Special estimated tax rules.

• Author: Brown, Robert M.

Special estimated tax rules that deny certain individuals the use of the 100% of preceding year's income safe harbor become effective for second quarter 1992 estimated payments. The special rules apply to taxpayers with adjusted gross income (AGI) for the current year of more than $75,000, and "modified AGI" for the current year that is more than $40,000 greater than the preceding year's AGI, and who made an estimated tax payment (or had been assessed a penalty) in any of the three preceding years.

An application of an overpayment on a tax return to the following year's estimated tax payments is not an estimated tax payment in testing whether the special rules apply. Sec. 6654(d)(1)(c)(ii)(III) specifically excludes the overpayment from estimated taxes for purposes of the third prong of the test.

A taxpayer with a less-than-ownership 10% interest in a limited partnership or an S corporation is allowed to compute modified AGI using the entity's preceding year passthrough items (income, deductions, gains and losses). Read literally, Sec. 6654(d)(1)(d)(i) appears to require a taxpayer to eliminate from income the actual passthrough items from all eligible entities for the current year, and add to income any passthrough items from all entities that would have been eligible entities in the preceding year. Thus, modified AGI could include income from entities in which the taxpayer does not have an interest in the current year but did have an interest in the preceding year. Similarly, a C corporation that elected S status for the current year would have had no passthrough items in the preceding year, and would thus not produce any current year modified AGI.

Apparently, the IRS will not enforce the statute so literally. Based on conversations with IRS personnel, and the limited discussion of the issue in IRS Publication 505, Tax Withholding and Estimated Tax, current-year passthrough items from eligible entities should be eliminated in computing modified AGI, and only items shown on the preceding year's tax return from these same entities that were eligible entities in the preceding year should be added in computing modified AGI. Thus, current-year modified AGI would disregard preceding year passthrough items from entities that have been disposed of, terminated or have changed form to an ineligible entity for the current year. A C corporation that elected S status in the current year would not produce any current-year modified AGI. An eligible...