To ensure the successful delivery of newsletters and updates from Hawkins Ash CPAs, please add info@ha.cpa to your email's safe sender list.

For business owners and individuals who pay in quarterly tax estimates, now may be a good time to review the rules. You want your business to pay the minimum amount of estimated tax without triggering the penalty for underpayment of estimated tax.

Four Possible Options

The required installment of estimated tax that a corporation must pay to avoid a penalty is the lowest amount determined under one of the following four methods:

1. Current year method. Under this option, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the current tax year’s return (or, if no return is filed, 25% of the tax for the current year) by each of four installment due dates. The corporate due dates are generally April 15, June 15, September 15 and December 15. If a due date falls on a Saturday, Sunday or legal holiday, the payment is due the following business day.
2. Preceding year method. Under this option, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the return for the preceding tax year by each of four installment due dates. (Note, however, that for 2022, certain corporations can only use the preceding year method to determine their first required installment payment. This restriction is placed on corporations with taxable income of $1 million or more in any of the last three tax years.) In addition, this method isn’t available to corporations with a tax return that was for less than 12 months or a corporation that didn’t file a preceding tax year return that showed some tax liability.
3. Annualized income method. Under this option, a corporation can avoid the estimated tax underpayment penalty if it pays its “annualized tax” in quarterly installments. The annualized tax is computed on the basis of the corporation’s taxable income for the months in the tax year ending before the due date of the installment and assumes income will be received at the same rate over the full year.
4. Seasonal income method. Under this option, corporations with recurring seasonal patterns of taxable income can annualize income by assuming income earned in the current year is earned in the same pattern as in preceding years. There’s a somewhat complicated mathematical test that corporations must pass in order to establish that they meet the threshold and therefore qualify to use this method. If you think your corporation might qualify for this method, don’t hesitate to ask for our assistance in determining if it does.

Also, note that a corporation can switch among the four methods during a given tax year.

We can examine whether your corporation’s tax bill can be reduced. If you’d like to discuss this matter further, contact us.

If you check the Internal Revenue Code, you may be surprised to find that most business deductions aren’t specifically listed there. For example, the tax law doesn’t explicitly state that you can deduct office supplies and certain other expenses. Some expenses are detailed in the tax code, but the general rule is contained in the first sentence of Section 162, which states you can write off “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Basic Definitions

In general, an expense is ordinary if it’s considered common or customary in the particular trade or business. For example, insurance premiums to protect a store would be an ordinary business expense in the retail industry.

A necessary expense is one that’s helpful or appropriate. For example, a car dealership may purchase an automatic defibrillator. It may not be necessary for the business operation, but it might be helpful if an employee or customer suffers a heart attack. It’s possible for an ordinary expense to be unnecessary — but, to be deductible, an expense must be ordinary and necessary.

A deductible amount must be reasonable in relation to the benefit expected. For example, if you’re attempting to land a $3,000 deal, a $65 lunch with a potential client should be OK with the IRS. (The Tax Cuts and Jobs Act eliminated most deductions for entertainment expenses but retained a 50% deduction for business meals.)

Proceed with Caution

The deductibility of some expenses is clear, while others are more complicated. Keep careful records to substantiate expenses you plan to deduct. Generally, if an expense seems like it’s not normal in your industry — or could be considered personal or extravagant — proceed with caution. Not surprisingly, the IRS and courts don’t always agree with taxpayers about what is ordinary and necessary. (See examples in “Relevant U.S. Tax Court cases” below.) Contact us with questions about deductibility. 

Relevant U.S. Tax Court Cases

Here are three recent U.S. Tax Court cases in which specific taxpayer deductions were disallowed:

1. A married couple owned an engineering firm. For two tax years, they claimed depreciation of $76,264 on three vehicles, but didn’t provide required details, including each vehicle’s ownership, cost and useful life. They claimed $34,197 in mileage deductions and provided receipts and mileage logs, but the court found they didn’t show related business purposes. The court also found the mileage claimed included commuting costs, which can’t be written off. The court disallowed these deductions and assessed taxes and penalties. (TC Memo 2023-39)
2. The court ruled that a married couple wasn’t entitled to business tax deductions because the husband’s consulting company failed to show that it was engaged in a trade or business. In fact, invoices produced by the consulting company predated its incorporation. And the court ruled that even if the expenses were legitimate, they weren’t properly substantiated. (TC Memo 2023-80)
3. A physician specializing in gene therapy deducted legal expenses of $360,295 for two years on Schedule C of his joint tax returns. The court found that most of the legal fees were to defend the husband against personal conduct issues. The court denied the deduction for personal legal expenses but allowed a deduction for $13,000 for business-related legal expenses. (TC Memo 2023-42)

In this episode of Tax Insights, Jeff breaks down the complexities of Social Security. He explores the various options available to listeners and examines the pivotal ages at which they can start claiming their benefits. Jeff shares considerations to equip you with the knowledge needed to make informed decisions about your Social Security journey. Let’s jump right in!

New businesses are launched every day, as evidenced by the number of Employer Identification Numbers requested, according to the U.S. Census Bureau. In the aftermath of the COVID-19 pandemic, there was a large increase in the number of businesses formed. For 2023, roughly 5.5 million new business applications were filed.   

How to Treat Expenses for Tax Purposes

Entrepreneurs often don’t know that many of the expenses incurred by start-ups can’t be currently deducted on their tax returns. Be aware that the way you handle some of your initial expenses can make a large difference in your federal tax bill. Here are three rules to keep in mind if you’re starting or planning to launch a new business:

1. Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one. 
2. Under the tax code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t go very far these days! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
3. No deductions, including amortization deductions, are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to start earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?

Eligible Expenses

In general, start-up expenses are those you make to:

• Investigate the creation or acquisition of a business
• Create a business
• Engage in a for-profit activity in anticipation of it becoming an active business

To qualify for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.

To be eligible as an “organization expense,” an expense must be related to establishing a corporation or partnership. Some examples include legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.

Plan Now

If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the election described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.