Basics of estimated taxes for individuals

By: The IRS News Room

The U.S. tax system operates on a pay-as-you-go basis. This means that taxpayers need to pay most of their tax during the year, as the income is earned or received. Taxpayers must generally pay at least 90 percent (however, see 2018 Penalty Relief, below) of their taxes throughout the year through withholding, estimated or additional tax payments or a combination of the two. If they don’t, they may owe an estimated tax penalty when they file.

The IRS has seen an increasing number of taxpayers subject to estimated tax penalties, which apply when someone underpays their taxes. The number of people who paid this penalty jumped from 7.2 million in 2010 to 10 million in 2017, an increase of nearly 40 percent. The penalty amount varies but can be several hundred dollars.

The Tax Cuts and Jobs Act, enacted in December 2017, changed the way tax is calculated for most taxpayers, including those with substantial income not subject to withholding. As a result, many taxpayers may need to adjust the amount of tax they pay each quarter through the estimated tax system.

Here are some simple tips to help taxpayers:

Who may need to pay estimated taxes

Individuals, including sole proprietors, partners and S corporation shareholders, may need to make estimated tax payments if:

  • they expect to owe at least $1,000 when they file their tax return.
  • they owed tax in the prior year.

Taxpayers who may need to make estimated tax payments include someone who:

  • receives income that isn’t from an employer, such as interest, dividends, alimony, capital gains, prizes and awards.
  • has tax withheld from their salary or pension but it’s not enough.
  • has more than one job but doesn’t have each employer withhold taxes.
  • is self-employed.
  • is a representative of a direct-sales or in-home-sales company.
  • participates in sharing economy activities where they are not working as employees.

Wage-earners and salaried employees can avoid estimated tax payments by having their employer withhold tax from their wages. To determine the right amount to withhold, use the Withholding Calculator, available on IRS.gov.  Then, based on its recommendations, they can use Form W-4, Employee’s Withholding Allowance Certificate, to tell their employer how much tax to withhold from their pay. Anyone can change their withholding any time during the year.

When to pay estimated taxes

For estimated tax purposes, a year has four payment periods. Taxpayers must make a payment each quarter. For most people, the due date for the first quarterly payment is April 15. The next payments are due June 15 and Sept. 15, with the last quarter’s payment due on Jan. 15 of the following year. If these dates fall on a weekend or holiday, the deadline is the next business day.

Farmers, fishermen and people whose income is uneven during the year may have different rules. See Publication 505, Tax Withholding and Estimated Tax, for more information.

If a taxpayer doesn’t pay enough or pays late, a penalty may apply.

How to figure estimated taxes

The IRS recommends that everyone do a paycheck checkup early in 2019, even if they did one in 2018, to determine if they need to adjust their tax withholding or make estimated tax payments throughout the year. Although especially important for anyone with a tax bill for 2018, it’s also important for anyone whose refund is larger or smaller than expected. By changing withholding now or making estimated tax payments, any taxpayer can better ensure they get the refund they want next year. For those who owe, making estimated tax payments in 2019 is the best way to head off another tax-time surprise a year from now.

Taxpayers should also make adjustments throughout the year if changes occur. When figuring their estimated taxes each year, taxpayers need to account for life events, like marriage or the birth of a child, that may affect their taxes. They should also adjust for recent changes in the tax law.

Individuals, sole proprietors, partners and S corporation shareholders generally use the worksheet in Form 1040-ES. They’ll need to know their expected adjusted gross income. They’ll also need to estimate their taxable income, taxes, deductions and credits. Some taxpayers find it helpful to use information from their prior year’s tax return when they complete the worksheet. Their estimates should be as accurate as possible to avoid penalties.

Some taxpayers earn income unevenly during the year. For example, a boat repair business might do more business in the summer. Taxpayers like this can annualize their income. Under this method, they’d make unequal tax payments, based on when they receive their income, rather than four even payments. Doing so could help them avoid or lower a penalty because their required payment for one or more periods may be higher with this method. See Worksheet 2-9 in Publication 505.

