When every dollar counts a bit more dearly, a greater number of taxpayers are taking a closer look at ways to improve cash flow. Increasing (or at least accelerating) tax refunds for past years while lowering estimated tax and withholding payments for this year are two areas of growing interest.On the refund side of the ledger, a variety of elections and decisions still to be made on 2008 returns can affect the size of a refund, either of 2008 tax payments or of prior years' under loss-carryback rules. Accelerating refunds, whether or not they are already set in stone, also can improve a taxpayer's immediate cash flow.
On the estimated tax/withholding side, the fact that the average individual tax refund for 2007 was a little over $2,400 is eye-opening to the amount that taxpayers unnecessarily overpay the government, effectively giving it an interest-free loan.
Knowing the ground rules for refunds and estimated tax/withholding payments can help a growing segment of taxpayers who are looking for the cash needed to get them over the next year while the economy hopefully recovers.
Many businesses are hopeful that an early economic stimulus package will bring with it an extended five-year net operating loss carryback period. Businesses that haven't done well in several years will immediately be able to claim refunds by offsetting current losses against profitable 2004 and 2005 tax years. This would also change the dynamics of many businesses in filing 2008 tax year returns.
First, they should take greater care in maximizing losses for 2008 that, for many firms prior to a stimulus bill, would only have been carried forward as an offset against possible future profits. Second, they should consider filing returns early to be able to realize an NOL that then could be carried back to generate a refund claim.
All taxpayers - individuals and businesses - also would do well to be aware of ways to accelerate any refund claim. Only corporations may apply for a "quick refund" of overpaid estimated tax payments, however, after the close of their tax year and before filing an income tax return for that year. However, all taxpayers have the benefit of new procedures that can help accelerate a refund after a return has been filed.
REFUNDS OF ESTIMATES
If an individual makes payments of estimated tax in excess of the amount that is later calculated to be the correct amount, no refund will be made until the taxpayer files a final return for the year. Likewise, a taxpayer may not recover income tax withheld until a return is filed for the tax year.
Changes in withholding and estimated tax payments during the tax year are permitted, however, making lower payments a way to get back some earlier overpayments - if they are realized in time. The principal strategy recommended in connection with squeezing more cash out of withholding and estimated tax payments is to be vigilant to changes in income, deductions and credits in order to react quickly before the next quarterly tax payment is due.
A An exception: A corporation that has made overpayments of its estimated income tax may qualify for a quick refund by filing a Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, by the 15th day of the third month after their tax year ends and before filing their tax return for the year. To qualify, a corporation's estimated tax payments must equal or exceed its expected income tax liability by 10 percent and $500. The procedures for obtaining the quick refund are similar to those for carryback adjustments. The IRS must act upon the application within 45 days after its filing. An addition to tax is imposed on corporations that receive an adjustment amount later determined to be excessive.
A E-File: The IRS predicts that nearly 90 million of the 140 million expected returns for 2009 will be filed electronically. The agency is billing as one of the major benefits of e-filing that system's ability to provide faster refunds. "Taxpayers who use e-file and choose direct deposit can receive their refund in as few as 10 days," IRS Commissioner Doug Shulman recently reported. While refund anticipation loans continue to be permitted under strict guidelines, the IRS has been under much pressure to compete with these high-interest loans. It sees e-file that is paired with direct deposit as a solution and plans to advertise its benefits aggressively during this tax season.
Amounts withheld from income are credited toward payment of estimated tax. Estimated tax is paid in four installments. Estimated tax paid for the year must equal 90 percent of tax shown on the current year's return or 100 percent of tax on the previous year's return. High-income taxpayers (generally, exceeding $150,000) must pay at a higher, 110-percent level.
A Annualized method. A taxpayer who receives taxable income unevenly during the course of the year - for example, one who realizes more income in the summer months - may benefit from using the annualized income installment method of paying estimated tax. Under this method, the required installment for a payment period is deemed to be the annualized income installment if that amount is less than the required installment of estimated tax computed under the regular method.
