New estimated tax payment rules.

On Nov. 27, 1991, congress passed the Tax Extension Act of 1991, which extended various expiring provisions through June 30, 1992. The loss of revenue anticipated from these extensions (e.g., employer-provided educational assistance, health insurance deduction for self-employed, research and experimentaion tax credit, and low-income housing tax credit) by six months is $3.2 billion over five years. The Budget Act of 1990 imposed "pay-as-you-go" requirements for direct spending during fiscal years 1991-1995. Therefore, the Tax Extension Act of 1991 offset the lost revenue from the extended provisions by providing for accelerating estimated tax payments of certain corporate taxpayers.

Prior to the Tax Extension Act of 1991, corporations could satisfy either of the following two tests through estimated tax payments to avoid underpayment penalties.

1. The corporation could make four equal timely estimated tax payments that totaled 90% of the tax liability ultimately shown on the return. Instead of making equal payments, the corporation could base its estimated tax installments on its annualized taxable income.

2. If not a large corporation, the taxpayer could make four timely estimated tax payments, each of which equaled 25% of the tax liability ability for the preceding tax year. A large corporation (i.e., one that had taxable income of $1 million or more for any of the three preceding tax years) could use this rule only for its first quarterly payment.

Effective for tax years beginning during 1992, corporations relying on test 1 will be required to base estimated tax payments on 93% (rather than 90%) of current year tax liability. The applicable percentage will be 94% in 1993 and 1994, and 95% in 1995 and 1996. The provision is scheduled to sunset for years beginning after 1996. (As this item was going to press, the applicable percentage was changed from 94% to 95% starting in 1993.)

Test 2 was not changed by the Tax Extension Act of 1991.

Individuals

Also during November 1991, Congress approved extended benefits for long-term jobless workers and paid for the measure by changing the estimated tax payment requirements for certain individuals.

Under prior law, for tax years beginning before Jan. 1, 1992, individuals could avoid underpayment penalties if they made four equal estimated tax payments that totaled either 100% of their prior year's tax liability (exception 1) or 90% of their current year's tax liability (exception 2). The 90% test could be based on the taxpayer's annualized income.

Effective for tax years beginning after Dec. 31, 1991, exception 1 will no longer be available to taxpayers who satisfy all three of the following conditions during a given year.

1. Current year adjusted gross income (AGI) is over $75,000 ($37,500 for married filing separately).

2. AGI increased by more than $40,000 over the prior year ($20,000 for married filing separately).

3. Estimated tax payments were made for any of the preceding three tax years, or penalties were assessed for failure to do so.

However, exception 1 will continue to be availble to all individuals for their first quarterly installment and to taxpayers with annualized AGI estimated to be within the threshold amounts. Any reduction in the installment under this exception must be made up by increasing the amount of the next required installment.

Gains from involunary conversions or from the sale or exchange of principal residences are not included in AGI for the $40,000 threshold. also, an owner of a less-than-10% interest in an S corporation or partnership, other than as a general partner, may use the prior year's income from those entities to determine whether the $40,000 threshold is exceeded and to compue estimated tax for the currently year. However, more-than-10% owners (and all general partners) must include current year income from the passthrough entity in meeting the current year tax liability test.

These new rules for individuals also apply to trusts and estates. And, as with the corporate changes noted previously, these changes are scheduled to expire after five years.

From John Withers, Esq., and Patrick T. Lee, CPA, Washington, D.C.

Editor's note: A singificant number of individuals are potentially affected by these new rules. Any proprietor whose business reports

  Example: Corprate Estimated Tax Payments
  For corporation C, the first quarter estimated payment is
based on three-month
actual numbers.  There is a $100,000 NOL carryover from the
prior year.  Assume that C will not have an alternative
minimum tax.
                                Deduct NOL      Deduct NOL
                                  before           after
                                annualization   annualization
Taxable income before NOL         $106,000        $106,000
NOL                               (100,000
3-month taxable income                 6,000       106,000
Annualized income             24,000               424,000
NOL                                               (100,000)
Net annualized income            24,000            324,0000
Tax at 34%                             8,160       110,160
First quarter
  estimated payment (22.5%)       $   1,836       $ 24,786

on Form 1040, Schedule C, any general partner, any more-than-10% limited partner, any self-employed person and any more-than-10% S shareholder will need to consider the ramifications of the new law. Particularly when the prior year is a recession year, taxpayers may readily exceed the $40,000 permitted AGI growth.

As a result, CPAs will have to explain carefully to potentially affected clients the need to compute actual or annualized income for estimated tax intallments due in June, September and January. The very real difficulty of determining income of passthrough entity businesses (or proprietorships) in the 15-day interval between, say, August 31 and September 15 will also have to be well understood by clients.

While Congress seemed to be edging toward some structural simplificantion of our tax laws, these two last-minute bills have taken a major step in the other direction.