How to pay estimated taxes

Taxpayers can pay online, by phone or by mail. The Electronic Federal Tax Payment System and IRS Direct Pay are two easy ways to pay. Alternatively, taxpayers can schedule electronic funds withdrawal for up to four estimated tax payments at the time that they electronically file their Form 1040.

Taxpayers can make payments more often than quarterly. They just need to pay each period’s total by the end of the quarter. Visit IRS.gov/payments for payment information.

Penalties related to estimated taxes

If a taxpayer underpaid their taxes they may have to pay a penalty. This applies whether they paid through withholding or through estimated tax payments. A penalty may also apply for late estimated tax payments even if someone is due a refund when they file their tax return.

In general, taxpayers don’t have to pay a penalty if they meet any of these conditions:

  • They owe less than $1,000 in tax with their tax return.
  • Throughout the year, they paid the smaller of these two amounts:
    • at least 90 percent (however, see 2018 Penalty Relief, below) of the tax for the current year
    • 100 percent of the tax shown on their tax return for the prior year – this can increase to 110 percent based on adjusted gross income

To see if they owe a penalty, taxpayers should use Form 2210.

The IRS may waive the penalty if someone underpaid because of unusual circumstances and not willful neglect. Examples include:

  • casualty, disaster or another unusual situation.
  • an individual retired after reaching age 62 during a tax year when estimated tax payments applied.
  • an individual became disabled during a tax year when estimated tax payments applied.

There are special rules for underpayment for farmers and fishermen. Publication 505 has more information.

2018 penalty relief

The IRS is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. The penalty will generally be waived for any taxpayer who paid at least 80 percent of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two. The usual percentage threshold is 90 percent to avoid a penalty.

The waiver computation is normally reflected in commercially-available tax software and in the latest version of Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts, and its instructions.

This relief is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect an array of changes under the Tax Cuts and Jobs Act.

The updated federal tax withholding tables, released in early 2018, largely reflected the lower tax rates and the increased standard deduction brought about by the new law. This generally meant taxpayers had less tax withheld in 2018 and saw more in their paychecks. However, the withholding tables couldn’t fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions. As a result, some taxpayers could have paid too little tax during the year if they did not submit a properly-revised W-4 withholding form to their employer or increase their estimated tax payments.

The IRS and partner groups conducted an extensive outreach and education campaign throughout 2018 to encourage taxpayers to do a “Paycheck Checkup” to avoid a situation where they had too much or too little tax withheld when they file their tax returns.

Although most 2018 tax filers are still expected to get refunds, some taxpayers will unexpectedly owe additional tax when they file their tax returns.

More information:

 

Want in-person help with your small business taxes? Attend the “Taxes and the Small Business Owner” seminar at Biz Fair on Saturday, Sept. 21.

How will your LLC be Governed?

By: Stacey Romberg, Attorney

When limited liability company (LLC) members chose to work with an attorney to form their business entity, the attorney will draft an “Operating Agreement,” which is also sometimes referred to as a “Limited Liability Company Agreement.” RCW (Revised Code of Washington) 25.15.018(1) provides that an Operating Agreement governs “[r]elations among the members as members and between the members and the limited liability company” and, if applicable, “[t]he rights and duties . . . [of the LLC] manager.”  In other words, the Operating Agreement sets forth the procedures for how the LLC will be governed. An attorney drafts this governance document in consultation with the LLC members. An Operating Agreement is needed for LLCs that have one member, hundreds of members, and everything in between. Sometimes, in addition to the lawyer representing the business entity itself, the LLC members will retain their own individual attorneys to advise them confidentially concerning the Operating Agreement’s provisions and assist them in negotiating for beneficial terms.

