Self employment tax and quarterly payments

[Athena]

Mr. Athena and I are both self-employed, and last year we lost one of our biggest clients. No big deal, they were kind of a pain in the ass, and we had plenty of lead time to plan for it. We’re in the US.

This year, as a result, we’ll be making a fair bit less money - at worst, about 50% of what we made last year, at best maybe 80%. I like to be conservative, money-wise, so I’m assuming it’ll be the 50% number.

In a quick conversation with our CPA last week, she seemed to indicate that we will have to magically know how much income we’ll make this year, and pay quarterly taxes on that amount. WTF? I have no clue what we’ll make, beyond a base amount. We may or may not find another client to make up for the one we lost. Chances are we’ll eventually find something, but whether that happens this week, next month, or next year is totally unknown.

If we don’t ante up on the quarterly payments, we’ll be subject to fines.

So I’m reading this as “If we estimate we’re going to make $X this year, and on December 1st we get lucky, and get a contract (and a check) for two times $X, I’m going to have to pay a fine to the IRS because back in April we were not able to forecast that we’d get that contract and pay the required taxes.”

Am I right on that? This seems unfair. But I’ve been in plenty of unfair tax situations before (I’m lookin’ at you, AMT), so I wouldn’t be at all surprised if that was the case.

For the record, I’m going to follow up on this with my CPA, but she’s kinda busy this week, if you know what I mean.

[Rumor_Watkins]

@Athena

Mr. Athena and I are both self-employed, and last year we lost one of our biggest clients. No big deal, they were kind of a pain in the ass, and we had plenty of lead time to plan for it. We’re in the US.

This year, as a result, we’ll be making a fair bit less money - at worst, about 50% of what we made last year, at best maybe 80%. I like to be conservative, money-wise, so I’m assuming it’ll be the 50% number.

In a quick conversation with our CPA last week, she seemed to indicate that we will have to magically know how much income we’ll make this year, and pay quarterly taxes on that amount. WTF? I have no clue what we’ll make, beyond a base amount. We may or may not find another client to make up for the one we lost. Chances are we’ll eventually find something, but whether that happens this week, next month, or next year is totally unknown.

If we don’t ante up on the quarterly payments, we’ll be subject to fines.

So I’m reading this as “If we estimate we’re going to make $X this year, and on December 1st we get lucky, and get a contract (and a check) for two times $X, I’m going to have to pay a fine to the IRS because back in April we were not able to forecast that we’d get that contract and pay the required taxes.”

Am I right on that? This seems unfair. But I’ve been in plenty of unfair tax situations before (I’m lookin’ at you, AMT), so I wouldn’t be at all surprised if that was the case.

For the record, I’m going to follow up on this with my CPA, but she’s kinda busy this week, if you know what I mean.

Your CPA should stop dispensing legal advice, is what I think. Or, at least get a clue.

Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller

http://www.irs.gov/taxtopics/tc306.html
I would find another CPA, frankly.

[pulykamell]

AFAIK, and what my accountant has told me before, is that you can adjust your estimated tax payment each quarter, so if you do get that Q4 surprise contract you weren’t expecting, you can just pay additional taxes for it on Jan 15. Here’s some info on it.

[Scarlett67]

Yeah, your CPA is full of shit. Time to find a new one.

I almost always “pay as I go.” I calculate (OK, I have my tax person calculate) what I owe each quarter based on income and expenses. Once in a while when I didn’t have time to do the bookwork, I just sent in a percentage based on what I paid in the last quarter or two. That is, if the amount I paid the last two quarters was 27% and 25%, I’d probably send in 27%. Occasionally I have a small penalty at the end of the year, but nothing worth getting my panties in a wad.

In the first quarter of this year, I made about half of what I made last year during the same period. If I paid my tax based on last year, I’d have nothing left. Why pay tax on money you haven’t earned yet?

[Athena]

@Rumor_Watkins

Your CPA should stop dispensing legal advice, is what I think. Or, at least get a clue.

What are you referring to as legal advice? The entirety of my question had to do with taxes and fines for not paying taxes on time - both solidly in the realm of CPA knowledge.

@Rumor_Watkins

Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller

I would find another CPA, frankly.

Did you read my OP? I do not want to pay based on last year, as my income this year could potentially be half of what it was last year. I’d be sending the government close to 80% of my earnings if I did that.

[Broomstick]

I agree, you need a better CPA.

Here’s what I do: I sit down with my accountant and, based on past performance and what I know about my present circumstance we estimate my income for the coming year. The CPA computes my estimated quarterly tax from that.

Normally, that’s what I pay.

