 percent of the total tax that you will owe for 2020, you do not need to make further estimated tax payments in order to avoid the penalty. Alternatively, if your total tax withheld/paid is at least 110 percent of the total tax incurred on your previous year’s return then you are not required to make any additional estimated tax payments.
Inarguably, a widespread ant-like instinct among human taxpayers undergirds the psychology behind estimated tax payments—and the “pay as you go” approach as a whole. In other words, if we were given the option to retain tax payments until they were actually due, most of us would pay them only upon submission of our year-end tax return. Unfortunately, this approach would leave many in the unenviable—and perhaps financially impossible—position of writing a potentially massive check to the IRS all at once.
Paradoxically, for 2020, the temporary reprieve on the first two quarterly installments could actually create the precise problem that the quarterly payment scheme was designed to prevent! Let’s suppose that you delay your first and second estimates to July 15, 2020. At that point, you’ll need to pay two estimates at one time—assuming you earned income in both of the first two quarters of 2020. Moreover, if you still owed income taxes from 2019, you’ll also have to pay that amount. Finally, before the sting of that cash-ectomy has even subsided, you’ll have approximately 60 days before you have to pony up September’s estimated payment. Ouch…
The good news is that it’s not too late to plan for that July 15th triple whammy.
If a taxpayer is attempting to hit the 90 percent of projected tax target, his estimated quarterly tax payment should be based on the amount of income, deductions and credits that he reasonably expects to realize based on his method of accounting. In making this determination, the taxpayer must take into account not only the facts and circumstances existing at the time prescribed for determining the estimated tax, but also those reasonably anticipated for the balance of the tax year. Accordingly, the amount of the required payments must be recomputed any time there is a change in the individual’s anticipated tax. This may occur as a result of an unexpected change in income, deductions (including exemptions), tax preferences, additional taxes or credits. In the event of any such change, the amount of the next required estimated tax payment computed must be increased by any shortfall (and may be reduced by any overpayment) of the prior installments with respect to the tax year. In addition, each of the remaining installments—if any—must be adjusted proportionately by the balance.
By thoughtfully restructuring the manner in which income from a business is received, TLS has helped thousands of small to mid-sized business owner clients substantially decrease their overall income tax liability while simultaneously increasing their current cash flow for almost 15 years. Of course, an ancillary benefit of our approach is that future estimated income tax payments are either reduced substantially—or even eliminated altogether—once a strategy is implemented and a client can calculate and confidently project a decrease in overall tax due for the year. Thus, by furnishing the means to maintain reserves that would have otherwise been paid to the IRS in order to meet the 90% “target”, TLS affords business owners the ability to retain cash reserves and prudently prepare for what could very well be a long winter ahead.
If you have any questions or would like to further discuss, please email TLS Support: firstname.lastname@example.org.