For those who pay estimated taxes, 2020 presents special issues and potential hardships.
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Tax Day 2020 is July 15, and for some taxpayers it could be a financial nightmare. Covid-19 prompted the IRS to delay the usual April 15 federal tax-return deadline to July 15, but it isn’t just 2019 tax returns that are due. The IRS also postponed the first two 2020 quarterly estimated-tax payments, which are normally owed by April 15 and June 15.
This means that on July 15 it’s possible for someone to owe half their estimated taxes for 2020 plus any taxes owed with their 2019 tax return. That’s bad news for people whose income has tanked in the past few months because of the pandemic.
On top of that, if you received a stimulus check, a loan from the Paycheck Protection Program (PPP), or unemployment benefits, your tax picture could get even more complicated. This article explains what you need to know to avoid the IRS penalty for tax underpayment, along with insights from tax pros on the special issues for estimated taxes in 2020.
How To Avoid The Penalty
If you are self-employed or a contractor, or a W-2 employee who does not pay enough in taxes during the year via payroll withholding, you typically pay quarterly estimated taxes in April, June, September, and January. Anyone with substantial taxable income that is not subject to withholding, including retirees, probably must pay estimated taxes. Underpayment of taxes subjects you to an IRS penalty.
You avoid a penalty through one of two safe harbors:
- you owe less than $1,000 in tax for the year
- you pay at least 90% of tax owed for the current year (2020), or 100% of the tax you paid for the prior year (2019), whichever is smaller
For adjusted gross income greater than $150,000 ($75,000 married filing separately) on the prior year’s tax return, the percentage of last year’s tax that you must cover during this year is higher: the safe harbor is 110%. If you don’t pay enough taxes, IRS Form 2210 helps you calculate any penalty for underpayment of estimated tax.
Will The IRS Waive The Penalty In 2020?
It’s too early to say whether the IRS will reduce or waive the penalty in 2020 or lower the safe-harbor percentages. For 2018 taxes, the IRS lowered the 90% requirement to 80%. It also removed the requirement that estimated-tax payments be sent in four equal installments, which is already impossible for this year.
My sources at the IRS tell me that changes in the safe harbor percentages for 2020 will “probably be considered.” However, they also say that right now it’s likely to be “at the bottom of the pile,” given all the other issues demanding immediate attention at the Treasury Department and the IRS.
Special Issues For 2020
Tax return professionals (CPAs and/or Enrolled Agents) have told me about four special issues in 2020 related to estimated-tax payments and the calculation of how much you owe:
- your stimulus check
- Paycheck Protection Program loans
- unemployment benefits
- ongoing financial hardship from the coronavirus pandemic
Stimulus Payments
Is your Covid-19 stimulus payment taxable income that needs to be considered for estimated taxes? Susan Allen, Senior Manager for Tax Practice & Ethics at the American Institute for CPAs (AICPA), cites guidance on this question in the IRS’s Economic Impact Payment Information Center. She explained to me that the IRS has clarified in its Q&A that “the payment is not included in gross income and, therefore, taxpayers will not pay tax on it.”
However, you will still need to report the stimulus payment as an advance 2020 tax credit next year when you file your 2020 tax return. “It should not affect the amount of taxes you owe or the amount of any tax refund you’re due from the IRS next year,” explained Bill Nemeth, EA, who is affiliated with Tax Audit Guardian and is the President of the George Association of Enrolled Agents.
Phyllis Jo Kubey, EA, the incoming president of the NY State Society of Enrolled Agents, does factor stimulus payments that will be credited on the 2020 tax return into her clients’ estimated-tax payments. She does this for taxpayers who were not eligible for a credit on either 2018 or 2019 income but probably will be on 2020 income. When you “can determine with reasonable accuracy that they’ll be entitled to a substantial credit on their 2020 tax returns,” she explained, “I reduce their estimated-tax payments by the expected economic impact payment” (EIP).
