Estimated Taxes And Stock Comp: Special Issues In 2021

When the IRS extended the tax return deadline to May 17, it kept the usual April 15 due date for the first quarterly estimated tax payment of 2021. This was awkward for the many people planning to base 2021 estimated taxes on 2020 income reported in their Form 1040 tax returns. How are you supposed to know your April estimated tax payment if you haven't yet done your 2020 tax return?

The standard flat 22% federal rate used for tax withholding on stock compensation is usually too low for most employees and executives getting these grants. Paying quarterly estimated taxes is one way to avoid an IRS penalty for tax underpayment. Most people who pay estimated taxes base their payments on the income reported on their tax return to fit into the 100% or 110% safe harbors. Some taxpayers simply finished their returns by April 15 and sent their estimated payments. Others are waiting to act on the first 2021 estimated tax payment until they finish their tax returns.

If you need to pay 2021 estimated taxes and are waiting to finish your 2020 tax return before you make your April payment, this blog commentary explains the issues involved, including insights from tax pros on this unusual situation.

Why 2020 Tax Returns Impact 2021 Estimated Taxes

According to the IRS Data Book, over 22.2 million individual estimated tax forms (Form 1040–ES) were filed in fiscal year 2019. This population of taxpayers includes self-employed people, gig-economy workers, small-business owners, retirees, and investors—a broad cross-section of people with widely varying income levels and occupations, not just the wealthy.

Federal tax law requires all of us to pay at least 90% of our income tax liability through either withholding and/or quarterly estimated tax payments. For those whose income is not subject to withholding, or if you’re a W-2 employee who does not pay enough in taxes during the year via payroll withholding, you pay quarterly estimated taxes on April 15, June 15, September 15, and January 15 of the following year (dates may vary slightly for weekends or holidays).

Underpayment of taxes subjects you to an IRS penalty. You avoid that penalty through one of three safe harbors:

• You owe less than $1,000 in tax for the year.
• You pay at least 90% of tax owed for the current year (2021), or 100% of the tax you paid for the prior year (2020), whichever is smaller.
• For adjusted gross income greater than $150,000 ($75,000 married filing separately) on the prior year's tax return, the percentage of last year’s tax (2020) that you must cover during this year is higher: the safe harbor is 110%.

For more details on estimated taxes with stock compensation, see myStockOptions FAQs on NQSOs, ISOs, SARs, restricted stock, and ESPPs. If you don’t pay enough taxes, IRS Form 2210 helps you calculate any penalty for underpayment of estimated tax. States that have income tax also have their own estimated tax requirements and safe harbors.

Some Taxpayers Met April 15 Due Date

To avoid the issue, some people filed their tax returns and first-quarter (Q1) estimated taxes on April 15. Others merely paid estimated taxes on April 15, with an informed guess as to what is owed, while waiting to file their tax returns.

Randy Joseph, a CPA with Joseph & Hetrick in Seattle, has many clients with equity compensation, such as employee stock options and restricted stock units. She explained that they pay estimated tax either quarterly or with each vesting to make up for the withholding shortfall. With two separate dates, "our concern has been client confusion over what to do on what date," she told us.

"No one has balked at making that first estimate by April 15," she continued. "My only balk came from a tech-company client who didn’t want to have to sell his company stock to pay 2020 taxes now and wanted to wait until May 17 because his company stock was rising. But he is one out of hundreds."

J.T. Harold Forbus, Senior Tax Manager with Bogdan & Frasco in San Francisco, explained that for clients who have substantial Q1 estimates the firm suggested they pay by April 15, particularly when the firm knew the Q1 estimates (e.g. based on stock option exercises) would be very large.

What To Do About Outstanding Q1 Estimated Tax

Some taxpayers chose to ignore the April 15 estimated tax due date and instead pay estimated taxes when the tax return is filed in May. The justification for this approach is that the penalty for paying estimated taxes late is so small that it’s not worth the extra effort, or additional expense from a tax return professional, to do it separately from the tax return.

