As tax season approaches for the 2024 tax year, both individuals and business owners are gearing up to file their returns. While tax filing may seem straightforward, there are numerous traps and pitfalls that can lead to penalties, unnecessary tax liabilities, or missed opportunities for savings. Unfortunately, many taxpayers fall into these traps due to a lack of awareness or understanding of the ever-evolving tax laws.
At MBS Accountancy, we believe in “Proactive tax so you’re never behind in your tax strategy.” This means staying ahead of potential tax issues, ensuring compliance, and optimizing tax outcomes for individuals and businesses alike. In this article, we follow through on that promise by outlining some of the key areas where taxpayers often run into trouble and how you can stay ahead this tax season.
Estimated tax payments
California, like federal law, imposes estimated tax underpayment penalties unless both of the following apply:
- The “required annual payment” is 90% of the tax shown on the return for the taxable year or 100% of the tax shown on the return for the preceding taxable year
- The 100% prior-year tax is increased to 110% if the taxpayer’s prior-year AGI exceeds $150,000 or $75,000 for married filing separately (using California AGI).
However, California does not allow the prior-year safe harbor for individuals with AGI of $1 million ($500,000 for married filing separate) or more, which means these individuals must pay 90% of their current-year tax to avoid an estimated tax underpayment penalty.
Trap
This is a common trap for taxpayers with a “one-time” large capital gain. The FTB and OTA have little sympathy for taxpayers’ ignorance of the law in this situation, consistently holding that a one-time capital gain is not considered an “unusual circumstance” that qualifies for penalty relief.
Trick
You may be able to minimize these penalties by using the annualized method for calculating estimated tax penalties (especially if the capital gain is recognized later in the year). However, estimated tax payment penalties may be completely avoided if you had a minimal tax liability in the prior year due to adequate withholding.
California does not assess an underpayment penalty for the current year if, in the prior year, you had a liability (minus credits for withholding, but not including estimated tax payments) of $500 or less ($250 for married filing separate).
This means that a taxpayer whose prior-year withholding covered the tax could have no withholding or estimates paid in the current year and owe no penalty. This provision also applies to a taxpayer whose AGI equals or exceeds $1 million. The FTB has programmed its computer system to consider this provision when assessing the penalty.
E-pay requirements
All payments made by an individual or corporation, regardless of taxable year or amount, must be remitted electronically after the individual or corporation has done either of the following:
- Made a single estimated tax or extension payment greater than $20,000. Note: A passthrough entity elective tax payment paid by a passthrough entity on behalf of a qualified consenting owner is not treated as an estimated tax payment of the owner and therefore does not count toward the owner’s $20,000 estimated tax threshold
- Filed an original return with a tax liability greater than $80,000 (the passthrough entity elective tax payment reflected on the return does count toward this $80,000 threshold). The triggering payment does not need to be made electronically.
Even if the FTB has not notified the taxpayer, once the return showing the tax liability is filed, all future payments must be made electronically.
Trap #1
A taxpayer who is required to remit electronic payments but remits payment by other means is subject to a penalty of 1% of the amount paid (10% for corporations), unless the failure to remit electronically was for reasonable cause and not willful neglect. The penalty applies even if the amount remitted is less than $20,000, but the taxpayer was otherwise required to remit payments via EFT.
Trap #2
Taxpayers who attempt to make an electronic payment but make an incorrect entry are subject to a late-payment penalty, not the e-pay penalty. Both the OTA and FTB have little sympathy for taxpayers who fail to verify that their electronic payments actually cleared the bank. You can review the Appeal of Lee and Liao, 2023-OTA-570 and the Appeal of Clapp, 2023-OTA-584 for more detailed examples.
In contrast, the OTA recently abated a late-payment penalty when the taxpayer determined that the payment did not go through within three weeks of scheduling the payment and immediately contacted the FTB to remit another payment. See the Appeal of Gelikman and Fisch, 2023-OTA-255SCP for more information.
Tricks
A good remind for taxpayers subject to the e-pay requirement is to make payments electronically (e.g., Web Pay, credit card, or electronic funds withdrawal), and make sure you verify that the payment actually cleared their bank account. Simply relying on a Web Pay confirmation from the FTB is not sufficient.
Passthrough entity elective tax
If a passthrough entity has satisfied the 2024 prepayment requirement by paying the greater of $1,000 or 50% of the passthrough entity tax due for 2023 by June 17, 2024, it must pay the remaining amount by March 17, 2025. The actual election is made by filling out the appropriate lines on the Form 100S (lines 29 and 35), 565 (lines 25 and 30), or 568 (lines 4 and 9) and attaching a Form 3804, Passthrough Entity Elective Tax Calculations, to the return by the extended filing deadline. Any amounts underpaid by the March 17, 2025, payment due date will be subject to the standard late- payment penalty.
Tricks and traps
Passthrough entity tax payments must be made separately from the entity’s other taxes using Web Pay, Form 3893, or by electronic funds withdrawal. An owner’s estimated tax payments may not be applied to the entity’s passthrough entity tax.
Overpayments of the 2024 passthrough entity elective tax cannot be applied to the entity’s June 16, 2025, prepayment for the 2025 tax year. However, they can be applied to any of the entity’s other outstanding tax liabilities (e.g., the S corporation 1.5% net income tax or LLC gross receipts fee).
Otherwise, the overpayment will be refunded to the entity. We are currently hearing from practitioners that this is taking upwards of eight months.
Missing information
One issue that lands in front of the Office of Tax Appeals on a regular basis involves taxpayers seeking late-payment penalty abatement due to reasonable cause as a result of their receiving late K-1s from partnerships in which they held minority interests. These taxpayers are very rarely successful in obtaining penalty abatements. Time and time again, the OTA will find that late K-1s were no excuse because the taxpayers failed to show what efforts were made to timely obtain the information.
Traps
Failure to pay the amount of tax shown on a return in a timely manner is not excused by:
- Lack of necessary information or documents
- The fact that information is lost, inaccurate, or difficult to obtain
- A taxpayer’s difficulty in determining income with exactitude
- Complexity and problems in accumulating the necessary information and/or documents.
Tricks
This is critical to keep in mind when making extension payments. It’s important that passthrough entity owners know that they must begin checking in with the passthrough entities to gather documentation of flowthrough income and expenses now, even if they only receive rough estimates. As a passthrough entity owner, you should keep a detailed log of all contacts made with the entity, who you spoke to, what information you requested, and the result of these conversations.
Remember, even if you do not have the correct information, if you make extension payments based on the best information available, the FTB and OTA are unlikely to impose or uphold late-payment penalties if you can demonstrate the efforts they made to obtain the information. You can review the Appeal of Moren, 2019-OTA-176P for more detailed information.
Avoid the Pitfalls, Maximize Your Tax Strategy
Understanding tax traps and implementing smart strategies can make all the difference during tax season. Whether you need guidance on estimated tax payments, electronic filing requirements, or passthrough entity tax obligations, MBS Accountancy is here to help. Our goal is to help you stay ahead of tax changes so you’re never behind in your tax strategy. Let’s put that into action for you—reach out to us today for expert tax advisory services.