However, if something unexpected happens - job loss, sudden increase in income, I win the lottery, whatever - I contact him again and we recalculate my taxes based on the new information. If necessary, I then pay more (or less) the next quarter. I suppose if something really amazingly drastic happened I might have to pay something immediately, but that’s never happened (yet).

As far as a CPA dispensing legal advice - some are qualified to give advice in regards to tax law, some are not. Check the accountant’s credentials. A competent one will know when to refer you to a tax lawyer.

[Athena]

As far as everyone telling me to ditch my CPA - it’s entirely possible that I misunderstood her. The info she gave was in the middle of a meeting that was primarily concentrating on last year’s taxes, and I didn’t follow up on it because I didn’t want to get off-track; getting last year’s taxes settled was the important bit.

As it’s the middle of the worst week of tax season, I’m not going to call and bug her about this until next week.

I’ve had this CPA for going on ten years now, and I have no reason to ditch her because of a misunderstanding that could very well be on my side. I’m just looking for more info to carry me through until I talk to her next week.

[Rumor_Watkins]

@Athena

What are you referring to as legal advice? The entirety of my question had to do with taxes and fines for not paying taxes on time - both solidly in the realm of CPA knowledge.

ok ok, i was a bit overzealous with the “legal advice” bit. but still if she’s telling you about what fines you may or may not be subject to (which i freely admit she did not, rather i misread what you “interpreted” to be coming from her) then she’s wandering into legal tax advice land, instead of accounting land.

Did you read my OP? I do not want to pay based on last year, as my income this year could potentially be half of what it was last year. I’d be sending the government close to 80% of my earnings if I did that.

and you’d be getting it back if you overpaid. your post said nothing about your ability to pay the estimated taxes one way or the other.

[Athena]

@Rumor_Watkins

and you’d be getting it back if you overpaid. your post said nothing about your ability to pay the estimated taxes one way or the other.

Heh. I WISH I were in the financial realm where I could afford to pay twice what I really owe in taxes (and get it back next year), but I’m not. It’s bad enough paying what I truly owe!

[bibliophage]

@Athena

As it’s the middle of the worst week of tax season, I’m not going to call and bug her about this until next week.

The first 2010 estimated tax payment is supposed to be mailed by April 15 (tomorrow). If that hasn’t been paid yet, you really should be bothering her.

[Athena]

@bibliophage

The first 2010 estimated tax payment is supposed to be mailed by April 15 (tomorrow). If that hasn’t been paid yet, you really should be bothering her.

We (as in, the CPA and us) did an estimate for first quarter based on our actual income and paid that amount. We’ll sort out whether or not that was right next week, that’s part of why I started this thread, I want to learn more about what to expect before we talk to her.

[Scarlett67]

@Athena

@Rumor_Watkins (bolding added by Scarlett67)

Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller

Did you read my OP? I do not want to pay based on last year, as my income this year could potentially be half of what it was last year.

Looks to me like the bolded part answers your question. When 2010 tax prep time comes around next April, if you made less money this year than last year, as long as you’ve paid in 90% of what you actually owe for this year (which would be smaller than 100% of last year’s tax), you’re fine.

[Rumor_Watkins]

@Scarlett67

Looks to me like the bolded part answers your question. When 2010 tax prep time comes around next April, if you made less money this year than last year, as long as you’ve paid in 90% of what you actually owe for this year (which would be smaller than 100% of last year’s tax), you’re fine.

well that’s her problem, she doesn’t know what she’ll owe this year.

I have no clue what we’ll make, beyond a base amount.

[Scarlett67]

I don’t know how much I’m going to make for this entire year either. That’s why I have my tax person calculate the tax for each individual quarter. For example, last week I gave her my 1st quarter 2010 records, and she calculated what I owe for this past quarter. I wrote a check out of the funds I’ve been setting aside out of each check for this purpose and sent it in. Repeat for each successive quarter. At the end of the tax year, she makes any final minor adjustments and figures my final tax. I rarely have to pay in because I’ve been keeping things close to the bone all year.

@Athena

We (as in, the CPA and us) did an estimate for first quarter based on our actual income and paid that amount. We’ll sort out whether or not that was right next week, that’s part of why I started this thread, I want to learn more about what to expect before we talk to her.

Sounds exactly right to me. That’s why it’s called quarterly payment of estimated tax. I believe that if you look at your past tax forms, any penalties are based on underpayment per quarter, not over the whole year. So if you’re keeping up with your quarterly estimates (based on actual income for each past quarter) and payments, you should be fine.

[pudytat72]

I base my quarterly tax payments on a percentage that I came up with using the previous years income tax form.