Jan F. Lewis, CPA and Tax Partner with Haddox Reid Eubank Betts in Jackson, Mississippi, explained to me why this approach can make sense. “We have to be reasonable and we have to be upfront with our clients. The estimated tax penalty is really interest—charged at a 3% annual rate—that makes the monthly charge a quarter of 1%. That’s $25 on a $10,000 estimate per month. So if we don’t have the numbers yet, or don’t have the time to get an accurate number by April 15, that’s a pretty low cost if the client needs to wait until May 17, when the picture may be clearer.”

Elliott Puretz, a CPA and retired college accounting professor in the Boston area, bluntly wrote to his clients that "I am not determining the amounts for the 2021 estimated tax payment No. 1 until the tax return for 2020 is completed. It would cost you more for me to do that (separate from the tax return) than the minuscule penalty the IRS might (unlikely in my opinion) charge for the payment being a month late (less than one half of one percent of the payment)."

IRS Guidance On Overpaying With A Tax-Return Extension

With an extension of your tax-return filing deadline on IRS Form 4868, you pay the IRS the amount of additional taxes you expect to owe for tax year 2020 when you file your return. You can overpay that amount by what you approximately calculate is needed for the first estimated tax payment due April 15. Then have the amount of the refund go to the first quarter estimated tax payment.

Jonathan Gassman, a CPA with the Gassman Financial Group in New York, explained that while his firm is working as if the April 15 deadline applies for the clients who normally make an estimated tax payment, this is the approach he takes with any extension. In addition, paying the first quarter estimated tax payment indirectly through the extension can provide some extra funds should the final tax amount due with the actual return be larger, he noted.

The AICPA, the world's largest member association representing the accounting profession, cautioned before the April 15 due date that "we are not certain that a payment with a Form 4868, even if paid by April 15, will be credited by the IRS as paid by April 15."

The IRS eventually issued additional guidance clarifying that the extension filing with the overpayment needs to occur by April 15 to get it credited to the first quarter estimated tax payment. The IRS repeatedly said in it and with examples that "An extension of time to file has no effect on either the date of payment or the date on which an overpayment exists."

Under this IRS guidance, the same logic would apply to a tax return punctually filed by May 15 that directs any 2020 overpayment to pay 2021 estimated taxes (see Form 1040 line 36).

Why The IRS Did Not Want To Move Estimated Tax Due Date

In spite of widespread pressure from tax professionals to have the dates match, including from CPAs and enrolled agents (EAs), the IRS refused. This caused an uproar in the tax profession and has even led to congressional legislation attempting to shift the date.

The IRS remained adamant in not moving the April date. To explain why, IRS Commissioner Charles Rettig made the following statement in a recent congressional hearing: "There’s a large contingent of wealthy individuals in this country who do not make their estimated payments and who essentially take the money they should be paying in quarterly estimated payments to the government and take the arbitrage, invest it, and we’re not going to give them a break of interest and penalties to do so."

He also said that "this issue is, where do we draw a line, and that line will quickly run to wealthy individuals who game the system." You can hear these statements in the video, around 1:13 and 1:42.

Phyllis Jo Kubey, EA, the president of the NY State Society of Enrolled Agents, told me her view of these statements, a sentiment echoed by every tax-return professional I contacted. "I was horrified to hear Commissioner Rettig’s remarks about not wanting to create an arbitrage opportunity for wealthy taxpayers. Most of my clients who pay estimated taxes are musicians, clergy, and senior citizens—and most have adjusted gross incomes (AGIs) well below $100K." Additionally, she said, the administrative complexity of keeping the estimated tax due date April 15 when the returns are due May 17 is "huge for taxpayers, tax professionals, and (I suspect) for the IRS."

For guidance on tax returns and estimated taxes on stock compensation (stock options, restricted stock/RSUs, ESPPs, and SARs), see the Tax Center at myStockOptions.com.

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