What happens if the LLC members fail to hire counsel to draft the LLC’s Operating Agreement? What if instead the LLC’s members shake hands on a verbal agreement? Previously, the Revised Code of Washington required Operating Agreements to be in writing. But the Washington Limited Liability Company Act, which became effective in 2016, changed that – instead indicating that these agreements can be oral or implied.  While oral Operating Agreements are now allowed under Washington law, virtually all business attorneys would nonetheless highly recommend that the Operating Agreement be in writing. Suppose you have a dispute with another LLC member? Suppose you want to sell your interest and move on? Or suppose you pass away, and your spouse seeks to collect your share of the business’s value as an asset of your estate? Perhaps the business was only worth a few dollars when the handshake occurred, but after years of hard work it has significantly increased in value. Would you want to rely solely on a handshake under those circumstances? Or would you prefer that the rules of the road were clearly set forth in a well-crafted document prepared by the LLC’s attorney?

If the LLC does not have a written Operating Agreement, and if the courts are unable to find the existence of an oral or implied agreement, RCW 25.15.018(2) provides that Washington law, specifically Chapter 25.15 of the Revised Code of Washington, “governs the matter.” In other words, if you fail to proactively provide for governance of your LLC, the answer to the question of “How will your LLC be governed?” will be found in statutory law, even if the default statutory language runs contrary to your own wishes or presumptions as to how your business should function.

For example, suppose ABC, LLC has three members. The first LLC member, Jane, makes an initial capital contribution of $300,000 into the business – an inheritance received from her grandmother. The other two members, John and JoAnne, each provide $10,000 worth of capital. ABC has no Operating Agreement. Jane, through a tip from her brother-in-law, finds a perfect and affordable commercial space to lease located in the Greenwood neighborhood of Seattle. John and JoAnne oppose the move, arguing that the business should instead operate out of JoAnne’s mold-infested basement for free. Even though Jane invested, by far, the most capital, under the 2016 Washington Limited Liability Company Act, each LLC member gets one vote unless the Operating Agreement provides otherwise. Here, where ABC, LLC does not have an Operating Agreement, JoAnne and John outvote Jane, and into the basement they go. Does that result seem fair to you, given the disparity in what each member contributed? It may not be fair. And Jane may not have envisioned this result when she deposited her inheritance into the LLC’s bank account. But again, since the LLC members failed to develop an Operating Agreement, Chapter 25.15 of the Revised Code of Washington will govern the LLC’s decision-making process about where to locate the business.

Don’t be caught off guard by unexpected results in terms of how your business will be governed. Take charge, and proactively work with counsel to develop a comprehensive Operating Agreement so that you know, without hesitation, the answer to the question: “How will your LLC be governed?”

Stacey L. Romberg is the founder of a virtual law firm focusing on business law, estate planning and probate. More information can be found at www.staceyromberg.com.

Attend Stacey Romberg’s seminar “Business Law Essentials” at the 23rd annual free Biz Fair on Saturday, Sept 21.

The Brooklyn Bridge isn’t for sale, and the guy on the phone isn’t an IRS agent.

By: Aaron Hoffman

Hucksters, con men, and scammers have been part of the American landscape since the country’s founding. From Wild West “snake oil” salesmen to modern day Ponzi Schemers, America has certainly seen its fair share. So, who holds the dubious title of the best con man in U.S. history? That honor goes to none other than George C. Parker. During his life, Parker “sold” a number of U.S. landmarks such as Madison Square Garden, the Metropolitan Museum of Art, Grant’s Tomb, and even the Statue of Liberty. However, he’s most famous for “selling” the Brooklyn Bridge on a number of occasions to willing dupes. Eventually convicted of fraud, a judge sentenced Parker to serve a life term in prison. While he died in Sing Sing Prison in 1936, his legacy lives on. His antics gave rise to the phrase, “and if you believe that, I have a bridge to sell you.” (Thanks Wikipedia!)

While modern day scammers might not have a bridge to sell you, they certainly have other nefarious ways to part you from your money. Did you know that every year, people posing as IRS agents scam millions of dollars from Americans?

Fortunately, the IRS has some helpful tips that can keep you from falling prey to a scam.

Tip #1 – Watch the mail

Most IRS contact comes via regular mail through the U.S. Post Office. If it comes from another source, be suspicious! In addition, if the IRS has to take official action, they will first notify you via letter through the U.S. Postal Service.

