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TAX NEWS - FEBRuary 2010

California Tax: Using the Annualization Method in 2009 and 2010

Estimated tax payments have undergone many changes since we started filing season one year ago. Beginning January 1, 2009, taxpayers were required to make estimated payments in installments of 30 percent for the first and second quarters and 20 percent for the third and fourth quarters. For those taxpayers who did not receive their taxable income evenly during the year, it may have been to their advantage to annualize their income. This method allows for better matching of estimated tax payments to the actual period when income is earned. To use the annualization method, the Form 5805, Underpayment of Estimated Tax by Individuals and Fiduciaries, should be filled out using the annualization schedule.

If your client began using Form 5805 to calculate estimated payments under the annualization method in 2009, the instructions and form would have calculated the quarterly payments using four equal installment payments of 25 percent. The legislation that changed estimated payment amounts based on a 30 percent, 30 percent, 20 percent, 20 percent installment method did not include the annualization method. It wasn't until later in the year that legislation was passed to change the percentage for the annualized method to the same 30 percent, 30 percent, 20 percent, 20 percent installment method as used for all other estimated payments. Committee on Budget, 2009/10, ABX4 17, took effect October 29, 2021 and the new percentages in R&TC Section 19136.1 for the annualized method apply to taxable years beginning on or after January 1, 2009.

This change in legislation has left some practitioners wondering if their clients, who chose the annualization method and paid the first three quarters each at 25 percent, would now be subject to a penalty due to the new legislation. The good news is R&TC Section 19136(g) prevents the imposition of a penalty for underpayment of estimated tax if the underpayment was created or increased by a law chaptered during and operative for the same taxable year. Since the amendments to R&TC Section 19136.1 by ABX4 17 with respect to the percentages for the annualized method were enacted in 2009 and operative for the 2009 taxable year, no penalty for underpayment of estimated tax can be imposed if the underpayment was created or increased by the changes made by ABX4 17. In addition, if your client used the annualized percentages prior to ABX4 17 to make the first three estimated tax payments, as prescribed on the form FTB 5805, the fourth estimated tax payment would have occurred after the change and would have also reached the 90 percent threshold, regardless of the change made by ABX 4 17. If an underpayment of estimated tax exists due to the changes to the annualized percentages for the first three estimated tax payments, you may request a waiver or reduction of the underpayment of estimated tax penalty by completing Part I of Form 5805.

For the 2010 taxable year, we are revising Form 540-ES, Estimated Tax Voucher for Individuals, to include language to tell taxpayers to use newly prescribed estimated tax amounts to meet the guidelines. Those amounts will be 27 percent, 63 percent, 63 percent, and 90 percent if using the annualized method. Please note the amounts in the chart below reflect the requirement to pay 90 percent of current year tax and cumulate the total percentages of income that should be paid in the quarter listed. For example, the amount listed for the first quarter is 27 percent (90 percent x 30 percent). In addition, a taxpayer making annualized estimated payments should pay 63 percent of the tax due by the end of the second quarter. That percentage stays the same for the third quarter since no estimated payment is due in that quarter.

Estimated Taxes for Individuals and Corporations Applicable Percentages - Annualized Method

2009                                2010

1st Qtr. 27% (30%)           1st Qtr. 27% (30%)
2nd Qtr. 54% (30%)          2nd Qtr. 63% (40%)
3rd Qtr. 72% (20%)          3rd Qtr. 63% (0%)
4th Qtr. 90% (20%)          4th Qtr. 90% (30%)
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