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Back to Basics Part XII – Form 2210 – Underpayment of Estimated Tax
Filed under: Back to Basics | Tags: Form 2210, interest, Les Miserables, penalty, Thenardier, Underpayment of Estimated Tax
Leave a comment Originally published in the Cedar Street Times
March 20, 2015
Believe it or not, time is actually starting to run out if you plan on filing your taxes by April 15. Many firms require complete information to be in the office by late March or the beginning of April in order to assure the returns are completed by the April 15 rush. Most people understand that personal tax returns and any tax owed are due on that day. Even if you file a 6-month extension for the return, the tax is still due on April 15. This requires you to consider the possibility of a short-fall and then send in an estimate by April 15 if deemed necessary, otherwise you will incur interest and penalties if you underestimate.
There are a number of charges the taxing authorities stack up to collect a little extra flow for the general treasury if you are delinquent, and they are all based on unpaid tax. There is a late return penalty, a late payment penalty, an underpayment of estimated tax penalty, plus interest! If you have ever seen the play Les Miserables, it can seem a bit like the opportunist innkeeper, Thenardier who sings, “Charge ’em for the lice, extra for the mice, two percent for looking in the mirror twice! Here a little slice, there a little cut, three percent for sleeping with the window shut.”
In two weeks we will discuss filing extensions and cover the penalties that can start accruing after April 15 – those include late return penalties, late payment penalties, and interest. This week we will focus on the penalty that can accrue throughout the past year up until April 15 – underpayment of estimated tax. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
Underpayment Penalties and Form 2210
While underpayment of estimated tax sounds like a concept that would just apply to people that make quarterly estimated taxes, the reality is that it applies to all of us. It even applies to those that file their returns on time and pay all of their taxes by April 15th. So why would you owe penalties for being such a model citizen?!
Think of it like this: if your employer decided that paying you every two weeks for the wages you had earned was too much of a hassle, and decided instead they were just going to cut you a check once a year in December (or heck, how about April 15 of the following year – why rush it!), you may have a difficult time paying your bills throughout the year, and would then have to borrow money and pay interest on it to carry you until you got your next annual paycheck.
Even if you were a superb money manager and budgeted your annual paycheck carefully so you wouldn’t have to borrow money, you would still conclude that this is an unfair deal and demand that they pay you some interest since you do not particularly fancy giving your employer a free loan for a year! The taxing authorities are the same way. Their “paycheck” is the taxes you owe them and they want to get paid throughout the year, or at least get compensated for your continued use of their paycheck. California and the federal government do not exactly have stellar records of managing money (what government does?). As such, they have to issue bonds to borrow money to cover their expenses and then are stuck paying interest on the bonds! So they want their paycheck!
Employees have taxes taken out of each paycheck and remitted regularly by their employers. Self employed people do not, and generally must pay quarterly estimates. But in either case, if you come up short at the end of the year, the taxing authorities will assess “underpayment penalties” if you do not meet certain thresholds.
So when are underpayment penalties assessed? In the simplest calculation, the federal taxing authorities take your total tax liability at the end of the year, divide it by four and assume they should have received 25 percent by April 15, 25 percent by June 15, 25 percent by September 15, and 25 percent by January 15 of the following year. They look at the dates and amounts sent in by you and then figure out how much your were short and for how many days. They then assess the three percent rate on those figures and amounts of time. California has a special schedule which requires 3o percent paid in April, 40 percent paid in June, 0 percent in October, and 30 percent in January. This unequal schedule requiring 70 percent of your tax to be paid in during the first five months of the year was California’s little trick to help balance the budget a few years back.
You also may be wondering why it is June 15 and September 15 instead of July 15 and October 15, as June is only two months after the first quarterly payment was due (but you owe it on income for three months!). The answer is that I have no idea. I heard once that it had to do with a projected budget short fall by Congress many decades ago, and they were trying to balance their budget. That would make sense, but I can’t say for sure.
If you have taxes withheld by your employer or another source, for calculation purposes, they are evenly spread out to the four quarters, no matter when the taxes were actually paid. For instance – if you got a large bonus at year-end, the taxes would be allocated evenly to all quarters. This makes sense since in the default calculation, the income is also spread out evenly to all quarters.
Self employed people can have problems with this, however, since the actual dates of the estimated tax payments are used in their cases, but the income is still spread out evenly by the default calculation. This could create unjust penalties if they earned a big chunk of their revenue near year end, and then sent in a check at year-end. The revenue would be spread out to all quarters, but the taxes would look delinquent since they were paid at year-end. The Form 2210 allows you to correct this by using an annualized income installment method whereby you enter in your year-to-date cumulative net income (as well as other income and deductions) at the end of each quarter to change the calculation method, and avoid these penalties.
Fortunately, there are some general rules that may allow us to be “penalty proof” so we do not have to worry about this every year, 1) If you have paid in at least 90 percent of the current year tax liability you are penalty proof, or 2) If you paid in at least as much tax as your tax liability in the prior year, then you are penalty proof unless your income is over $150,000 (75,000 if Married Filing Separate), then simply paying in at least as much tax in the prior year will not qualify you – you will have to pay in 110 percent of the prior year amounts, or 3) If the net tax you owe is less than $1,000 after subtracting out payments you made by April 15, then you are penalty proof. California conforms to all of these federal rules. It also has an additional rule for taxpayer’s that make over $1,000,000 ($500,000 Married Filing Separate) – those taxpayers are required to pay in 90 percent of the current year tax or they will face penalties.
