A corporation is required to pay quarterly federal tax installments if the expected liability for the year is $500 or more. These installments are due on the 15th day of the 4th, 6th, 9th and 12th months of the corporation’s tax year, and must be processed using the Electronic Federal Tax Payment System established by the Internal Revenue Service (IRS). If payments are not made timely, or if a corporation does not pay enough for each quarter, penalties and interest can be assessed.
There are two general approaches to consider when calculating estimates; the safe harbor or the annualized income methods. The safe harbor approach is the easiest to prevent penalties and interest, but is limited and can result in a disproportionate amount paid compared to actual activity for a given tax year. Under this method, a corporation is required to prepay the smaller of 100% of the prior year tax or 90% of the current year liability, in four equal installments. This method works best for taxpayers who have a consistent tax liability each year, as it assumes the prior year performance will be a good indicator of the current year.
The annualized income method can be used by a corporation as an alternative but is required for any corporation who exceeds the limitation to use the safe harbor approach. Under this method, a corporation must annualize their projection of taxable income based upon the most recent financial statements. Although different interim periods can be used, the standard method generally results in using actual data that is a quarter in arrears, to project the amount due for the current quarter. In the simplest approach, the taxable income for an interim period would be annualized to estimate income for a full year. The annualized amount would be used to calculate the projected tax liability for the full year, discounting the amount due on a prorated basis for each given quarter. This method is best for companies who experience seasonal fluctuations or other unpredictability in taxable income, as it allows for a more accurate matching of the amounts paid to what is ultimately owed.
There are additional factors to consider to safe guard your company against underpayment penalties and interest. If the corporation had no tax liability in the prior year, you cannot match 100% of zero under the safe harbor method. Further, the safe harbor method can only be used in the first quarter for any taxpayer who had $1 million or more in taxable income in any of the prior three tax years. You generally cannot alternate between methods mid-year, based on which produces the smallest payment.
Depending on where your company operates, a corporation is also often required to prepay state tax installments. These rules are not consistent among states, so please contact us if you have questions or would like assistance with the rules of a particular state.