It seems that every year I have to run after some clients to remind them to pay their quarterly tax estimates.  Estimates are a requirement of law.  Basically the government wants your taxes to be PAID IN ADVANCE of the yearly tax bill.  How is that fair?

Like many things in life, it is not fair; it is just the law.  Both businesses and individuals are required to pay taxes in quarterly installments throughout the year in anticipation of the yearend bill which is effectively due for most individuals on April 15^th.

One problem with estimates is that the due dates are remarkably useless.  Instead of paying estimates at the end of each calendar quarter [which makes logical sense] our government has made the estimate due dates are the 15^th of April, June, September and January.  This creates unique timing problems in that April 15 is also the due date of the prior year’s taxes in addition to the first estimated tax due date on earnings for the first 3 months of the current year.  The June 15^thdate, means that if you use the calculation method calculate taxes on April and May monthly earnings; the September 15^th estimate is for earnings in the moths of June, July & August; the last estimate technically due January 15^th after yearend is for the 4 months of earnings September, October, November & December.  So clearly, the equal estimates are hardly equal in every way; they represent different numbers of months.

Estimate calculations have two categories that you should be aware of.  The first calculation is called a protective estimate.  A protective estimate is 110% of last year’s tax.  This is the safety type estimate, in that, no matter how much taxes you owe or don’t owe at yearend, if you prepaid a total of 110% of last year’s tax bill you by-pass the possibility of penalties and interest, as long as you pay any remaining personal balance by 4/15 of the following year.  For businesses it is the same, except for the fact business tax returns are due 3/15 which is the business deadline for settling your business tax bill with the government.  And by government I mean federal, state and city/county income taxes.

Self-employment income calculation is another method to pay estimated taxes.  Calculate how much you earned during each period and pay the correct amount of tax attributable to each period by the quarterly due date.  In theory, by the fourth estimate 1/15, you have paid all taxes for your pending tax returns.  This is a good system if you keep good tabs on your earnings.  Especially favorable if you have a sharp upswing in income [like winning the lottery] or favorable if you can only afford to pay as little as possible based on declining actual business results.

Estimates by their very nature are rarely 100% perfect. Before I leave this discussion on tax estimates, please realize how important they are:  the penalty usually starts at 10% plus interest on the entire amount of owed taxes, often back dated pro rata to each month the partial amount of the estimate was due.  So the penalties for missing estimates can be rather high.  Also, always pay the 4^th estimate to  your home state in December, not in January [in January on or before January 15^th] as not to lose the current year itemized state income tax payment deduction on schedule A of your form 1040.  If you don’t know what that means, be sure you are using a CPA when you file your taxes.

Recently there has been a uptick in clients requesting us to send documents to third parties, who most often are lenders. In addition, since most of our clients are self employed, banks also ask for self employment verification letters from our CPA firm. Often the mortgage broker or bank officer says things like, “We won’t be able to approve the loan without your CPA’s letter” or similar statements to our clients, implying that if we do not cooperate the client’s potential outcome is zero.

It is important to recognize exactly what is going here because it runs contrary to law. Regulation Z requires banks and lenders to obtain third party communication. From the bank’s perspective, there is no better source than the CPA as the go to person. The statement “We won’t close without the CPA letter” is not only false [banks will close loans without a CPA comfort letter as a matter of fact], but the implication of such a statement is that the lender is relying materially on the CPA letter to accept the loan.

The lender’s tone often puts the CPA at odds with the client and also puts the CPA firm at risk of being drawn into a suit should the loan not perform. The AICPA has made it clear that a CPA may not release letters of assurance on a client if the engagement was a non-assurance engagement:

“Tax return preparation is not an assurance engagement; neither is write-up of client’s records, consulting or compilation statements. In fact, the agreement all clients sign for taxes and write-up clearly state the work we are doing isn’t a review or audit that would attribute professional assurances to the numbers.”

We have been advised by our insurance company not to write third party verification letters. For the most part, we do not write them. After several public discussions on this topic with our carrier and other CPA colleagues, the general consensus is that writing the letter takes on inherent risks. Third party letters can be designed to mitigate a CPA firm’s exposure to being at fault for a non-performing loan, but they do not stop the lender from dragging a CPA firm into court even if the CPA firm isn’t liable. As I write this, it almost seems strange that a CPA firm confirming a client is self employed or made ‘x’ number of dollars last year could make them, in reality, a co-signer to a loan. It seems ridiculous except for the evidence.

Our CPA firm has never been drawn into a non-performing loan circumstance and we’d like to keep it that way. When it comes down to who should you listen to, we all should follow our gut instinct. If you have special circumstances we certainly will listen and do our best to help our clients. My gut reaction to most third party letter requests is not affirmative.changes in staff, such as hiring a new employee.