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Tax rules assist in estimating annual income
Failure to make timely payments that accurately reflect the tax liability of the optometric practice can result in penalties.
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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 optometrist or optometric practice, large or small, can usually avoid penalties by simply basing those 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 optometric professional or his or her practice, gets the use of 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 optometric practice 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 optometric professionals rely on software programs or a professional to help with estimated tax payments, few are aware of how to anticipate or handle the changes that occur during the course of a year.
Estimating taxes
Mark E. Battersby
Think of estimated taxes as a “pay-as-you-go” tax. Four times a year (quarterly), every optometric professional is required to send the U.S. federal government 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 by making estimated tax payments, the optometrist and/or his or her practice may face a penalty for underpayment of estimated tax. However, the IRS knows that calculating earnings is not easy, so it offers a safe harbor rule: paying at least as much as the previous year’s liability or paying within 90% of the actual liability. There’s no penalty for underpayment.
Paying estimated taxes
Anyone filing as a sole practitioner, partner, S corporation shareholder and/or self-employed individual, is generally required to make estimated tax payments if they expect to owe tax of $1,000 or more. If it is not through withholding, then it has to be done by quarterly estimated taxes. If the optometric practice 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 nondeductible interest charge – currently the federal short-term interest rate plus 3% – accruing from the date the payment was due.
Paying estimated taxes weekly, bi-weekly or monthly 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.
Annualized income installment method
Fortunately, those receiving income unevenly during the year can avoid or lower penalties 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. In addition, the penalty may be waived if the optometric professional 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.
What forms to use
Those filing as a sole practitioner, partner, S corporation shareholder and/or self-employed should use Form 1040-ES, Estimated Tax for Individuals, to both figure and pay estimated tax. Incorporated optometric practices are 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% of the corporation’s “required annual payment,” which is the lesser of two amounts: current year tax liability (100% of federal income tax reported on return for the year of the payment) and prior year safe harbor (100% 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% prior year safe harbor amount to determine their required estimated tax payment. In addition, 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 optometric practice 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 optometric practices are generally required to use Electronic Federal Tax Payment System to pay their taxes, while Form 2220, Underpayment of Estimated Tax by Corporations, is used to determine if 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.
Do not forget the special quick refunds for some estimated tax overpayments. An incorporated optometric practice 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% of its expected tax liability and at least $500.
Depreciation deductions
In general, incorporated optometric practices estimate the annual depreciation deductions on the practice’s assets 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 optometric practice’s estimated tax depreciation deduction: a proportionate depreciation allowance or 90% of the preceding year’s depreciation.
Under the proportionate depreciation allowance method, incorporated practices 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. Using 90% 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.
ODs must estimate annual income
The federal government, in the form of the Internal Revenue Service, demands each optometrist and every optometric practice 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 optometric practice 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 optometric practice – or that of its principal – can result in penalties.
Obviously, every optometrist and optometric practice should give careful consideration to all of their estimated tax payment calculations. Fortunately, 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 the associated penalties. Obviously, professional assistance may be necessary not only when first computing the estimated tax bill for year ahead, but also should events dictate change.