When
you run your business as a regular C corporation, it can make sense to pay a
little tax this year to avoid large estimated tax payments next year.
According
to the general rule for corporate estimated taxes, the IRS won’t charge a
penalty as long as a company pays current-year estimated tax of at least the
amount that was owed on the preceding year’s return. However, this “safe
harbor” is available only when at least some tax was owed for the prior year.
If a company shows zero tax liability in a given year, the next year’s
estimated payments must equal 100% of the expected tax liability for that year.
As a result of this quirk in the law, you might want to plan corporate income
and deductions so that you always show at least some taxable income and some
tax liability.
Example. Your corporation will incur a small operating
loss this year. Next year is likely to be more profitable, with the company projected
to owe about $100,000 in federal income tax. If you do no planning, you may be
required to pay next year’s tax bill in full via quarterly installments of
$25,000 each, creating a potential cash flow crunch just when your company
might need liquidity.
However,
if your company were to report, say, $10,000 of taxable income this year
(perhaps by delaying deductible expenditures or selling an appreciated asset),
this year’s tax bill would be $1,500 (15% of $10,000). Next year, you would be
required to prepay a total of only $1,500, reducing your quarterly installments
to $375 each. The remainder of your tax bill would be due on the filing date
for next year’s return, but in the meantime, you have the use of your cash.
Warning: If this planning strategy might apply in your
situation, be aware that the safe harbor exception is only available to
corporations with taxable income of less than $1 million for the preceding
three years.
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