Tip #2 – Listen for threats and intimidation

If you get a caller on the phone and they claim that they’re from the IRS, be aware that an IRS agent will never do any of the following:

  • Demand payment via gift card, wire transfer, or a pre-paid debit card
  • Demand that you pay taxes without the opportunity to appeal or question the amount that you owe
  • Threaten to bring in local police, immigration officers, or other law enforcement officers and have you arrested for not paying.
  • Threaten to revoke your driver’s license, business license, or immigration status

Tip #3 – Look for credentials

If you get an “in-person” visit from an IRS agent, they will produce two forms of official identification; a pocket commission card and an HSPD-12 card. If they don’t have these or refuse to produce them, you can assume that they’re scammers!

Tip #4 – Who gets the money?

If your caller or visitor demands money and they want the payment to go some entity other than the U.S Treasury, don’t pay because it’s a scam.

Tip #5 – Report them!

Phone Scams

If you get a call from someone posing as an IRS Agent, contact the Treasury Inspector General for Tax Administration. You can call 800-366-4484, or file an online complaint at IRS Impersonating Scam Reporting.

Also, you can report a phone scam to the Federal Trade Commission (FTC). Be sure to add “IRS Telephone Scam” in the notes section.

Email Scams

If you get an email from someone claiming to be from the IRS, or an IRS related component, report it to the IRS at phishing@irs.gov

For more info, please see the IRS publication How to know it’s really the IRS calling or knocking on your door.

Fun Fact!

One of the earliest recorded cases of insurance fraud comes from ancient Greece. In 300 B.C., a merchant named Hegestratos took out a large insurance policy on his ship. He reportedly planned on sinking his empty ship, selling its cargo, and pocketing the insurance money. Hegestratos’s passengers and crew caught him red-handed, and he drowned as he tried to escape (Investopedia.com).

Aaron Hoffman works for the Department of Labor and Industries. Along with his duties as Contract Manager for the COHE Program, he regularly contributes to L&I’s social media campaign. He earned his BA and MBA from Pacific Lutheran University.

Meet your local L&I representative and the entire Washington Small Business Liaison team at the “How Washington State Can Help Your Business” session at Biz Fair on Saturday, September 29 at Renton Technical College. More info at www.bizfair.org.

Tips for Success in Choosing a Business Structure

By: Stacey Romberg, Attorney at Law. www.staceyromberg.com

Choosing a business structure can be a daunting task! I recommend that entrepreneurs, in making their selection, analyze the following four factors:

Evaluate Your Risk

Does your business idea involve some risk of liability? If so, in what sense? And how much risk? For example, do you want to lead rock climbing excursions? Or to provide a more common example, suppose you want to operate a cross training gym? The risks involved in these types of businesses are clear – the participants may be injured. On another note, suppose you are a wedding photographer? You could be on the hook if the photos don’t turn out well and the bride and groom become angry and litigious. Generally speaking, if your business involves a great deal of potential risk, a business entity such as a corporation or a limited liability company (LLC) may prove helpful in shielding you from individual liability.

Evaluate Your Business Relationships

Breaking up is hard to do! Most couples, when they get married, incorrectly assume that their relationship will last forever so no prenuptial agreement is necessary. Similarly, many business owners assume they will always be able to work together well so there’s no need to spend money on legal fees to develop a corporate Shareholders Agreement or LLC Operating Agreement. These agreements govern the relationship between business owners, and can spell out what will happen if business owners are deadlocked or how a business owner may exit out of the business. A breakup of a business relationship can resemble the dissolution of a marriage, with all the accompanying drama, stress, and expense. If you are going into business with another person, enter into that relationship with caution and a solid legal agreement in place.

Confer with Your Certified Public Accountant (CPA)

Be sure, as you consider what business structure to form, to consult with your CPA about the tax implications of the various business structures. It’s important that you understand all the financial facts regarding your potential tax liabilities before making a decision.

