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Part 20. Penalty and Interest

Chapter 1. Penalty Handbook

Section 3. Estimated Tax Penalties (Cont. 1)

20.1.3  Estimated Tax Penalties (Cont. 1)

20.1.3.5  (09-12-2006)
Corporate Estimated Tax Penalty (IRC Section 6655)

  1. IRC section 6655 imposes an addition to tax when a corporation (C or S), private foundation, private foundation organized as a trust, or tax exempt organization makes an underpayment of estimated tax. IRC section 6655 also applies to qualified settlement funds described in Treas. Regs. 1.468(B)(1).

20.1.3.6  (09-12-2006)
Assertion Criteria

  1. To avoid the estimated tax penalty a corporation must make estimated tax payments if its tax shown on the return (income tax minus credits) is $500 or more. If the tax is less than $500, no ES payments are required and a penalty will not be assessed.

  2. The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100–647), enacted November 10, 1988, clarified that IRC section 6655 will apply to private foundations and private foundations organized as a trust or corporation.

20.1.3.6.1  (09-12-2006)
Determining the Required Annual Payment

  1. Corporations and certain tax exempt organizations with unrelated business taxable income are required to prepay the lesser of:

    1. 100 percent of its tax liability for the current year,

    2. 100 percent of prior year tax liability, or

    3. The amount determined under the annualized or adjusted seasonal income installment method.

  2. The corporation's prior tax year must have been a full 12–month period for which the corporation filed a return showing a tax liability greater than zero.

    1. Rev. Rul. 92–54, 1992–2 C.B. 320, states IRC section 6655(d)(1)(B)(ii), which allows a taxpayer to base required installment payments of estimated tax on the tax shown on the return for the preceding taxable year, does not apply to a corporation that filed a return for the preceding taxable year showing $0 tax liability.

    2. For example, a corporation (other than a large corporation, see 20.1.3.6.1.6) may use 100 percent of the prior year's tax to determine the current year's ES payments when the tax reported on the prior year's tax return was for an amount greater than zero.

  3. Corporations may use Form 1120-W, Corporation Estimated Tax Worksheet, to determine the amount of the required payment for either the regular, annualized income installment, or the adjusted seasonal installment method. Tax exempt organizations may use Form 990-W, Estimated Tax on Unrelated Business Taxable Income for Tax-Exempt Organizations. These forms are designed to assist the corporation and should not be filed with the Internal Revenue Service.

  4. If a corporation wants to use certain annualization periods for estimated tax purposes, it must make an election on Form 8842, Election to Use Different Annualization Periods for Corporate Estimated Tax, by the due date of the first estimated tax installment (by the 15th day of the 4th month of the year for which the election is being made).

20.1.3.6.1.1  (09-12-2006)
Annual Payment Requirement Where the Tax is Small

  1. A corporation is not required to make estimated tax payments if its tax is less than $500.

20.1.3.6.1.2  (09-12-2006)
Domestic Corporations

  1. Domestic corporations shall be required to make estimated tax payments based on tax and credit determined taxable under any of the following IRC sections:

    • IRC section 11—Tax Imposed

    • IRC section 1201(a)—Alternative Tax for Corporations

    • Subchapter L of chapter 1—Insurance Companies

    • IRC section 55—Alternative Minimum Tax Imposed

    • IRC section 59A—Environmental Tax Credit, plus

    • IRC section 887—Imposition of Tax on Gross Transportation Income of Nonresident Aliens and Foreign Corporations

    • Any applicable credits against tax. (See IRC sections 21, 22, 25 and 26 to determine applicable credits.)

20.1.3.6.1.3  (09-12-2006)
Foreign Corporations

  1. A foreign corporation that has income described in IRC section 882 (Tax on Income of Foreign Corporations connected with United States business), which is subject to taxation under IRC section 11 or 1201(a), or under subchapter L of Chapter 1, must make estimated tax payments on this income in the same manner as a domestic corporation described in 20.1.3.6.1.2 above.

