Estimates can be taxing

Consider these tips for reducing the frustration of the estimated taxes process.

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 estimated tax payments is easy: Anyone, including any sand or gravel business, large or small, can usually avoid penalties by basing its estimated tax payments on its previous year’s tax bill.

But 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 to use those funds — interest-free — for as long as 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 aggregates mining business can be a nightmare, especially when compounded by the economy, our battling lawmakers and the uncertainty over healthcare and tax reform. While most self-employed and small businesses have software programs or a professional to help with estimated tax payments, few are aware of how to anticipate or handle changes.

The basics
Think of estimated taxes as a “pay-as-you-go” tax. Four times a year (quarterly), the owner of every aggregates business is required to send Uncle Sam enough of his or her revenue to cover income tax, as well as self-employment tax (Social Security and Medicare) obligations. If enough taxes are not paid throughout the year, either through payroll withholding or by making estimated tax payments, a producer and/or his or her business may face a penalty for underpayment of estimated tax.

However, the U.S. Internal Revenue Service (IRS) knows that calculating earnings isn’t easy, so it offers a safe harbor rule — paying at least as much as the previous year’s liability, or paying within 90 percent of the actual liability. There’s no penalty for underpayment.

Paying estimated taxes
Anyone filing as a sole proprietor, partner, S corporation shareholder, and/or a self-employed individual, is generally required to make estimated tax payments if he or she expects to owe tax of $1,000 or more. If it’s not through withholding, then it has to be done by quarterly estimated taxes. If the sand-and-gravel business is structured as a corporation, estimated tax payments are required if a final tax bill of $500 or more is expected.

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 is due 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, as long as enough has been paid in by the end of the quarter. If enough 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 — as is the case with many quarries — 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:
1. 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

2. If a sand-and-gravel business owner retired (after reaching age 62) or became disabled during the tax year for which estimated payments were required to be made or in the preceding tax year, and the underpayment was due to reasonable cause and not willful neglect.

Paying up
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. Incorporated aggregates 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 federal income tax reported on return for the year of the payment.

■ Prior-year safe harbor — 100 percent of a corporation’s federal income tax reported on 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 aggregates business figure and deposit its estimated tax only to find that its tax liability for the year will be more or less than originally estimated, it may have to refigure its required installments. An immediate catch-up payment should be made to reduce any penalty resulting from the underpayment of any earlier installments.

All incorporated sand-and-gravel businesses are generally required to use the Electronic Federal Tax Payment System (EFTPS) to pay their taxes. Form 2220, Underpayment of Estimated Tax by Corporations, is used to determine whether a corporation is subject to the penalty for underpayment of estimated tax and to figure the amount of the penalty.

Estimated tax refunds
Much as is the case with individuals, if a corporation does not pay a required estimated tax installment by its due date, it may be subject to a penalty. That penalty is figured separately for each installment due date. The corporation may owe a penalty for an earlier due date, 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.

Don’t forget the special “Quick Refunds” for some estimated tax overpayments. An incorporated quarry business that has overpaid its estimated tax for the year may be able to apply for a quick refund 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 10 percent of its expected tax liability.

■ At least $500.

Tax planning
In general, incorporated aggregates businesses estimate their annual depreciation deductions by taking into account purchases, sales or other dispositions, changes in use, additional first-year depreciation and similar events — based on information available as of the last day of the quarter. The tax regulations contain two safe harbor methods that can be used when determining an incorporated crushed stone, sand or gravel business’ estimated tax depreciation deduction: a proportionate depreciation allowance or 90 percent of the preceding year’s depreciation.

Under the proportionate depreciation allowance method, corporations estimate their depreciation deduction based on assets placed in service as of the end of the previous year and by the end of the installment period. Keep in mind that using 90 percent of the preceding year’s depreciation to calculate estimated tax payments may provide a tremendous benefit to taxpayers reporting substantial tax depreciation under 2013’s favorable bonus depreciation rules.

A changing of the mind
Uncle Sam, in the form of the Internal Revenue Service, demands every individual and every aggregates business that is required to pay taxes guess their income for the coming year — and pay an estimated tax bill by making installment payments over the course of the year. After an estimated tax payment has been made, changes in income, adjustments, deductions, credits or exemptions may make it necessary to refigure the estimated tax installment.

An individual or aggregates business that does not receive income evenly throughout the year will often find that the required estimated tax payments may vary. Failure to make timely payments that accurately reflect the tax liability of the business — or that of its owner — can result in penalties.

Every aggregates business and business owner should give careful consideration to his or her estimated tax payment calculations. Our tax rules contain clear guidelines that can not only help in figuring those estimated tax bills, but provide so-called “safe harbors” that can substantially reduce, or even avoid those penalties. Obviously, professional assistance may be necessary not only when first computing the estimated tax bill for the year ahead, but also should events dictate change.

 Take note
The IRS knows that calculating earnings isn’t easy, so it offers a safe harbor rule – paying at least as much as the previous year’s liability, or paying within 90 percent of the actual liability. There’s no penalty for underpayment.

Mark E. Battersby is a freelance writer who has specialized in taxes and finance for the last 25 years.