Safe Harbor – Estimated Tax Liability
Your therapy private practice is up and running, it’s generating profit–so it’s all smooth sailing from here, right? With an accounting team who understands the inner workings of a therapy private practice, you can set yourself up for success! Whether you have professional help or are trying to handle the bookkeeping yourself, let’s talk for a moment about tax liability.
The first thing to understand is that most private practices are pass-through entities. All this means is that the business net income flows through to your personal tax return–you pay taxes personally rather than through the business. Have you ever heard your tax preparer talk about ‘safe harbor’ and feel like they are speaking another language? Allow us to clarify! Safe harbor is a legal term used in multiple legal topics to describe a certain point/amount. “Meeting” safe harbor means that conditions to reduce or eliminate liability in certain situations have been met. For a small business owner, safe harbor most commonly references fixed assets and estimated tax liabilities. Since we are nearing the end of the year, we will focus on the latter! Every year, taxpayers are required to pay a certain amount of their expected tax liability to avoid underpayment penalties and interest. Once you have paid enough in taxes to avoid the penalty and interest, you have reached “safe harbor”! This applies to both federal and state tax liabilities. Keep in mind that meeting “safe harbor” does not mean that you will not owe additional taxes when you file your tax return. It just means that you will not owe penalties and interest on the unpaid amounts. State requirements can vary widely by state, so we will only discuss the federal requirements. IRS regulations* state that to meet safe harbor, taxpayers must meet one of the following requirements:
Have paid in at least 90% of the current year liability or 100% of the prior year liability, whichever is smaller
For high income earners, you must pay 110% of the prior year liability.** This applies if your 2018 Adjusted Gross Income (AGI) was $150,000 or higher ($75,000 or higher if you are Married Filing Separately)
The easiest (and sometimes required!) way to meet safe harbor is to make quarterly estimated tax payments. Most business owners have a requirement to make quarterly estimated tax payments because of the pass-through income from their businesses (Schedule C, Schedule E, Form 1120S and Form 1065). These payments are normally based on your prior year tax liability. This is why tax preparers often give quarterly estimated tax vouchers for the current year when they prepare your prior year tax return!
Usually, the estimated payments are equal amounts and must be paid throughout the year. If you are in a business with a lot of volatility in income throughout the year, or perhaps a new business that doesn’t start bringing in income until the end of the year, the estimated payments can vary accordingly. The quarterly payments must still be paid timely per quarter, but you can avoid the underpayment penalty and interest by correctly allocating your income to each quarter when your tax preparer files your return. You are not required to make quarterly estimated payments if your total unpaid liability is $1,000 or less, after subtracting withholdings (W-2s and 1099s) and other credits. All income and withholdings, including a spouse’s if married and filing together, are considered in the safe harbor calculation. A loss from one business can be used to offset the gains of another. S-Corp owners have the advantage of being able to withhold additional amounts through their payroll and can reduce or avoid quarterly estimated payments entirely. This is especially beneficial if a quarterly payment was missed or filed late during the year. Most tax professionals do a safe harbor comparison in November or December to help avoid underpayment penalties. You’ll need to supply the following information:
Year to date Profit & Loss Statement(s) to see where your current year income stands compared to the prior year
Most recent paystub(s) for yourself and your spouse (if applicable)
List of all estimated tax payments made throughout the year
If you are a new client, they will also need a copy of your prior year tax return
With the help of your tax professionals, you can anchor your business in a safe harbor! Smooth sailing? With the right preparation, you can bet on it! Greenoak Accounting has helped hundreds of therapy private practices increase profit and manage the financial side of their business. If this is something you’d benefit from, learn more at https://www.greenoakaccounting.com/.
*IRS Publication No. 306: https://www.irs.gov/taxtopics/tc306
**IRS Publication No. 505: https://www.irs.gov/pub/irs-pdf/p505.pdf
This article is designed to provide information only and should not be considered legal or tax advice. Because of the complexity of the law and the variables in your own personal tax situation, you can’t rely on our advice specifically related to your unique circumstances. In order to get the best tax savings and legal advice available to you, you should consult with your own accountant, attorney or advisor regarding your particular facts and circumstances.
GreenOak Accounting is an accounting firm that specializes in working with counselors and therapists in private practice. We provide monthly accounting & bookkeeping services, 1-time services and online courses. For more information on our specialized services for therapists please visit https://www.greenoakaccounting.com/our-specialized-services-for-therap