  2. A foreign corporation that has income described in IRC section 881 (Tax on Income of Foreign Corporations not connected with United States Business), in addition to income described in IRC section 882 must treat the tax imposed under IRC section 881 as an IRC section 11 tax on which estimated tax payments also must be made.

  3. For taxable years beginning after December 31, 1994, taxpayers using the annualization method to compute estimated tax payments must take into account income under sections 936(h) and 951(a) in a manner specified in section 6655(e)(4). For more information, see Rev. Proc. 95-23, 1995-1 C.B. 693.

  4. A foreign corporation that is not subject to tax under IRC section 882 is not required to make estimated tax payments on the tax imposed under IRC section 881.

20.1.3.6.1.4  (09-12-2006)
Tax Exempt Organizations and Private Foundations

  1. IRC section 6655(g)(3) requires estimated tax payment on the unrelated business taxable income or net investment income of tax exempt organizations and private foundations.

20.1.3.6.1.5  (09-12-2006)
S Corporations

  1. Effective for taxable years beginning after December 31, 1989, IRC section 6655(g)(4) requires estimated tax payments on certain taxes imposed on S corporations.

    1. IRC section 1371(d)(2) (Coordination with Subchapter C) shall be treated as taxes imposed by IRC section 11.

    2. IRC section 1374(a) (Tax Imposed on certain Built-In Gains).

    3. IRC section 1375(a) (Tax Imposed when Passive Investment Income of Corporation Subchapter C Earnings and Profits Exceeds 25 Percent of Gross Receipts), and

    4. Only ES payments under IRC section 1375(a) may be based on prior year tax. Prior year's tax does not have to be for an amount greater that zero.

20.1.3.6.1.6  (09-12-2006)
Large Corporations

  1. A large corporation (or its predecessor) is defined as a corporation having taxable income of $1,000,000 or more during any of the 3 years preceding the taxable year.

  2. Large corporations for tax years beginning after December 31, 1993, are required to pay 100 percent of the current year's tax.

    1. A large corporation may use 100 percent of prior year tax liability to determine the estimated tax payment required for only the first installment of any tax year (IRC section 6655(d)(2)(B)).

    2. When the first estimated tax payment is based on 100 percent of the prior year's tax liability, and that payment is less than the applicable percentage for the current year's tax liability, the result is considered an underpayment.

    3. That underpayment from the first quarter must be added to what would otherwise be the required payment (applicable percentage for the current year's tax liability) for the second quarter installment.

  3. If any of the three preceding years were less than a full year, the corporation must multiply the taxable income for the short year by 12 and divide the resulting amount by the number of months in the short year to determine if the corporation meets the $1,000,000 criterion.

  4. When the corporation is a member of a controlled group the $1,000,000 amount specified shall be equally divided among the members of the controlled group, unless all members agree to an unequal allocation of the amount.

  5. Large corporation taxable income is determined without regard to any amount carried to the taxable year under IRC section 172 or 1212(a) (net operating loss carryback or carryover).

20.1.3.6.1.7  (09-12-2006)
Annualized or Adjusted Seasonal Method of Determining the Required Payment

  1. A corporation may be able to lower one or more of its required deposits if its income is expected to vary during the year. In general, if a corporation establishes that either the annualized or adjusted seasonal method can reduce its required installment from what it would be if the regular method were used, the corporation may pay the lesser amount.

    1. OBRA 1993 provides for an election to be made if the corporation wants to use different annualization periods for taxable years beginning after December 31, 1993.

    2. To make this election the corporation must complete Form 8842, Election To use Different Annualization Periods for Corporate Estimated Tax, and file it by the due date of the first installment (by the 15th day of the 4th month of the year for which the election is being made).

  2. The corporation must attach a completed Form 2220 to its return if the annualized or adjusted seasonal method of determining the payment is used.

  3. A corporation that reduces any required installment by annualizing its income, then switches to another method to determine a required deposit, must recapture 100 percent of any prior reduction in the next installment using the other method.

