Tax

The United States has a “pay as you go” tax system in which payments for income tax (and, where applicable, Social Security and Medicare taxes) must be made to the IRS throughout the year as income is earned, whether through withholding, by making estimated tax payments, or both.

You suffer an estimated tax penalty if you don’t pay enough to the IRS during the year.

The IRS levies this non-deductible interest penalty on the amount you underpaid each quarter. The penalty rate equals the short-term interest rate plus three percentage points.

Due to the rise in interest rates, the current penalty rate is 8 percent—the highest in 17 years. And since it’s not deductible, the net cost likely far exceeds 8 percent.

If you’re an employee and have all the tax you owe withheld by your employer, you don’t have to worry about this penalty.

But you must worry about it if you’re self-employed because no one withholds taxes from your business income. Likewise, you must worry if you receive income from which no, or not enough, tax is withheld—for example, retirement distributions, dividends, interest, capital gains, rents, and royalties.

C corporations are also subject to the underpayment of estimated tax penalty.

Fortunately, it’s easy to avoid this penalty!

• All individual taxpayers have to do is pay (1) 90 percent of the total tax due for the current year or (2) 100 percent of the total tax paid the previous year (110 percent for higher-income taxpayers with adjusted gross incomes of more than $150,000 ($75,000 for married couples filing separately).
• Corporations must pay 100 percent of the tax shown on their return for the current or preceding year (but large corporations can’t use the prior year).

Most individuals and corporations make equal quarterly estimated tax payments to the IRS. The IRS applies the penalty separately for each payment period. Thus, you can’t reduce the penalty for one period by increasing your estimated tax payments for a later period. This is true even if you’re due a refund when you file your tax return.

Some individuals and corporations can use alternate methods for computing estimated taxes, such as the annualized income method. But the alternate methods can be complicated.

If you want to discuss your estimated taxes, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 20, 2024

First question: Is your employee retention credit (ERC) claim improper? Are you sure? If you’re sure, the IRS has a proposition for you.

Pay back 80 percent of all your ERC claims, and keep the remaining 20 percent.

You read that right.

Say you made an improper employee retention credit claim, received the improper cash, and put that improper cash in your bank account.

Now, because the claim was wrong, you return 80 percent of the credit to the IRS and keep the remaining 20 percent, including interest. That’s a good deal.

But it gets even better.

Your 20 percent is tax-free. And you get to keep the interest you received on the 100 percent.

Example. In 2023, you amended some of your 2020 and 2021 payroll tax returns using IRS Form 941-X and collected $200,000 in ERC cash plus $12,000 of interest from the IRS. Now, however, you realize that was wrong. No problem! Just complete some IRS paperwork to qualify, wait for approval, and then return $160,000. You keep the rest—$40,000 is tax-free ($200,000 – $160,000), and $12,000 is taxable.

Why Is the IRS Doing This?

With the 80 percent payback deal, the IRS has you name the tax preparers, payroll processing companies, and ERC scammers who filed or helped you file your improper claim.

You give the IRS their names, addresses, and telephone numbers, and you tell the IRS what services they provided in connection with the improper claim.

Why 80 Percent?

The IRS reasons that you likely paid a percentage fee for help with your improper ERC claim, and thus you never received the full amount of the credit—therefore, the 80 percent.

Be Quick! Time for Filing Is Short

You must first request to claim $0 ERC before midnight on March 22, 2024. You do this electronically using IRS Form 15434.

Next, the IRS reviews your application package and mails you a letter telling you whether your application is accepted or rejected.

Accepted. If your application is accepted, the IRS mails you a closing agreement. You must sign and return the closing agreement within 10 days of the date of mailing by the IRS—so stay alert.

You make your multiple 80 percent repayments as directed by Form 15434 using the Electronic Federal Tax Payment System (EFTPS). You should make these payments at the same time you sign and submit the closing agreement.

