Tax Considerations During Disruptive Economic Times

While many businesses and individuals are actively planning for the economic impacts of COVID-19 related to cash-flow and profitability, they may not have stopped to contemplate how their responses may impact their tax planning.

Specifically, many closely-held small corporations and owners of flow-through businesses may use the safe harbor method of calculating and paying their estimated taxes each quarter. Under the safe harbor method, taxpayers will pay-in based upon the assumption that their tax will be equal to or, for higher income taxpayers, exceed their prior year tax.

Once a taxpayer has made an estimated tax payment, that payment is generally unrecoverable until the taxpayer files their annual tax return for that tax year. As a result, taxpayers who fail to carefully and proactively plan ahead for the making of estimated payments may find that they have effectively loaned a portion of their crucial cash reserves, interest-free, to the Internal Revenue Service (IRS).

Consider the following example for Taxpayer A:

Taxpayer A owns 100 percent of an S-corporation that is engaged in manufacturing, generating $500,000 of taxable income for the 2019 tax year. After considering wages from the S-corporation, other sources of income and items of deduction, Taxpayer A’s 2019 tax is $120,000.

The S-corporation has been in a period of growth for the past few years, and Taxpayer A usually makes estimated payments using the safe harbor method. Under the safe harbor method, Taxpayer A will pay equal installments each quarter that will equal 110 percent of prior year tax.

The S-corporation began to experience some disruptions in its supply chain as early as February 2020. In response, Taxpayer A took proactive steps such as modeling various operating projections, reviewing and evaluating in place contracts and planning for additional disruptions and delays.

However, Taxpayer A did not factor taxes into the planning and did not adjust the estimated payments. Accordingly, Taxpayer A made two estimated payments of $33,000 each ($120,000 * 110 percent / 4) at the first and second quarter estimated payment dates.

By the third quarter, delays in production indicate that in a best-case scenario, the S-corporation will break even for the year. Additionally, due to the overall impact on the economy, Taxpayer A anticipates that his investment income will also be down for 2020. As a result, Taxpayer A is projecting that the tax due will only be $5,000 for the 2020 tax year.

Unfortunately, Taxpayer A has no way of reclaiming the $66,000 already paid in estimated taxes until filing the income tax return for the 2020 tax year. As such, Taxpayer A will not be able to currently access and deploy those funds to continue business operations or cover personal expenses.

There is one exception to the general rule regarding refund of estimated taxes – C-corporations that have overpaid their estimates by at least a specified amount may apply for a quick refund prior to filing their tax return using Form 4466. The IRS will act on Form 4466 within 45 days of its filing.

However, Form 4466 may only be filed after the end of the corporation’s year-end. While it will allow taxpayers to access those funds earlier than the filing of their corporate return, it will not allow them to do so within the tax year itself.

Taxpayers who believe they may be impacted by the current global economic situation or by any other significant change during 2020 should strongly consider discussing potential ramifications with their tax advisor to develop a strategy for calculation and payment of estimated taxes, which will achieve the dual objectives of meeting tax obligations and optimizing deployment of resources for the benefit of their company, their employees and themselves. To speak with a tax advisor, reach out to us at tax@dhg.com.