  4. The annualized income installment for a corporation is the excess of an amount equal to the applicable percentage of the tax for the taxable year computed by placing on an annualized basis the taxable income, alternative minimum taxable income, and modified alternative minimum taxable income:

    1. for the first 3 months (2 months in the case of exempt organizations) of the taxable year, in the case of the first required installment,

    2. for the first 3 months of the taxable year, in the case of the second required installment,

    3. for the first 6 months of the taxable year, in the case of the third required installment, and

    4. for the first 9 months of the taxable year, in the case of the fourth required installment, over the aggregate amount of any prior required installments for the taxable year.

20.1.3.6.2  (09-12-2006)
Period of Underpayment

  1. For corporations the underpayment period is determined by the number of days from the payment due date to either:

    1. The date the payment or partial payment is received, or

    2. The due date of the return (15th day of the 3rd month), without regard to extensions.

    3. To determine the number of days see either the Perpetual or Leap Year Julian Date Calendars.

    4. If a payment due date falls on a weekend or legal holiday, payments received the next business day are considered paid on the due date.

20.1.3.6.2.1  (09-12-2006)
Tax Exempt Organization

  1. For certain tax exempt organizations with unrelated business income, the underpayment period shall be from the date the payment is due until either:

    1. The date the payment or partial payment is received, or

    2. Due date of the return without regard to extensions (the 15th day of the 5th month rather than the 3rd month) following the close of the tax year.

20.1.3.6.2.2  (09-12-2006)
Private Foundations

  1. For Private Foundations and Private Foundations organized as a Trust or Corporations the underpayment period is determined by the number of days from the payment due date to either:

    1. The date the payment or partial payment is received, or

    2. The due date of the return (15th day of the 5th month) after the end of the tax year without regard to extensions.

20.1.3.6.2.3  (09-12-2006)
Excessive Adjustment

  1. IRC section 6425 allows for an adjustment to an overpayment of corporate estimated income tax. Form 4466, Corporation Application for Quick Refund of Overpayment of Estimated Tax, shall be filed after the last day of the taxable year, and

    1. On or before the 15th day of the 3rd month after the close of the taxable year, and

    2. Before the day on which the corporation files its return.

  2. In the event of an excessive adjustment, IRC section 6655(h) imposes a penalty.

  3. An excessive adjustment is equal to the lesser of:

    1. The amount of the adjustment, or

    2. The amount by which the income tax liability shown on the return for the taxable year exceeds the estimated income tax paid reduced by the amount of the adjustment.

  4. The penalty rate shall be determined using the information contained in IRM 20.1.3.6.6.

  5. The period of the underpayment as it relates to an excessive adjustment under IRC section 6425 is:

    1. From the date that the credit is allowed (the 23C date), to

    2. The return due date (without regard to extensions).

20.1.3.6.3  (09-12-2006)
Payment Due Dates

  1. A corporation's estimated tax payment due dates are determined:

    1. For a full 12-month period: 12-month calendar year payments are due on the 15th day of April, June, September, and December. 12-month fiscal year payments are due on the 15th day of the 4th, 6th, 9th, and 12th months of the fiscal year. Note: In the case of private foundations, the first installment payments are due on the 15th day of May.

    2. For a period of less than 12 months (short period return) payment due dates are determined by the number of months in the short period. See Exhibit 20.1.3–2 for payment dates for individuals (Form 1040) corporations (Form 1120) and estate and trusts (Form 1041) short-period returns. For a short period return of less than 4 months the corporate taxpayer is not required to make estimated tax payments. For a short period of 4 or more months the corporate taxpayer is not required to make estimated tax payments if its liability (income tax minus credits) is expected to be less than $500 by the 1st day of the last month in the short taxable year.

  2. A corporation filing a short period return that is either an initial or final return, is not required to annualize its taxable income to compute the penalty.

  3. A corporation filing a short period return as a result of changes to its annual accounting period should annualize its taxable income to compute a penalty.

  4. If sufficient income to meet the estimated payment requirements is not earned until the last month of a short taxable period, the corporation is not required to make estimated tax payments on that income earned in the last month. However, the corporation is required to file a Form 2220, with supporting worksheet, showing the annualization of the income, and must pay all estimated tax on or before the 15th day of the last month of the short taxable year.