I take the total taxes due (line 61 on the 1040) and multiply it by 100, then divide that amount by my gross income (line 7 on the Schedule C) to get a percentage amount. Last year, for me, that number was 14%. I add a bit for “cushion”/avoiding tax penalty and this year I will send 18% of my gross income each quarter to the IRS. In the 7 years I have been doing this, I have not gotten a penalty, even though my income varies during the year.

My 2009 taxes will have an added twist. I will have to do them two times. Once as Head of Household with one dependent, and will I file that version. Then I will do the forms as Filing single (my dependent turned 23 and for 2010 I won’t be claiming him as a dependent). I will use the percentage that I get from the Single filing status to determine what I pay for quarterly taxes in 2010. I’m sure the new percentage will be higher. . .sigh.

[amarone]

@Scarlett67

Looks to me like the bolded part answers your question. When 2010 tax prep time comes around next April, if you made less money this year than last year, as long as you’ve paid in 90% of what you actually owe for this year (which would be smaller than 100% of last year’s tax), you’re fine.

What you say is true for people who pay tax through withholdings, but not for self-employed people. Self-employed people have to pay quarterly taxes of at least a certain amount depending on their income in that quarter. You cannot pay zero for the first three payments and then send a big lump on January 15 for payment 4. As the instructions for form 1040 say:

You may owe this penalty if: …
You did not pay enough estimated tax by any of the due dates. This is true even if you are due a refund.

If you genuinely have lumpy income, then you can adjust your quarterly payments accordingly and will not pay a penalty.

The safest way is to work out your taxable income for the first quarter, apportion any deductions, exemptions and credits, and send the tax you owe.

[Anglachel]

You are getting suspect advise here, stick with your CPA. The current quarterly payment system is geared towards incomes increasing year over year, not decreasing. The protections it has in place are no help to you in your situation. If you underestimate your potential income or get a rush at the end of the year, you will likely owe some “penalty”. IIRC it is based on interest rates, and with current low rates it shouldn’t be a huge risk factor.

[Nothar]

CPA checking in. Usual disclosures - I am not your CPA and any advice given should be gone over with your personal CPA.

The people telling you that your CPA is wrong and to get a new one do not have any clue what they are talking about.

Based on your income levels the rules for avoiding any underpayment penalties or interest are to pay in 90% of current year tax or 100% of prior year tax.

Since you will make less in 2010 than you did in 2009, you do not want to pay the 100% of prior year tax method, which is why the CPA wanted an estimate of your 2010 earnings. The best thing to do is to keep up with your earnings quarterly and then pay in 90% (or a little more) of the estimated tax for each quarter. This will mean getting together with your CPA for each quarter and having them calculate the tax. You may have to pay additional fees to the CPA for this assistance.

This is a little more complicated for the tax preparer because when it comes time to prepare next year’s taxes, they will have to perform an “Annualization” of all of your income and deductions (not just your Self Employment activity) for the underpayment penalty calculation to avoid the penalty. This can be a little bit time consuming based on the complexity of your return and might jack up the fee owed to your CPA for next year.

Therefore it is easy to see why the CPA would rather you just give them a ballpark (on the safe side) number for the year instead of doing it quarterly. It would be easier for them and might cost you more money in fees to the CPA. It might be worth it to avoid the penalty but that depends on the scale of earnings we are talking about and should be discussed with your CPA.

[Scarlett67]

@amarone

What you say is true for people who pay tax through withholdings, but not for self-employed people. Self-employed people have to pay quarterly taxes of at least a certain amount depending on their income in that quarter. You cannot pay zero for the first three payments and then send a big lump on January 15 for payment 4.

Where did I suggest sending nothing for the first three quarters? I said nothing of the sort. True, I did not include it explicitly in the part you quoted above, but throughout the thread I have been talking about paying estimated tax each quarter.

The safest way is to work out your taxable income for the first quarter, apportion any deductions, exemptions and credits, and send the tax you owe.

This is exactly what I HAVE been saying. Don’t we agree?

@Nothar (a CPA)

Since you will make less in 2010 than you did in 2009, you do not want to pay the 100% of prior year tax method, which is why the CPA wanted an estimate of your 2010 earnings. The best thing to do is to keep up with your earnings quarterly and then pay in 90% (or a little more) of the estimated tax for each quarter. This will mean getting together with your CPA for each quarter and having them calculate the tax.

This is also what I have been saying (in agreement with Rumor_Watkins). Where is the confusion?

[Nothar]

No confusion from me Scarlett - I just wanted to add in the information regarding the extra work required by the CPA and that the cost of that work might not be worth the effort to calculate the tax quarterly.