Planning Tips for Corporate Estimated Tax
Author: Greg Usry
Corporations calculating their 2012 quarterly estimated federal tax payments can take advantage of a potential tax planning opportunity. Companies with significant tax depreciation deductions in 2011 should consider special rules that could result in lower estimated tax payments in 2012.
Corporations pay estimated income tax in quarterly installments. In general, each quarterly federal tax payment is 25 percent of the corporation’s “required annual payment,” which is the lesser of two amounts:
- Current-year tax liability – 100 percent of federal income tax reported on return for the year of the payment
- Prior-year safe harbor – 100 percent of a corporation’s federal income tax reported on return for the preceding year
Corporations with no tax liability in the preceding year cannot use the 100 percent prior-year safe harbor amount to determine their required estimated tax payment. Also, certain “large corporations”—those with taxable income of $1 million or more in any of the three preceding tax years—only may use the prior-year safe harbor amount when calculating their first-quarter payment. For purposes of this $1 million threshold, taxable income is calculated without regard to net operating loss or capital loss carryback or carryforward. Corporations with a short tax year in any of the three immediately preceding years must annualize taxable income for the short tax year by multiplying the taxable income for the short tax year by 12 and dividing the result by the number of months in the short year.
Corporations may compute their required quarterly estimated tax payments using one of two alternative methods: the annualized income method or adjusted seasonal income method. In general, the alternative methods will provide a benefit when a corporation earns most of its taxable income during part of the year. If either alternative method provides quarterly installments that are less than 25 percent of the required annual payment under the general rules, a corporation can pay the lesser amount for that quarter.
Corporations calculate estimated tax payments under the annualized method by taking the following steps:
- Annualize taxable income for the quarter’s appropriate annualization period
- Calculate tax on the annualized income
- Multiply the tax by the applicable annualization percentage
- Subtract payments made in previous quarters
Here are the annualization periods and percentages for each quarter:
Taxpayers can elect two alternative annualization periods by filing IRS Form 8842, Election to Use Different Annualization Periods for Corporate Estimated Tax. Form 8842 is due by the 15th day of the fourth month of the applicable year and must be filed annually to elect Option 1 or 2 each year, even if the same option was elected the previous year. Once an election is made for a tax year, it cannot be revoked. There are two options for alternative annualization periods:
Tax Planning Opportunity
Special rules apply when determining the amount of certain deductions allowed in calculating a taxpayer’s estimated taxable income each quarter. Taxpayers generally estimate their annual depreciation expense and include a proportionate amount to annualize their estimated taxable income.
In general, corporations estimate their annual tax depreciation deduction by taking into account purchases, sales or other dispositions, changes in use, additional first-year depreciation and similar events and provisions, based on information available as of the last day of the annualization period. Relevant available information includes capital spending budgets and financial statement projections. The regulations also provide two safe harbor methods to determine a corporation’s estimated tax depreciation deduction: proportionate depreciation allowance or 90 percent of the preceding year’s depreciation.
Under the proportionate depreciation allowance method, corporations estimate their depreciation deduction based on assets placed in service as of the end of the previous year and by the end of the installment period. Using 90 percent of the preceding year’s depreciation to calculate estimated tax payments may provide a substantial benefit to taxpayers reporting substantial tax depreciation in 2011 due to favorable bonus depreciation rules. Taxpayers using the general rule to compute depreciation expense for their first-quarter estimate can switch to either of the safe harbor methods in computing depreciation for their second-, third- and fourth-quarter estimates. Any taxpayer using a safe harbor method may switch to the general rule for subsequent quarters; however, they may not switch between safe harbor methods.
Penalties apply to taxpayers underpaying required quarterly payments. The penalty consists of an interest charge—currently 3 percent. However, the penalty is nondeductible. Taxpayers should give careful consideration to their estimated tax payment calculations.
For more information on calculating tax payments, contact your BKD advisor.