20.1.3.6.4  (09-12-2006)
Application of Estimated Tax Payments and Credits

  1. This subsection contains procedures for application of estimated tax payments and credits.

20.1.3.6.4.1  (09-12-2006)
Credit Applications Within the Year

  1. Payment application for taxable years beginning on or after December 31, 1987:

    1. Installment payments are applied in received date order against the earliest liability within the tax period regardless of when the payment was received.

    2. When that installment is satisfied, any excess will be applied to the next liability until all liabilities within a given period are satisfied.

20.1.3.6.4.2  (09-12-2006)
Credits Applied from a Prior Year

  1. TC 716 or 710 (overpayment arising on or before the due date of the prior year's return) is applied against the first required installment of the next year's estimated tax unless the taxpayer notifies the Service by means of a statement attached to his income tax return, that the overpayment should be applied to another installment.

20.1.3.6.4.3  (09-12-2006)
Verifying Credits on Master File

  1. Credits claimed by the corporation should be verified. This can be done by checking the appropriate CFOL, IDRS (i.e., TXMOD), or MRS transcripts. Review both the dollar amounts and the received dates of any payments.

  2. TC 710 or TC 716 credit is a "credit elect" overpayment received from the prior tax period. It will be applied as a credit to the first required installment period.

  3. TC 660 deposits are made using an 8109 or 8109-B deposit coupon. This deposit will post to the tax module with the date the payment was received at the Federal Depository.

  4. TC 670 subsequent payments will be credited to a tax period as of the received date of that payment.

  5. TC 610 is a payment that is received with the return. This payment will also post to the tax module as of the date the payment was received.

20.1.3.6.5  (09-12-2006)
Determining Amount of the Underpayment

  1. The amount of the underpayment is the required installment payment minus the amount (if any) paid or credited on or before the due date of the installment.

20.1.3.6.6  (09-12-2006)
Penalty Rate

  1. The estimated tax penalty rate is the underpayment interest rate as described in IRC section 6621 (Federal short-term interest rate plus three percentage points). The underpayment interest rate is determined quarterly. This means that the penalty on a $1,000 underpayment for one quarterly tax period may be different from the penalty on a $1,000 underpayment for a different quarterly tax period.

  2. The underpayment interest rate or the estimated tax penalty rate can be obtained from the Internal Revenue Bulletin, News Releases, TAX NEWS, Servicewide Electronic Research Program (SERP), and Notice 746, Information About Your Notice, Penalty and Interest.

  3. The estimated tax penalty rate is NOT compounded daily.

20.1.3.6.7  (09-12-2006)
Determining the Penalty Amount

  1. For each installment, the penalty is determined by multiplying:

    • The amount of the underpayment, by

    • The number of days the payment is late, by

    • The applicable percentage rate.

  2. See LEM 20.1.3.6.7.

  3. Estimated tax penalties are computed on the amount of tax reported on the original return. A second return filed on or before the due date of the return is considered an original return.

    1. If an adjustment is made to the tax of an original return, before the due date (including extensions), as a result of either an audit or the taxpayer filing an amended return before the due date, the penalty amount may be adjusted, based on the new tax amount.

    2. If an adjustment is made to the tax of an original return, after the return due date, including extensions, as a result of either an audit or the taxpayer filing an amended return, the penalty amount cannot be adjusted.

  4. If a corporation did not timely make its required payments, Master File will compute the penalty unless the tax module is restricted (prior TC 170/171 or computer condition code).

  5. Revenue Agents, Revenue Officers, and Tax Examiners with access to IDRS may use command codes:

    1. COMPAE/COMPAS to facilitate the computation of the estimated tax penalty.

    2. PINEX (PIEST) to explain a computer generated estimated tax penalty computation to the taxpayer.

    3. Specific instructions regarding the input of both the COMPA and PINEX command codes are contained in the AIMS Handbook (IRM 2.8), IDRS Terminal Inquiries and IDRS Terminal Input.