Confer with Your Business Attorney

A business attorney should form any business entity other than a sole proprietorship. If your business is not formed properly, you may be disappointed to discover that, in the event of litigation, the business entity fails to shield you from personal liability because the structural documents are insufficient, inappropriate, or not being consistently followed.

Stacey L. Romberg, Attorney at Law. www.staceyromberg.com This post is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting with an attorney.

Buyer Beware: 6 Things to Ask the Seller for When Buying a Business

By: Rose Gundersen, Small Business Liaison with WA State Department of Labor & Industries

Did you know when you buy an existing business — or a part of one — you assume the workers’ compensation claim liabilities of that business? It’s true. The new business owner inherits the claim responsibilities and their impact on premium rates.

How to protect yourself
To uncover potential hidden future expenses and risks, ask the seller to disclose the following 6 items before you buy a business. (This information isn’t usually included in financial documents and L&I can only disclose it to the current business owner, not to a potential buyer.)

1. Injury and Cost Profile: This 1-page report covers a 5-year history of workers’ compensation and injury data for the business, including:

  • Premiums which may include savings from a Claim-Free Discount or higher rates due to time-loss or disability claims.
  • Total number of claims per year.
  • Experience factor (over 1.0 means higher rates).
  • Claims-Free Discount history.
  • Top 5 types of injuries specific to the industry and the injury types incurred by the business.

2. Injury Report: This report shows the claim expenses incurred by the business without revealing identifiable information such as the injured worker’s name or the claim number. Claim expense categories include medical, time-loss, partial permanent disability, pension, and more.

3. Estimated Future Rate Projection: This predicts the business’s future experience factor and premium expenses, assuming that the business data remains unchanged.

4. Safety and Health Consultation Report: The business’s workplace safety culture is an intangible asset or risk that you’ll inherit as a buyer. Scheduling a no-cost, risk-free L&I safety consultation will help you assess this culture and evaluate whether it is an asset or a risk. The consultation includes a walk-through visit to the worksite to look for workplace hazards and an evaluation of the Accident Prevention Program. The business can’t be fined as a result of the consultation. Correcting serious hazards, however, is required with no financial penalties.

5. Occupational Safety and Health Act (OSHA) Log Records: Businesses with 11 or more employees may be required to record workplace injuries and illnesses on an OSHA 300 log (OSHA.gov).Reviewing these logs will inform you of hazards and the effectiveness of workplace health and safety programs. (The business must keep these reports on site for 5 years.)

6. Risk Management Consultation: This free consultation provides a review of the business’s injury history and a step-by-step plan with best practices to help control costs. If you plan to proceed with the purchase after learning the injury history and safety culture, a risk management consultation is an excellent mitigation step.

Partial business purchases
Even if you purchase only a part of a business, you can inherit the seller’s workers’ compensation liabilities. For example, if you bought a customer list, inventory or other partial assets and employees working in those reported risk classifications were injured on the job, you could potentially assume the claim liability.

Example of potential impact
To better understand workers’ compensation rates, remember that:

  1. The risk class reflects the overall loss history of each industry.
  2. The experience factor reflects the loss history of the business.
  3. A claim affects a business’s experience factor for 3 years, but your rate won’t be affected for 2-3 years after the injury date.
  4. An experience factor above 1.0 means more claim liability than average for that industry. An experience factor below 1.0 means less claim liability than average for that industry.

Assuming 10 full-time employees working 480 hours per quarter, here is an example of how various experience factors could affect the annual premium you’ll pay.

Table showing how a business's experience factor affects workers' compensation premium rates. Row 1: Telephone clerks with a risk class base rate of $.1569/hour will cost $3,012 at a 1.0 experience factor, $2,711 at a 0.9 experience factor, and $6,025 at a 2.0 experience factor. Row 2: Roofing work with a risk class base rate of $7.6753/hour will cost $147,366 at a 1.0 experience factor, $132,629 at a 0.9 experience factor, and $294,732 at a 2.0 experience factor.

More resources
If you’d like to learn more about ways to protect yourself and manage premium costs for your business, visit www.Lni.wa.gov/ControlMyCosts or our Help for Small Business web page.