Among the numerous responsibilities of operating a profitable business, paying income taxes is an important one that should not be left until the income tax return is filed. The IRS and many states require estimated tax payments be made quarterly to avoid underpayment tax penalties. In this blog, we outline the various methods for calculating estimated income taxes, the due dates, and how to make the payments.
Entities taxed as a C-Corporation must make estimated federal income tax payments during the tax year if it expects its total tax for the year (less applicable credits) to be $500 or more. Federal estimated income tax payments must be made in four equal 25% installments, due by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. For a calendar year taxpayer, this would be April 15th, June 15th, September 15th, and December 15th.
There are two primary methods for determining the amount of a corporation’s Federal installment payment of estimated income tax. Taxpayers should use the method that results in the lowest installment payment required:
- Current Year Method – a corporation can avoid underpayment penalties by paying 25% of the current year tax amount in four quarterly installments. This requires an accurate projection of current year taxes;
- Preceding Year Method – each required installment is 25 percent of the tax shown on the corporation’s return for the preceding tax year. However, a corporation may not use the Preceding Year Method unless:
- it filed an income tax return for the preceding year;
- the income tax return was for a full twelve months; and
- the income tax return showed a positive tax liability (not zero).
Large corporations (those with $1 million or more of modified taxable income in any of the three immediately preceding tax years) may use the last year’s income tax liability only to compute their first installment of estimated tax. They must compute the Quarter 2, Quarter 3, and Quarter 4 installments based on their expected current year’s tax liability and must recapture any reduction in the first installment by increasing the amount for the next installment.
A corporation may qualify to use the annualized income installment method or the adjusted seasonal installment method to determine its estimated tax liability if such method results in payments lower than the required installment payments. One of these methods may be advantageous if the taxpayer’s income is expected to vary during the year.
Under the annualized income installment method, a taxpayer is allowed to determine the installment by annualizing its taxable income for a given number of months of the tax year under the standard method (standard monthly periods) and two optional methods (optional monthly periods, which requires Form 8842 to be completed).
For example, under the annualized income installment method using the standard method, installments are based on the following financials for a calendar year taxpayer:
|January – March
|April – June
|July – September
|October – December
The adjusted seasonal installment method may be used only if the average of the corporation’s taxable income for the same six-month period in the three preceding years was 70 percent or more of annual taxable income. An adjusted seasonal installment is the excess (if any) of 100 percent of the amount determined by following the steps below, over the aggregate amount of all prior required installments for the tax year.
The amount of any installment is determined as follows:
- take the taxable income for all months during the tax year preceding the month in which the installment is required to be paid (the “filing month”);
- divide this amount by the base percentage for such months;
- determine the tax on the result; and
- multiply the tax by the base percentage for the filing month and all preceding months during the tax year.
Federal Payment Options
The IRS requires that corporations make estimated payments electronically via EFTPS. Note that EFTPS requires enrollment, which can take several business days to complete.
Some states follow estimated tax payment rules similar to the IRS, but many states differ. For instance, California requires 30% for the first installment, 40% for the second installment, no estimated tax payment is required for the third installment, and 30% for the fourth installment. Therefore, it is important for taxpayers to understand the states they have income tax obligations and the methods used to calculate estimated income taxes.
State of California Payment Options
If a corporation is expecting a tax liability in California that exceeds the $800 minimum corporate tax that is due by April 15th of every year, they can make estimated payments as follows:
- Mail estimated tax payments with Form 100-ES;
- Electronic Funds Transfer (EFT): California law requires that Corporations remitting an estimated tax payment or extension payment in excess of $20,000 or having a total tax liability in excess of $80,000 must remit all payments through EFT. Once a corporation meets the threshold, all subsequent payments regardless of amount, tax type, or taxable year must be remitted electronically to avoid a 10% non-compliance penalty. EFT options for California are:
- Web Pay – Use Web Pay to pay with your checking or savings account for free, or
- Credit Card – California Franchise Tax Board uses ACI Payments (who charges a convenience fee for using this service) to process credit card payments.
Pass-through entities (those taxed as S-Corporations and Partnerships)
With pass-through entities, the income from the entity passes through to the owner’s individual tax returns where it is taxed at the owner’s marginal tax rate. Because of this, the estimated tax must be considered in the owner’s estimated tax calculations and payments. Please see our blog on paying taxes as an individual.
Note that some states have separate entity level income taxes for pass-through entities, such as the California 1.5% tax on S-Corporation taxable income. These may also require quarterly payments to avoid underpayment penalties.
Sole proprietors (Schedule C)
Similar to pass through entities, the income earned from your sole proprietorship is taxed at the owner’s marginal tax rates on the owner’s individual tax return. As a result, these too must be considered in the owner’s estimated tax calculations and payments.
For more information, or to discuss your businesses specific circumstances please reach out to a member of our team.
Aura Advisors is a boutique tax consulting, compliance, and representation firm working with affluent individuals and owners/officers/founders of start-up/emerging growth companies. Building connections beyond the code.