20.1.3.6.7.1  (09-12-2006)
Form 2220, Underpayment of Estimated Tax by Corporations

  1. Corporations may complete Form 2220 to compute, reduce or eliminate an estimated tax penalty. In some cases a corporation must file a Form 2220. See Instructions for Form 2220 for more information.

    1. Part lI determines the amount of any underpayment for each of the four installment periods.

    2. Part IIl is used to compute any applicable penalty. Several of the last lines of Part lII provide the formula, but do not provide the applicable percentage rate for determining the penalty amount. To determine the appropriate penalty rate, see IRM 20.1.3.6.6.

    3. If a corporation's income varies during the tax year, it may use the Annualized Income Installment Worksheet or the Adjusted Seasonal Installment Worksheet included with the Form 2220.

20.1.3.7  (09-12-2006)
Penalty Transaction Codes

  1. ES Penalty Transaction Codes are:

    • TC 176—Computer generated assessment of an ES penalty,

    • TC 177—Computer generated abatement of an ES penalty,

    • TC 170—Manual assessment of an ES penalty,

    • TC 171—Manual abatement of an ES penalty.

  2. Manual assessments are determined by Area or Campus employees and are input through IDRS. Employees who cannot directly input the penalty assessment to IDRS need to follow functional guidelines to request the input of an assessment.

20.1.3.8  (09-12-2006)
Adjustments After the Penalty Assessment

  1. This section discusses the procedures and criteria for abatement or waiver of estimated tax penalties.

20.1.3.8.1  (09-12-2006)
Evaluating Claims for Abatement or Waiver of Estimated Tax Penalties

  1. Reasonable Cause is not grounds for adjusting or abating BMF Estimated Tax Penalties.

  2. Estimated Tax Penalties may be adjusted or abated when:

    1. Misapplied prepayments are located and applied to the correct tax period or identification number, or

    2. Prepayments were refunded in error and are returned by the taxpayer within 10 days, or

    3. If it is determined the estimated tax penalty was assessed as the result of a Service error.

  3. Waivers are sometimes granted by legislation, regulation, or administrative pronouncements to provide relief from estimated tax penalties created by the retroactive application or a change in statute or Service position.

20.1.3.8.1.1  (09-12-2006)
Procedures for Requesting a Waiver

  1. To claim a "waiver" the corporation must explain the specific legislative or administrative provisions that caused the tax increase and related underpayment. Only after this information is provided can a waiver be considered.

  2. To claim the waiver, affected corporations should:

    1. Compute the penalty (by completing Form 2220) on the basis of the law in effect before the changes were made, and on the basis of the law in effect after the changes were made. The penalty amount eligible for the waiver is the difference between the two computations.

    2. Write the word "waiver" on the bottom margin of the return.

    3. Write the " waiver amount" on the dotted line to the left of the column provided for the penalty amount.

  3. The corporation must attach an explanation showing its computation and the amount of penalty to be waived.

    1. Review the corporation's explanation of " waiver eligibility" .

    2. Math verify the corporation's Form 2220 computation and
      attachments.

20.1.3.8.1.2  (09-12-2006)
Bankruptcy: IRC Section 6658

  1. IRC section 6658 prohibits the assertion of estimated tax penalty on liabilities during the time the case is pending a Title 11 bankruptcy proceeding filed on or after October 1, 1979.

  2. Abate corporate estimated tax payment penalties with respect to an order by the court finding probable insufficiency of funds of the estate to pay administrative expenses.

  3. Abate corporate estimated tax payment penalties where:

    1. The tax was incurred by the debtor before the earlier of the order for relief, or the appointment of a trustee (in the involuntary case), and

    2. The bankruptcy petition was filed before the due date prescribed by law (including extensions) for filing a return of such tax, or on or before the date for making the IRC section 6655 penalty was imposed.

20.1.3.8.1.3  (09-12-2006)
Request for Abatement Due to an Erroneous Refund of Estimated Tax Payment, Offset, or Overpayment (Credit Effect)

  1. If the taxpayer claims that an overpayment (credit elect) was refunded in error or if an estimated tax payment was erroneously refunded by the Service, the taxpayer may be entitled to have a portion of the penalty abated. Verify the taxpayer's statement by requesting the prior year return and reviewing account information.

