Estimated Tax Payment Requirements and Underpayment Penalties

Posted on July 2, 2024

TAX PLANNING STRATEGIES- ESTIMATED PAYMENTS

As a Tax Professional, we usually look at the following three strategies for tax planning purposes:

• Timing,
• Income-Shifting and
• Estimated Payments

We have already discussed the first two strategies earlier and now we would be examining the "Estimated Payments" strategy.

Effective corporate tax planning includes strategies to:

• reduce corporation's tax liability,
• minimize or eliminate any underpayment penalties for the corporation's taxes.

In general, corporations (other than those with tax liabilities less than $500) must make quaterly estimated tax payments due on the 15th day of the 4th, 6th, 9th and 12th month of the corporation's fiscal year. Here it is presumed that you are on a calendar year end.

TIMING OF ESTIMATED TAX PAYMENTS

It is interesting to note that the estimated tax payment for the first quarter is due after the first quarter is over, which is January to March and payment is due on April 15 but for the other three quarters the payment is due before the quarter is over. For example, let's take the second quarter, April to June, which ends on June 30 but the payment is due on June 15. Similarly, the third quarter ends on September 30, but payment is due on September 15 and finally, the last quarter ends on December 31, but the payment is due on December 15.

In such a scenario, we calculate the estimated tax liability as below:

• Each payment is equal to 25 percent of the corporation's annual required payment;
• The minimum annual required payment is lowest of the following:
• 100 percent of tax liability in the current year
• 100 percent of tax liability on the prior year's tax return
• This may only be used for the first quarter payment for large corporations (over $1,000,000 in taxable income in three prior years)
• May not be used if the corporation did not have a tax liability on prior year tax return
• 100 percent of estimated tax liability in current year using the method of annualizing quaterly taxable income.

ANNUALIZATION FACTOR

The annualization factor is obtained by dividing 12 by the number of months of income as follows, for each quarter respectively. Just because estimated payments are due 15 days following the end of the quarter, the annualization lags one quarter, with the exception of the first quarter:

April 15: Months 1-3

Months of Income Considered: First Quarter - Months 1-3

Annualization Factor: 12/3

Payment Required: 25% of annualized tax

June 15: Months 1-3

Months of Income Considered: Second Quarter - Months 1-3

Annualization Factor: 12/3

Payment Required : 50% of annualized tax

Sept 15: Months 1-6

Months of Income Considered: Third Quarter - Months 1-6

Annualization Factor: 12/6

Payment Required : 75% of annualized tax

Dec 15: Months 1-9

Months of Income Considered: Fourth Quarter - Months 1-9

Annualization Factor: 12/9

Payment Required : 100% of annualized tax

Summarizing the calculations of the estimated tax payments, as explained above:

• When income is not expected to be earned evenly across quarters , corporations use the annualized method to calculate the amount of the remaining estimated tax payments.
• The method of annualizing quaterly income essentially estimates the tax that would be due if the corporation continues earning income at the same rate for the remainder of the year.
• Multiplying the income over that period by the annualization factor, arrives at estimated taxable income.
• The corporation then compares the tax liability on that annualized income to confirm that it has paid the required percentage of annualized tax.