Key point. Don’t let the Form 15434 instructions confuse you (they can be confusing). Here are the steps you need to follow for the 80 percent payback deal:

1. Complete IRS Form 15434.
2. Wait for the acceptance or rejection letter. If accepted, wait for the closing agreement.
3. Sign and send the closing agreement to the IRS.
4. On the day you send the closing agreement to the IRS, use EFTPS to make your multiple 80 percent payments.

Form 15434 makes it sound like you should submit the multiple payments when you complete the form. The IRS states in its FAQs: “Paying at the time you apply for the ERC-VDP can help speed up processing and resolve your case more quickly.”

Recommendation. Wait for the closing agreement before paying. If you pay upfront, here is what happens:

• Your money is in limbo for the time it takes the IRS to process your claim.
• The IRS could reject your claim—and because you paid upfront with the form, the IRS now has your money.

Rejected. If the IRS rejects your application, it will explain why in its rejection letter and will offer potential solutions.

The Big Question: Should You Go for the 80 Percent?

Before doing anything, check your ERC claim. Is it valid?

It’s possible that many small businesses that qualify for the ERC will mistakenly do the 80 percent deal—to their detriment. Think back to the example in the opening of this article:

• If the claim is valid, you win by $200,000.
• If the claim is invalid, you win by $40,000.

That’s a $160,000 difference. Nothing to sneeze at.

Key point. Confirm whether your claim is valid or invalid before taking action.

Criminal Aspect

Executing the 80 percent closing agreement does not preclude the IRS from investigating you for any associated criminal conduct or recommending prosecution for violation of any criminal statute, and does not provide any immunity from prosecution.

If you want to discuss the ERC payback deal, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 16, 2024

Have you heard about the enormous tax savings you can reap by investing in a Maltese individual retirement arrangement or utilizing Puerto Rican captive insurance for your business? Before you invest your hard-earned money in these or other highly promoted tax schemes, you should check the IRS Dirty Dozen list.

For over 20 years, the IRS has issued an annual Dirty Dozen list identifying tax scams and avoidance schemes. This year’s list includes everything from employee retention credit claims to the use of fake charities.

Some items on the Dirty Dozen list involve fraud, such as identity theft through “spearphishing.” Other items involve tax credits or deductions, such as conservation easements, that can be legitimate but have been prone to abuse by taxpayers in the IRS’s view.

The Dirty Dozen gives you red flags that trigger IRS scrutiny and can result in aggressive enforcement action against taxpayers who claim such deductions or credits and those who promote them.

When you see a new item on the Dirty Dozen list, especially if it’s at the top, you know it’s something the IRS is particularly interested in. A case in point is the employee retention credit (ERC). It didn’t make it to the list until 2023, and then the IRS placed it at the top.

The top position tells you that combating fraudulent ERC claims is a high priority for the IRS. This doesn’t mean you shouldn’t claim the ERC if you’re entitled to it. Just make sure you have all the necessary records in case of an audit.

As part of its Dirty Dozen awareness effort, the IRS encourages members of the public to report individuals who promote improper and abusive tax schemes as well as tax return preparers who deliberately prepare improper returns. The IRS also created an Office of Promoter Investigations in 2021 to identify and stop promoters and enablers of abusive tax avoidance transactions.

Employing a strategy or scheme on the Dirty Dozen list makes an audit more likely. It can also result in substantial tax penalties if an audit occurs and the IRS concludes that taxes were underpaid due to the use of the strategy. The strategy being on the Dirty Dozen list can make it difficult to avoid the penalties the IRS can impose on

• taxpayers,
• tax preparers, and
• promoters.

Taxpayers can avoid the accuracy-related penalty if they establish that they had reasonable cause for the underpayment and acted in good faith. But it is challenging, if not impossible, for taxpayers to demonstrate that they acted in good faith when they adopt a strategy or scheme listed in the IRS’s Dirty Dozen.

If you have any questions or need my assistance, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 13, 2024