Avoiding Tax Underpayment Penalties in the Thoroughbred Industry

Photo by Erik MacLean

The racing industry has some of the highest highs and the lowest lows of any vocation. For most people in the industry, their business profits and losses tend to track closely with those emotional highs and lows. A win at the track or a successful sale can bring a rush of euphoria, while setbacks can feel devastating. However, when it comes to your taxes, riding that emotional rollercoaster is a risky strategy.

The Challenge of Early-Year Tax Projections

In other posts, I’ve emphasized the importance of staying on top of your business profits and losses and regularly updating your tax estimates so you pay the right amount of taxes at the right time. But let’s face it: for many in the racing and breeding business, projecting a realistic full-year estimate by April 15th—the deadline for your first quarterly estimated payment—is no small feat.

For example, if you’re in the breeding business like I am, most of your income arrives in the second half of the year, with the yearling sales kicking off in July and the weanling sales wrapping things up in November. That kind of income pattern makes early-year tax projections especially challenging.

The Consequences of Underpaying Taxes

Unfortunately, getting your estimated tax payments wrong can have serious consequences. If you don’t pay in enough throughout the year, you’re not only facing a large tax bill when you file but also potential penalties for underpayment. That’s an added expense no one wants.

The IRS Safe Harbor Rule: Your Safety Net

Fortunately, there’s a way to protect yourself: the IRS safe harbor rule. This rule provides a safety net to help you avoid underpayment penalties, and it comes in two forms:

Option 1: The Prior-Year Safe Harbor

The first method relies on your previous year’s tax liability. If you pay in at least 100% of the total tax you owed last year (110% if your adjusted gross income was over $150,000), you’ll meet the safe harbor requirements and avoid penalties, even if your actual tax liability is higher this year.

For many in the racing industry, where income can be unpredictable, this is often the safer and more reliable option. It provides a fixed target and removes some of the guesswork from the equation.

Option 2: The Current-Year Safe Harbor

The second method is based on your actual income for the current year. If you calculate your tax liability in real time and ensure you’ve paid at least 90% of what you’ll owe by year-end, you’ll also meet the safe harbor requirements.

While this method can save money if your income is significantly lower than the prior year, it requires frequent updates to your income projections and tax estimates—a tall order in an industry with so many variables.

Why the Prior-Year Safe Harbor Often Wins

Given the variability in racing and breeding income, the prior-year safe harbor method is often the better choice. It’s predictable and gives you a concrete benchmark to aim for, regardless of how your year unfolds. While it might result in slight overpayment if your income drops, it’s a small price to pay for the peace of mind that comes with avoiding penalties.

Mixed-Income Households: Special Considerations

It’s important to note that the safe harbor rule applies to your combined household tax liability, even if your spouse has a W-2 job with tax withholding.

While W-2 income generally has taxes withheld throughout the year, those with self-employment or variable income—like many in the racing industry—often have less predictable earnings and no automatic withholding. In this case, the taxes your spouse’s employer withholds may not be enough to cover your total household liability.

By using the safe harbor rule, you can ensure that your combined tax payments meet the required thresholds, reducing the risk of penalties. This makes choosing the right safe harbor method even more critical for couples with mixed income types.

The Bottom Line

Staying compliant with your tax obligations doesn’t have to feel like trying to pick the winning horse in a crowded field. By understanding and leveraging the IRS safe harbor rule, you can avoid costly penalties and keep your focus on what matters most: growing your business and enjoying the ride.

Evaluate your situation carefully and choose the safe harbor method that works best for you. Just like in racing, preparation and strategy are the keys to long-term success. With the right approach, you’ll ensure that both your financial and professional journeys are on the right track.

Lastly, keep in mind that this article primarily addresses this topic at the federal level. Individual states will have their own tax rules. Some states make every effort to match their tax rules to federal tax rules but many states do not.

If your tax-preparer, accountant, CPA, or financial advisor is not proactive in helping you navigate the financial aspects of your thoroughbred business, reach out to me at Derek@TrophyPointFP.com.