Corporate estimated tax requirements.
The new regulations address the perceived abuses, which included deferral techniques such as accelerating recognition of a net operating loss (NOL) carryover into the first installment period, treating bonus depredation as allocable to the installment period in which the qualifying asset is placed in service, and treating a liability-as incurred in the installment period in which the two-prong all-events test (i.e., liability is fixed and can be determined with reasonable accuracy) is met provided economic performance is satisfied by the end of the tax year (as opposed to an earlier date that more closely coincides with the end of the quarter for which the estimate was made).
Sec. 6655 imposes a penalty for the underpayment of estimated taxes by a corporation. Corporations that do not make required minimum payments when due are subject to a penalty that resembles interest. The penalty is equal to Sec. 6621's underpayment interest rate multiplied by the underpayment amount for that period. The underpayment amount for each quarter would be the excess of the "required installment" over the estimated tax actually paid.
The due dates depend on the taxpayer's fiscal year. Absent a first-quarter election to use different annualization periods, each required payment is generally due by the 15th day of the 4th, 6th, 9th, and 12th month of each fiscal year. The required annual payment for smaller taxpayers is generally equal to the lesser of the required quarterly percentage of 100% of the prior-year tax or 100% of the current-year tax based on an annualization of taxable income for the period (annualization method).
A "large corporation" can only rely on the prior-year tax liability for its first quarter. It is generally defined as having had taxable income of at least a $1 million before the application of an NOL carryback or carryforward in any of the prior three years.
Economic Performance Rules
Under the all-events test for income, a taxpayer recognizes income when all events have occurred that fix the right to the income and the amount of the income is determinable with reasonable accuracy. Under the all-events test for a deduction, a taxpayer recognizes expenses when all events have occurred that fix the right to the liability and the liability amount is determinable with reasonable accuracy. For purposes of accruing deductions, taxpayers must also meet economic performance rules. Because these rules were issued subsequently to the original proposed corporate estimated tax regulations, there was uncertainty as to the interplay between these two sets of rules.
The proposed regulations provide that items of income or loss should be taken into account during each annualization period in accordance with the existing guidance. If a taxpayer has a history of incurring a specific expense that is attributable to income earned throughout the year, but is not incurred until the end of the first year or after, for the applicable annualization period, the taxpayer could take into account the expense amount properly allocable to such period (Prop. Regs. Sec. 1.6655-2(e)(2)(i)). For instance, expenditures are deemed to be incurred at year-end under the recurring item exception even though they could be paid up to 8 1/2 months after year-end.
The amount so included would have to be determined with reasonable accuracy and deducted by the taxpayer in the current tax year. A taxpayer would satisfy the reasonable-accuracy requirement if the item were allocated to an annualization period ratably throughout the tax year, or the taxpayer could dearly demonstrate that the item is more appropriately allocated by another method.
A taxpayer would satisfy the history requirement if, in each of the two tax years immediately preceding the current tax year, it incurred or paid the expense at the end of the tax year or after the "end of each taxable year" that was deemed incurred during such tax year. The "end of the taxable year" means the period beginning with the 15th of the month the estimated payment is due and ending the last day of the last month of the tax year.
Accounting Method Changes
Prop. Regs. Sec. 1.6655-6 generally would require a taxpayer to compute taxable income for an installment period using the accounting method for computing taxable income for the tax year for which the estimated tax is being computed. However, special rules apply when a taxpayer makes an accounting method change.
For accounting method changes under the automatic consent procedures, taxpayers could take the new method into account in determining the estimated tax payment for a particular installment period if they file a copy of Form 3115, Application for Change in Accounting Method, with the IRS National Office on or before the last day of the annualization period (Prop. Regs. Sec. 1.6655-6(b)(1)). For method changes that require advance consent, the change would only be allowed if the taxpayer received and signed the consent and then returned it to the IRS National Office (Prop. Kegs. Sec. 1.6655-6(b)(2)); see Tax Clinic, Lucks, Rubin and Blazek, "Sec. 263(a) 12-Month Rule and Economic Performance Accounting Method Changes" this issue.
See. 481(a) Adjustments
A favorable accounting method change (or negative Sec. 481(a) adjustment) normally results in a tax deduction and possible tax benefit in the year the method change is applicable, while an unfavorable method change adjustment (or positive Sec. 481(a) adjustment) is spread ratably over four years. In general, under Prop. Regs. Sec. 1.6655-2(f)(2)(iv), in computing estimated tax payments, taxpayers would recognize a Sec. 481(a) adjustment ratably over the number of months in the tax year.
