Estimated tax payments aren't estimates anymore.

For many years, calculating required estimated tax payments for individuals was a relatively simple exercise. But the Emergency Unemployment Compensation Act of 1991 (EUCA) changed that. This month, Thomas J. Thorpe, CPA, a sole practitioner in Lincoln, Rhode Island, and Kathleen Simons, CPA, DBA, assistant professor of accounting, Bryant College, Smithfield, Rhode Island, explain the complicated new rules for 1992 estimated payments.

In the past, an individual required to make quarterly estimated tax payments was protected by a safe harbor in Internal Revenue Code section 06654(d)(1)(B), which defined required annual payments as the lesser of the following:

* 90% of the tax shown on the individual's return for the taxable year (or, if no return was filed, 90% of the tax for such year).

* 100% of the tax shown on the individual's return for the taxable year (assuming the preceding taxable year was 12 months and a return was filed).

Individuals who anticipated their current year's tax would exceed the prior year's tax would make quarterly estimated payments sufficient to cover the tax shown on the prior year's return. If this was done, no underpayment penalty applied.

Example: Pitt's 1990 tax liability was $49,000. His 1991 estimated payments totaled $50,000. His 1991 tax liability, as shown on his return, is $500,000. Because 1991 estimated payments were at least 100% of his 1990 tax liability, no underpayment penalty is imposed.

NEW RULES

Congress passed EUCA on November 15, 1991, to fund an extension of unemployment benefits. It amended IRC section 6654(d)(1) and changed the required estimated tax payments for certain individuals. The amendments apply to taxable years beginning after December 31, 1991, and are set to expire for taxable years beginning after December 31, 1996.

Under the revised rules, a taxpayer must, in certain cases, make quarterly installments sufficient to cover the greater of

* 100% of the tax shown on his or her return for the preceding taxable year.

* 90% of the tax shown on the current year's return, taking into account certain adjustments to arrive at a modified adjusted gross income (MAGI), as defined below.

Example: For 1992, Lawson's tax liability, as shown on her return, is $100,000. Her 1992 estimated tax payments total $10,000, which equals 100% of her 1991 tax liability. Lawson is subject to the new rules and there are no modifications to her adjusted gross income (AGI). Under these circumstances, Lawson is considered to have underpaid her 1992 tax liability and is subject to penalties on $80,000 [(90% x 100,000)-$10,000], the amount of the underpayment.

For purposes of determining the first required quarterly installment, the preceding year's tax liability may be used. Any resulting reduction in the installment must be recaptured by increasing the second required installment by the reduction amount.

MODIFIED ADJUSTED GROSS INCOME

MAGI is adjusted gross income with the following adjustments:

* Less-than-10% owners of S corporations and partnerships substitute the prior year's pass-through items for the current amounts (income, gain, loss, deductions or credits).

* Recognized gains from involuntary conversions or the sale of a principal residence are excluded.

Calculating MAGI is important for two reasons. If MAGI for the current year does not exceed AGI for the preceding taxable year by more than $40,000, the new law does not apply. Also, MAGI is the starting point in calculating the current year's tax to determine if 90% of the current year's tax is greater than 100% of the preceding year's tax.

AFFECTED INDVIDUALS

The provisions of the new law apply to individuals if

* MAGI for the current year exceeds AGI from the preceding taxable year by more than $40,000 ($20,000 if married filing separately).

* The AGI shown on the current year's return exceeds $75,000 ($37,500 if married filing separately).

* They made estimated payments for any one of the preceding three taxable years (or were assessed a penalty for failure to pay estimated tax with respect to those years).

If an individual does not meet all the above requirements, the EUCA changes do not apply and making current year estimated tax payments at least equal to the preceding year's tax will continue to prevent an underpayment penalty.

Example: Spencer's 1991 AGI was $100,000, and the tax shown on her return was $40,000. In 1992 her AGI is $240,000 and the tax shown on her return is $80,000; Spencer makes 1992 estimated payments of $41,000. Spencer's 1992 MAGI is $200,000 and her 1992 tax, using MAGI as a starting point, is 70,000. Spencer made estimated tax payments in both 1990 and 1991.

Because Spencer's 1992 MAGI exceeds her 1991 AGI by more than $40,000, her AGI for the current year exceeds 75,000 and she made estimated payments in at least one of the last three years, EUCA changes apply. Spencer's required payment is the greater of 90% of her current year's tax using MAGI (90% x $70,000 = $63,000) or 100% of her prior year's tax ($40,000). Thus Spencer's required estimated payments for the year are $63,000. If she pays only $41,000, her underpayment, subject to penalties, is $22,000.

ANNUALIZATION EXCEPTION

Before the EUCA amendments, a taxpayer with income that varied during the year could lower or eliminate a required estimated payment by using the annualized income installment method. For those subject to the new rules, an additional annualization exception applies.

The penalty will not apply to an installment if either of the following are true:

* A taxpayer can establish satisfactorily that annualized MAGI for the months in the current year ending before that quarterly installment's due date does not exceed the preceding taxable year's AGI by more than 40,000.

* Annualized AGI for the months in the current year ending before the installment's due date does not exceed $75,000.

UNEQUAL PAYMENTS

Under the new rules, a taxpayer may be required to make quarterly estimated payments of differing amounts.

Example: Blair's 1991 tax liability is $40,000, and based on this, he makes his first 1992 quarterly estimated payment of $10,000 on April 15,1992. On June 15,1992, Blair, who is subject to the new rules, estimates his 1992 tax liability actually will be 120,000.

Blair's second quarterly estimated payment is $50,000 [(50% x $120,000)-$10,000 (the first payment)]. The implication is Blair's first payment should have been $25,000; however, he win not be subject to a penalty if he makes up the difference in his second payment.

In early September, Blair sells some stock and incurs a capital gain. He determines his 1992 tax liability will be $160,000. Blair's third quarterly estimated payment, due September 15, 1992, will be $60,000 [(75% x $160,000)-$60,000 (the amount already paid)]. Blair's payment for the fourth quarter also could change if his income changes by yearend.

AN END TO SIMPLICITY

Calculating required estimated tax payments is no longer as simple as covering the prior year's tax. Beginning with the second quarterly tax payment for 1992, due June 15, 1992, many taxpayers must summarize their income and deductions to date to calculate required payments. Practitioners must determine which clients are affected by the new rules and make them aware of the revised calculations and the information necessary to compute accurate estimates.