Contrary to its unfortunate label as a “penalty,” it is essentially just interest. And it is currently at that same rate of three percent per annum. I often have clients that say they hate paying penalties and want to do whatever they can to avoid underpayment penalties. When I ask them if they would like a loan at a three percent rate of interest instead, they want to know where they can get more of it! If you are going to owe a substantial sum and would need to take the money out of investments that are almost certainly earning more than three percent in todays markets, it would be a wise decision to pay the penalties and pocket the spread. If your money is just sitting in a bank account, however, it would be a different story.
In addition to the calculation sections, the Form 2210 also has boxes to request relief from late payment penalties.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
Back To Basics Part XI – Form 2106 Employee Business Expenses
Filed under: Back to Basics | Tags: 2%, 2106, 2106-EZ, actual expenses, cell phone, clothing, DMV fees, Gas, insurance, Lease payments, Logo, logoed, miscellaneous itemized deductions, not subject to two percent, overnight travel, repairs, standard mileage deduction, two percent limit, uniform, union dues
Leave a comment Originally published in the Cedar Street Times
March 6, 2015
Looking back over the past four months in our Back To Basics series, we have covered the 1040, Schedule A – Itemized Deductions, Schedule B – Interest and Ordinary Dividends, Schedule C – Profit or Loss from Business, Schedule D – Capital Gains and Losses, Schedule E – Supplemental Income and Loss (i.e. – rental properties), and Schedule F – Profit or Loss from Farming. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog . We are now going to shift our attention to a few common supporting forms in your tax returns.
Form 2106 – Employee Business Expenses is our topic today. Unreimbursed employee business expenses documented on this form feed into the section near the bottom of Schedule A called Job Expenses and Certain Miscellaneous Deductions. Any expenses you incur that are necessary and ordinary to your profession for which you are not reimbursed by your employer are potentially tax deductible. Note that these expenses do not have to be required by your employer. They can be common and expected expenses in your profession, or they could simply be items that are helpful and appropriate. Clearly there is a lot of judgement in this standard, but it is not a blank check.
Common expenses include the use of your vehicle for work purposes (other than to and from your home), 50 percent of meals and entertainment expenses (often in sales related positions), union dues, educational conferences, trade magazines, books, classes, etc. in your job field. Overnight travel expenditures such as lodging, meals (50 percent), airfare, and car rentals could be deductible. A portion of your cell phone or internet service fees could be deductible. If you have a home office in lieu of a regular office and it is for the convenience of the employer (not for your convenience), then a percentage of the expenses of maintaining your household could be deductible. (This is actually documented on a separate Form 8829.)
There are also areas of abuse that have led to rules that prohibit specific things that might otherwise be deductible. One of these areas is clothing. You might think that your business attire should be deductible, unfortunately it is not if it can be worn in public and not be clearly identifiable as a uniform. Your employer must also require you to wear it. For instance, a nurse or police officer clearly has a deductible uniform, but business people, even if they have to “look nice” for clients and wear suits, for instance, cannot deduct the cost of their clothing. I unfortunately, cannot deduct my bowties, even though it is a bit of a trademark look for me!
If you have logoed clothing with your business name, however, you would likely not have a problem if your employer requires you to wear it. A number of years ago I gave this speech to a client that was a business owner; the next year he came into my office, turned around, and sure enough, he had his business name logoed on the seat of his pants! If you do have a uniform or logoed clothing, you can also deduct the cost of laundering these items.
Logically, to the extent you are reimbursed for your expenses, you cannot deduct them. If, however, your employer includes your reimbursements in your W-2 box 1 taxable wages, you would need to claim the expenses. Also, if your employer has an accountable plan where they will reimburse you for expenses and you simply fail to submit for reimbursement, you are out of luck, and cannot deduct the expense. If the employer will not reimburse you, but you still deem the expense as helpful and appropriate, you can claim the expense.
Calculating deductible vehicle expenses can get quite complicated. The 2106 is a two page form and the entire second page is devoted to figuring out the vehicle expenses. In addition, there are other forms for the depreciation. The simplest method is to use the standard mileage rate (currently 56 cents a mile) and tracking your business miles. You can only use the standard mileage rate if you started using that method in the first year you placed the vehicle into business use. For expensive vehicles or low mileage use, this generally does not pay off. The actual expense method involves tracking all the receipts for gas, repairs, insurance, DMV fees, lease or finance payments, etc. as well as calculating and tracking depreciation expense on the vehicle. But if you have an inexpensive vehicles that you will drive a lot for a long time, you would likely be better off with the standard mileage method.
Form 2106 is the full version of the form, which allows you to not only document hard costs, but also handle vehicle expenses either through standard mileage or actual expense and depreciation. It is also used when you receive partial reimbursements from an employer. The 2106-EZ is a one page form that can be used if you do not have employer reimbursements to report and you do not use the actual expense method for calculating vehicle expenses. If you do not have vehicle expenses at all or reimbursements, you can report the hard costs directly on the schedule A, and you do not need a 2106 or 2106-EZ.
As previously mentioned, these expenses flow into the Schedule A as Miscellaneous Itemized Deductions Subject to 2% along with a few other things such as tax preparation fees and investment expenses. This means they are subject to a two percent of adjusted gross income (AGI) threshold. For example, if your AGI is $100,000, the first $2,000 of these expenses do not even count as an itemized deduction. In addition, you have to have enough itemized deductions to get over the standard deduction (2014 – $6,200 for Single and $12,400 for Married Filing Joint) before they will reduce your taxable income.
Generally, a better strategy is to get your employer to pay for these expenses, even if it means you take a lower salary as a trade-off. You are better off since you will not be subject to a two percent floor!
As with everything there are exceptions. People in the military reserves, for instance, are not subject to the two percent floor. Detailed IRS publications exist on all the rules if you are looking for some more bedtime reading!
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.
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