A Penalties. Taxpayers must pay a penalty if they do not pay sufficient estimated tax. In most cases, however, that "penalty" is only the application of market-rate interest to each quarterly underpayment until payment is due with the year's income tax return. For first-quarter 2009, for example, the general underpayment rate is 5 percent.
The failure-to-pay penalty, however, starts after the deadline is passed for filing the income tax for that year and paying the tax still owed. An extension to file generally cannot postpone this day of reckoning, although some disaster victims and military personnel are entitled to relief.
The failure-to-pay delinquency penalty (0.5 percent each month, up to 25 percent) is imposed on the net amount of tax still due at the time that the return must be filed. This amount is the correct tax liability minus any tax payments made on or before the due date of the return and any credits that may be claimed on the return. Carrybacks from later years do not affect the amount due for purposes of the delinquency penalty, but carryovers from previous years are taken into account. The penalty increases to 1 percent per month after the IRS provides notice that it will levy on the taxpayer's assets. The penalty can be reduced to .025 percent each month if the taxpayer is under an installment payment agreement.
STRATEGIES FOR ESTIMATES
Can a taxpayer in this tight credit market in effect get a relatively low-interest loan from the government by under-withholding and/or not paying estimated tax? For the most part, the answer is, "No," as far as purposely paying or withholding an incorrect amount of tax. But it is "Yes," as far as allowing the taxpayer the benefit of the doubt in anticipating hard times in this year of economic uncertainty. As long as an estimate is within reason, only interest will be due for an underpayment.
The IRS's official position, of course, must be aimed at preventing wholesale abuse of the system. It has maintained that a penalty of $500 is justified in cases of under-withholding if there was no reasonable basis to claim withholding allowances on Form W-4 that reduced the amount of tax withheld to below an amount due. In addition, a criminal penalty of up to $1,000 and one year in prison may be imposed for deliberately and knowingly falsifying a Form W-4 to lower proper withholding during the tax year. No similar penalties apparently exist, however, for underpayment of estimated tax, although abuse can contribute to reasons to impose higher negligence penalties if payment is not forthcoming by the time the income tax return for that year is due.
Considering that the majority of individual taxpayers statistically are due a large refund each year, however, the main issue apparently is not underpaying withholding and estimated tax so much as it is not overpaying.
Individual taxpayers are often concerned about the consequences of coming up short when income tax for the tax year is due with the return - especially the psychological angst of having to pay, rather than receive what many consider "found money" (or at least money kept away from their shopping tendencies).
However, if any year in recent history calls out for taxpayers to examine the extent to which they are giving the government an interest-free loan through significant over-withholding and estimated tax payments, it is 2009. Return preparers clearly can help by pointing out ways to reduce refunds for this year to a level that will provide a cushion to guarantee that tax will not be owed on April 15, 2010, while improving the taxpayer's cash position during this difficult year.
In addition, a revised computation of the tax shown on the return for the current year should be made any time a significant unanticipated change in any of the above items takes place or can be predicted. Each of the four regular-method required payments for purposes of determining whether a penalty is owed is based on the actual tax for the year as shown on the return, irrespective of how well-intentioned or reasonable the estimates seem at the time.
One unfortunate misperception among a certain group of taxpayers is that the return preparer who "gets them" a big refund must be smart, and those who tell them that tax is owed are below par.
An essential part of the strategy that we have outlined, therefore, requires client communication. The tax preparer should educate clients about the benefits of lowering withholding and estimated tax by showing them how they overpaid in 2008 and then having them proactively make the choice this year between a big refund later and more cash now over the course of the year.
For the 2008 tax year, the bottom line is that those who anticipate refunds should file as soon as possible, using e-file with the direct-deposit option. For the 2009 tax year, taxpayers should re-evaluate their estimated tax payment schedule each quarter. They also should consider using additional exemptions to lower withholding from wages to adjust for investment losses ($3,000 for capital losses) or for credits such as the new homebuyer credit or the residential energy property credit, or other tax benefits that may become available for 2009 when stimulus proposals become law.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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