Introducing the Commonsense CPA

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” - Milton Friedman

For the past two years almost every message I’ve written to our clients has been about the pandemic. Messages about stimulus programs. Messages about tax credits. Messages about pandemic rules, pandemic loans, pandemic survival, and, most of all, pandemic sanity.

You did amazing.

You controlled what you could control, you rolled with the punches, and you did your best to keep going.

Now we’re on to the next phase.

By now you are fully aware that a nasty wave of inflation has buffeted the economies of the world. Prices are rising at rates not seen for half a century. Gas is at an all time high. Labor costs are spiraling out of control. The stock market just endured its longest losing streak in more than a century. You’d be forgiven for feeling like we escaped the storm of the pandemic just to jump into an economic tempest… you’re not wrong.

There is a recession on the horizon, and the front edges of that storm are already here.

In this environment, it is incredibly important to make your decisions with as clear a view of the road ahead as you can reasonably achieve. If you’re driving in the rain, it helps to use your wipers. As CPAs, we tend to spend a lot of time - maybe an inordinate, unhealthy amount of time (LOL) - thinking about your money. How to help you make it, how you should care for it, and how to help you keep as much of it as possible. A large part of our value as your advisors comes from sharing with you this unique, monetary perspective on life. That’s why, over the months to come, you can expect Harmony Group to share this perspective with you in what I hope will become a long series of monthly Commonsense CPA newsletters.

I’m not planning to blow your mind with these missives, nor do I expect to solve all of the world’s economic problems. Instead, the goal is just to ensure we communicate regularly, clearly, and concisely with all of our clients about our evolving expectations, while simultaneously helping you to bone up on the financial and tax knowledge subjects that you should be aware of as a sophisticated taxpayer. Frankly,we could be in for a long slog through a multi-year recession, even though I truly hope I’m wrong about it.

Either way, I’m hoping that by constantly educating you on these items - like this month’s discussion of how estimated taxes work - we can help you thrive no matter what economic environment we end up in.

I hope you find it useful.

Matt Hetrick, CPA
President and founder of Harmony Group Inc.

Estimated Quarterly Tax Payments

For people who receive primarily wages, called W-2 income, income taxes are withheld from each paycheck along with the employee’s half of the required contribution for Social Security and Medicare Taxes (for W-2 wages, the employer is responsible for the other half of FICA taxes). The net effect of this arrangement is that most taxpayers don’t have to deal with estimated tax payments.

If you run your own business, freelance, or control your own hours as an independent contractor, however, you become liable for managing the ongoing tax payment process by paying estimated taxes. Estimated taxes are required to be paid as you earn income throughout the year. Since non-wage income earnings can be unpredictable and not subject to withholding, estimated tax payments are calculated estimates of your tax bill. Anyone who is earning income resulting in a tax liability in excess of $1,000 is responsible to pay estimated taxes quarterly to the IRS and, usually, to their state, as well.

As complicated as this seems, it is easy to handle your estimated tax payment obligations efficiently and (relatively) painlessly as long as you are communicating regularly with your Harmony tax accountingteam and staying on top of your estimated tax payments.

The IRS requires estimated taxes to be paid approximately quarterly, according to the schedule below:

* Due dates that fall on a weekend or a legal holiday are shifted to the next business day.
** Note two-month period

To pay your Federal estimated taxes you need to submit your payment with a quarterly estimated tax payment form (Form 1040-ES), which you will obtain from your Harmony Tax preparer. Your baseline estimated tax vouchers amounts for the current year are set annually, during the preparation of your prior year tax return, and these are generally emailed to you at the same time as your completed return. If you have misplaced the forms or need a copy, you can get a copy from your Harmony Client Portal or simply email our admin team at admin@harmonycpa.com and we’ll coordinate them for you.

Your tax advisor prepares these vouchers for you based on our professional knowledge of your ongoing income; there are minimum amounts that need to be paid, based on prior year results, but we will sometimes advise you to pay in an amount that varies from the statutory minimum based on what we expect to happen in a given tax year.

Once we’ve calculated your potential liability you will make payments according to the schedule (although you can prepay your liability if you desire) and payments can be made by mailing in the payment stubs on the Form 1040-ES, online or through the IRS2GO app.

If you miss a deadline or make an underpayment the IRS will assess penalties and interest on any amount that wasn’t filed or underpaid. These assessments can add up quickly. Failure-to-pay penalties are assessed at 5% a month, up to 25% on any delinquent amount and if you don’t file, failure-to-file penalties can be added as well. You will also be subject to interest on any late payments so it’s vital to make up any shortfalls or delinquencies and not wait for filing deadlines. Additionally, the IRS may be more receptive to waiving penalties when taxpayers are proactive in remedying any issues.

If you are making estimated tax payments, as long as you pay 90% of the total tax obligation for the year in a timely manner you will be exempted from any penalties. Often the total tax obligation is difficult to pin down, as your business income and expenses are in flux for 365 days per year, so an easy way to avoid any underpayment penalty is to pay paying 100% of your previous year’s tax obligation (110% if your gross income is over $150,000) as estimated tax payments. This safe harbor strategy protects you from underpayment penalties and ensures you pay in the minimum required amount, but it doesn’t match your estimates to your income: if your business has declined vs the prior year, you may end up with a large refund, or if your business has grown, the balance due with your return could be quite substantial. To that end, we recommend reaching out to our team at the beginning of November if you get close to the end of the year and expect that your final taxable income will vary substantially from the prior year’s; we can schedule an estimated tax review together and update your Q4 vouchers to reflect expected final balances.

Estimated taxes are a bit scary for many taxpayers, but they’re not nearly as complex as they sound. Handling them successfully follows the same rules for success as every other aspect of small business – planning, relying on expert advice and adhering to schedules. By working together with your Harmony Tax team we can make the process smooth and easy.

Journal Entries

Audit Risks
The IRS, though still underfunded, has been more aggressive recently in auditing higher income taxpayers. If you earn more than $100,000 a year, your audit risk has doubled. Though an audit is still highly unlikely, it's critical to have your books and returns in order.

Work-From-Home
Theories about the pandemic’s effect on business abound. Did the pandemic create new paradigms or merely accelerate existing trends? Nowhere is that more evident than work-from-home and to what extent workers will return to the office. Some companies are taking a hard line at bringing people back and seeing push back from employees, despite some evidence it’s currently an imperfect solution. Of course, the ubiquitous Elon Musk is at the center of the debate.

Inflation
Labor shortages, supply chain disruptions and inflation are the primary headwinds facing businesses large and small. We know inflation is a challenge and the extent to which those factors are intertwined will be studied for years. Here’s a good primer on the topic that has been dominating the headlines.