If a corporate taxpayer understates estimated tax required as a result of an unforeseeable event arising subsequent to an installment due date, a recomputation of taxable income for the prior period is not required (Prop. Regs. Sec. 1.6655-2(h) (i)). All facts and circumstances would be applied in determining whether the events were reasonably foreseeable as of the installment due date.
Deferred Compensation Accruals
The regulations provide special rules for determining when to take into account deductions related to accrued compensation fixed and determinable by the end of the annualization period. As the applicable annualization period is not treated as a short tax year, payments received by employee(s) shortly after the last day of the tax year for which estimated tax is being determined will be allowed:
Example: Calendar-year, accrual-basis, corporate taxpayer, T, historically pays annual bonuses to its employees. T's board of directors passes a resolution in early March 2006 to pay cash bonuses to employees employed in December 2006, and T pays the bonuses in February 2007 (within 2 1/2 months of the end of the year). T uses the annualized amount of that bonus accrual to lower its corporate estimated tax requirement for each of the four annualization periods. For example, for a $1 million bonus, it can use $250,000, $500,000, $750,000 and $1 million as a deferred compensation deduction in each of the respective succeeding quarters.
Under Prop. Regs. Sec. 1.66552(f)(2)(v), a proportionate amount of a taxpayer's estimated annual depreciation (and/or amortization) expense is taken into account in determining the annualized income installment. Estimated annual depreciation expense would be the estimated depreciation expense included in determining the taxpayer's taxable income for the tax year and could include asset purchases, sales or other dispositions, changes in use, bonus depreciation and other provisions that, based on all relevant information available as of the Last day of the annualization period, would be reasonably expected to occur or apply. The regulations also require allocating bonus depreciation ratably through the year rather than including it entirely in the installment period in which the asset eligible for bonus depreciation is placed in service.
NOL Carryovers and Tax Credits
Net operating loss (NOL) and tax credit carryovers must now be taken into account after annualizing the taxable income for the annualization period (Prop. Regs. Sec. 1.6655-2(f)(2)(ii) and (iii)).This eliminates the opportunity to reduce pre-annualized taxable income by the entire NOL and continues to require tax be on an annualized basis before being reduced by tax credit carryovers of former loss corporations turning profitable.
When a taxpayer elects to apply an overpayment from year 1 to year 2'S estimated tax payment, no overpayment interest is accrued on the overpayment that is applied to the second year's estimated tax payments. An overpayment should be applied, if necessary, in the order of each installment due.
If the taxpayer's year 1 return results in an IRS audit deficiency (when the taxpayer elected to apply an overpayment to the subsequent year's estimated tax liability), underpayment interest would not begin to accrue until the amount of the overpayment credited was used to cover the deficiency.
Short Tax Years
Prop. Kegs. Sec. 1.6655-2(f)(2) (v)(B) does not prevent a corporation from using the annualized income installment method simply because the corporation had a short year. If the corporation's short year is less than four full months, no installment payment is required. For corporations with tax years longer than four months, but not quite a full 12-month year, the regulations set forth the following estimated tax due dates:
* If the first installment would be due before the 15th day of the fourth month of the corporation's short year, the first installment would be due on the next due date following the 15th day of the fourth month of the corporation's tax year.
* When the corporation's short year resulted from an early termination of the tax year, the final installment would be due on the due date of the next installment without regard to the termination of the corporation's tax year. If the next due date were within 30 days of the termination of the corporation's tax year, the final installment would be due on the 15th day of the second month following the month of the termination.
For corporations with a short year, the amount of the required installment payment for the year would be 100% of the required amount divided by the number of installment payments required. When there are four required installments, the applicable percentages are 25%, 50%, 75% and 100% of the total required tax due. When there are three required installments, the applicable percentages are 33 1/3%, 66 2/3% and 100%, and the same concept applies for years when there are two required installments and one required installment.
Under Prop. Regs. Sec. 1.6655-2(i), the proposed regulations would be effective for tax years beginning 30 days after the final regulations are published in the Federal Register. However, a taxpayer may rely on the proposed regulations for tax years beginning after Dec. 11, 2005, provided the taxpayer applies all of the proposed rules in determining its required installments. When effective, the proposed regulations would eliminate many of the perceived abuses that previously existed to defer estimated tax payments into later installment periods.
FROM RANDY A. SCHWARTZMAN, CPA, MST, MELVILLE NY, AND JAMES FIELDING, CPA, DALLAS, TX
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|Publication:||The Tax Adviser|
|Date:||May 1, 2006|
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