  2. Abate the penalty if the taxpayer promptly returns the refund check or repays the refund amount within 10 days of its issue. Consider each case individually to determine if the refund was returned or repaid promptly.

20.1.3.8.2  (09-12-2006)
Denying the Request for a Waiver

  1. If the waiver is denied, send an 854C letter using paragraph "V" informing the taxpayer of the reason for denial and explaining their appeal rights. Input TC 290 for zero with blocking series 98/99.

20.1.3.8.3  (09-12-2006)
Penalty Appeal Procedures

  1. For a complete discussion of penalty appeals, refer to IRM 20.1.1.

Exhibit 20.1.3-1  (09-12-2006)
INSTALLMENT DUE DATES FOR FORMS 1040 AND 1041

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Exhibit 20.1.3-2  (09-12-2006)
INSTALLMENT DUE DATES AND PERCENTAGES OF ESTIMATED TAX DUE FOR FISCAL OR SHORT PERIOD RETURNS

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Exhibit 20.1.3-3  (09-12-2006)
Modified Adjusted Gross Income
Modified Expected Tax

Modified Adjusted Gross Income
     
For purposes of this provision, "modified adjusted gross income" is determined by making the following adjustments to the expected current year's adjusted gross income (AGI):
     
 • do not include any taxable gain from the sale or exchange of a principal residence,
     
 • do not include any taxable gain from a casualty, theft, condemnation, or other involuntary conversion,
     
 • unless the taxpayer is a general partner or 10 percent owner in a passthrough entity (partnerships and/or S corporations), items from passthrough entities for the PRIOR year (if any) are to be treated as if occurring in current year and any actual passthrough items for the current year are disregarded.
     
  • Items from passthrough entities include any item of income, gain, loss, deduction, or credit attributable to an interest in a partnership or S corporation.
     
  • Gain or loss from the disposition of a interest in a partnership or S corporation is not considered a passthrough item.
     
 • If 90 percent of the current year's "modified expected tax" , based on "modified adjusted gross income" is larger than 100 percent of the preceding year's tax, then the required current year's payment is the smaller of 90 percent of the current year's total expected tax or 90 percent of the current year's " modified expected tax"
     
Modified Expected Tax
     
Generally, "modified expected tax" is computed the same as total estimated tax with the following exceptions:
     
 • begin with the modified adjusted gross income, and
     
 • do not include itemized deductions, credits or items affecting other taxes.
     
Review Publication 505, Tax Withholding and Estimated Tax, each year for additional specific instructions regarding income to include or exclude.

Exhibit 20.1.3-4  (09-12-2006)
Farmer/Fishermen Gross Income

Taxpayers qualify as Farmers or Fishermen if two-thirds of their gross income is from farming or fishing.
Determining Farmer/Fishermen Gross Income
Analyze income items found on page 1 of Form 1040:
 Wages
 Interest
 Dividends
 Refunds of state and local income tax
 Alimony received
 Capital gain distributions not reported on Schedule D
 Fully taxable pensions, IRA Distributions, and annuities
 Taxable portion of other pensions and annuities
 Taxable amount of unemployment compensation
 Taxable amount of social security benefits
 Other income
Analyze entries on schedules and forms:
 Schedule C, gross income (losses are considered zero)
 Schedule D, short term and long term capital gains (each must be considered separately, losses are considered zero)
 Schedule E, rents, royalties, partnerships, and trusts (all gains are considered separately, losses are considered zero)
 Schedule F, gross income, Part I, or gross income, Part III
 Form 4797, Sale of Business Property
Compute two-thirds gross income:
Gross income times .6667 = two-thirds gross income
Compare two-thirds gross income to gross farming or fishing income:
If the farming or fishing income is two-thirds of the gross income, the taxpayer qualifies as a farmer or fisherman.

Exhibit 20.1.3-5  (09-12-2006)
Qualified Farm Income

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