Example: Married joint filers with no children had income above the stimulus-check tax threshold in 2018 and 2019, but they are eligible for it on their 2020 tax return based on their decline in 2020 taxable income. Kubey factors in a $2,400 credit in the estimated-tax calculation for 2020. If initially their total 2020 estimated-tax liability was $4,000 (or $1,000 per quarter), once Kubey knows they’ll be eligible for a $2,400 EIP, that reduces the 2020 estimated-tax payments to a total of $1,600.
For additional details on stimulus payments and related income phaseouts, see another Forbes.com article I wrote: Stimulus Checks Can Tell You How Much Your Friends, Relatives, And Co-Workers Earn.
Paycheck Protection Program Loans
In Notice 2020-32, the IRS took the position that no tax deductions are permitted for expenses, such as payroll, that are funded by PPP loans which are later forgiven. Under the IRS guidance, which may eventually be reversed by Congress, the inability to deduct these expenses affects the estimated-tax calculation by individuals who own businesses that pass through their income to the owners, such as with an S Corporation, Limited Liability Company (LLC), or sole proprietorship.
How does this affect the 2020 estimated-tax calculation? The loss of this deduction means their 2020 taxable income will be higher. Elliott Puretz, a CPA, tax-return preparer, and retired college accounting professor in the Boston area, told me that for now “you have to assume the deduction will not be allowed.”
Unemployment Benefits
So far in 2020, there have been over 36 million new claims for unemployment benefits. Many of these people are collecting unemployment for the first time in their lives and may be confused about the tax treatment.
Unemployment benefits are taxable by the IRS and by states that have income tax, including the special Pandemic Unemployment Assistance (PUA) and Pandemic Emergency Unemployment Compensation (PEUC). As explained on the IRS website, you do need to make estimated-tax payments on this taxable income unless you elected to have federal income tax withheld with Form W-4V, Voluntary Withholding Request.
Financial Hardship: Skipping Estimated-Tax Payments
Enrolled Agent Bill Nemeth expresses “real concerns about taxpayers actually making these estimated-tax payments if they are economically fragile.” He gave me an example of a single mother who works in a service industry as a contractor and is thus self-employed (e.g. hair or nail salon, Uber, Lyft, Grubhub, DoorDash). Because the April and June estimated taxes were postponed to July, she received temporary tax relief. However, Nemeth points out, now she must make a big estimated-tax payment by July 15 at a time when she may not even be able pay her rent and utilities because she’s been out of work for three months.
For this reason, Nemeth predicts a massive influx of IRS collection cases. On top of that, he foresees “a huge number of self-employed service industry workers who are going to have a large IRS balance due when they file their 2020 returns.”
Beth Logan, EA, who works with Kozlog Tax Advisers and is the President of the Massachusetts Society of Enrolled Agents, described to me another type of problematic situation. Many businesses that did well in January and February had to close in March under state lockdown orders and have had no meaningful revenue since then. They have been using profits received in January and February to pay bills and personal expenses during the Covid-19 shutdown. “Those who are not disciplined savers will struggle,” she observed, adding that “I would rather my clients eat and pay their bills.” Survival, she emphasizes, should come before taxes: “We’ll just have to deal with any interest for paying estimated taxes late.”
CPA Elliott Puretz explained that not paying estimated taxes on time and triggering the IRS penalty is like getting a loan from the federal and state government at a 5% to 6% annual rate calculated quarterly (not compounded). He advises that if you have “access to cheaper funds (e.g. a home-equity loan), you may want use that to make the estimated-tax payments.” However, if your only funding source for taxes is a credit-card advance, presumably with a much higher interest rate than the rate of the IRS penalty, then it makes sense “to consider not paying the estimated-tax payments.”
For guidance on tax returns and estimated taxes on stock compensation (stock options, restricted stock/RSUs, ESPPs, and SARs) see the Tax Center at myStockOptions.com.