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The New Rules of Estimating Income TaxesApril 1, 2007 By: Mark E. Battersby Home-Based Travel Agent
Keeping an eye on your Income Taxes will help keep you out of trouble with the IRS
THE MUCH-DISCUSSED TAX GAP—the difference between what taxpayers should have paid and what they actually paid—comes to a staggering $345 billion, and lawmakers are pressing the Internal Revenue Service to get more aggressive about reducing it. Read on for how to comply with the laws.
Little wonder that the government wants what it is due—and wants it on a timely basis. There is little cheating when an employer reports wages paid to the IRS. That is why, under our tax rules, all self-employed travel agents, partners and businesses are required to make payments on their estimated tax bill for the year, usually in quarterly installments. Compliance with these rules, however, is less than 50 percent for income not subject to third-party withholding.
Estimated tax payments are used to pay tax on income that is not subject to withholding. Those quarterly installments include both income tax and self-employment tax, along with any other taxes or amounts reported on your tax return. In other words, those quarterly installments are usually based on a pro rata portion of the individual's or the travel business' estimated annual tax liability.
Do you have any idea of what your income from your travel-related activities will be? Or, can you guess what your tax bill for all of 2007 is going to be? Not too surprisingly, the IRS expects everyone, be it independent travel agents, tour guides, owners of travel agencies and related businesses, whether incorporated or not, to know, or at least make a reasonably accurate guess, of their tax bill for the year. And, now it appears as if our lawmakers may enter the fray, raising the existing penalties even higher. Generally, you must pay estimated tax for 2007 if both of the following apply: First, you expect to owe at least $1,000 in taxes for 2007 after subtracting your withholding and credits. And secondly, you expect your withholding and credits to be less than the smaller of 90 percent of the tax shown on your 2007 tax return, or 100 percent of the tax shown on your 2006 tax return.
Sole proprietors, partners and S corporation shareholders must make estimated tax payments if they expect to owe taxes of $1,000 or more. The general rule is that at least 90 percent of an individual's federal income tax must have been paid either through withholding or estimated tax payments.
Incorporated travel agents and businesses are required to make estimated tax payments if they expect to owe taxes of $500 or more. Corporations must deposit the estimated tax payments, while everyone else has the option of using the mail. Terms at a Glance
Any business or self-employed travel agent who fails to pay a required estimated tax installment or fails to arrive at a close approximation of their annual tax liability faces penalties levied by the IRS.
ANNUALIZATION IS NOT A BAD WORD
The Treasury Department and the IRS recently proposed new regulations for computing estimated tax liabilities for many incorporated businesses. The new rules reflect more than 21 changes that were made to the tax laws in this one area since 1984.
Under our tax rules, "annualization" means to extend an item to an annual basis. Taxable income for part of the year is ordinarily multiplied by 12 (months) and divided by the number of months involved. If, for example, an independent travel agent's taxable income for three months were $20,000, it would be annualized as $80,000.
The IRS reportedly discovered that some taxpayers, particularly those using a so-called "annualized" method, managed to reduce, if not eliminate, their estimated tax payments for one or more installments. The new regulations outline guidelines the IRS believes will result in a more accurate reflection of annualized income than the methods that many taxpayers are now employing.
The new rules provide extensive guidance on how to determine the amount due with each quarterly installment, whether based on the corporation's estimated annual tax liability or on its annualized or adjusted seasonal taxable income.
Underpayment of any of the required estimated tax installments can result in a penalty, a so-called "addition to tax," on the amount of the underpayment for the entire period of that underpayment. The addition to tax is based on the underpayment interest rate, which is determined quarterly by the IRS. For underpayments, Form 2220, "Underpayment of Tax" is used.
In order to avoid expensive penalties for underpaying your estimated taxes, the total installments of a calendar year for an incorporated travel agent or business must equal the lesser of:
- 1. 100 percent of the tax shown on its return for the preceding tax year, or
- 2. 100 percent of the tax shown for the current year (determined on the basis of actual income or annualized income).
CHANGING YOUR MIND
If, after estimating your annual tax liability, you find that your tax liability for the year will be more or less than originally estimated, it is possible, and legal, to refigure those required installments. Failure to adjust can result in an underpayment penalty. An immediate catch-up payment is also permitted to reduce any penalty resulting from the underpayment of earlier installments.
Are you—or your travel business—going to be caught in the predicted crackdown on those who fail to pay estimated taxes?
No penalty for failure to pay estimated tax will apply to an individual whose tax liability for the year, after credit for any taxes withheld, is less than $1,000. In fact, no one needs to pay estimated tax if he or she had no tax liability for the preceding tax year.
Independent travel agents, business owners, partners and principals in travel agencies who do not qualify for any of the exclusions already mentioned, can avoid the penalty for failure to pay estimated tax by: paying at least 90 percent of the tax shown on the current year's return; paying 100 percent of the tax shown on the previous year's return; or making installment payments using an annualized income installment method.
Individuals with adjusted gross income in excess of $150,000 ($75,000 for a married individual filing separately) in 2006 or thereafter can avoid the estimated tax penalty only by paying 110 percent of the amount of tax shown on the tax return for the prior tax year.
The IRS wants what it is due—usually paid in quarterly installments during the year. The "grey areas" that many incorporated travel agents and businesses using the annualization method employed to reduce underpayment penalties have been largely curtailed under the IRS' newly released guidelines. However, paying your and your travel operation's estimated tax liability on a timely basis during the year remains an obligation. The penalties and fines for underpaying that estimated tax bill also remain and may increase dramatically if Congress becomes involved.