Taxpayers must understand that, even if they file for an extension on their tax return, they are only given an extension to ‘file’ not to ‘pay’. Meaning, that even if you file an extension, you are still required to pay or incur penalties.
Of course, typically this deadline is April 15th, but can vary based on the day of the week that may fall on. For example, in 2022, Taxpayers had until April 18th to file their 2021 personal 1040 tax return, OR file an extension.
But then two important questions immediately arise:
- If I filie an Extension on April 15th, how much should money should I send in, and
- If I can’t afford to send in money and still owe taxes on April 15th, what will the penalties and interest be?
Remember, taxpayers can choose to file an Extension on April 15th no matter what the situation is. HOWEVER, they will owe if they still owe taxes for the prior year, and don’t send in any remaining taxes in full with the Extension.
Determining How Much to Send In
First, IF you had a W-2 from any job during the prior year, AND had enough withheld from your paycheck you shouldn’t owe anything when you filed your Extension.
Also, if you had a small business, AND you sent in enough estimated payments throughout the year you shouldn’t have to worry either.
However, it can get complicated because we may have multiple sources of income, bought and sold assets like Stock, ETFs, or crypto, and could be ‘guessing’ at whether or not we had enough money withheld or made the proper estimated payments with your business.
Here’s what you need to do in order to minimize or eliminate any possible penalties and/or interest:
- File an Extension NO MATTER WHAT!
- Pay what you can with your extension to minimize penalties.
- Calculate as close as you can to what you should send in with your extension following the general guidelines below.
- Always file your tax return by October 17th, EVEN IF you can’t pay what you owe.
File an Extension No Matter What!
Again, an extension (Form 4868) IS NOT an “extension” to pay any taxes you may owe, but an “extension” to file. Thus, it’s important to consider if you ‘owe’ and should send in some money with your extension.
Some of you may say: “Well, I can’t afford to send in any money on April 18th, so I’ll just forget filing an extension altogether”. NOT GOOD!! The extension (Form 4868) is more important than the deposit of money!!
HERE’S WHY: The failure-to-file penalty (if you fail to file an extension) is more expensive than the failure-to-pay penalty. When you don’t file an extension the failure-to-file penalty automatically kicks in!! This onerous penalty accrues at the rate of 5% per month, or part of a month, (to a maximum of 25%) based on the amount of tax you owe.
Essentially, when you don’t file even an Extension the IRS is “in the dark” and assumes the worst.
Think of that first date you had when you promised to call that special someone back. If you don’t call (no matter how valid the reason) …they’re going to assume the worst and that ‘first date’ turns into the ‘last date’ faster than you can spell “booty call” or “text and swipe left”.
That’s what the IRS assumes when you don’t file an extension – they feel like you ‘ghosted’ them. Not good… Keep them in the loop!!
How the Penalties are Calculated
If you owe ANY money on April 15th and don’t pay the bill in full, the failure-to-pay penalty kicks in and plays out in two parts: Penalties AND Interest!
- The penalty accrues at the rate of one-half a percent (.05%) per month, or part of a month, on the amount actually shown as due on the return…AND keeps accruing to a maximum of 25% until you pay the bill!
- The interest on any unpaid taxes accrues at the annual rate of six percent (6%). Not too bad actually, but it’s the penalty that will catch up to you.
EXAMPLE OF FILING EXTENSION, BUT NOT PAYING: In real numbers, if you file an Extension on April 15th, and take the next six (6) months to ultimately pay your $10,000 tax (let’s assume before October 15th), your interest and penalties would be as follows: 3% in compounding interest for approximately 1/2 of the year, AND 3% in penalties (.05% x 6 months). The total would be approximately $550 in penalties and interest. Again, not the end of the world and not too bad of an interest rate either. BUT you have to work quickly because those penalties add up fast.
The real problem is if you don’t file the Extension AND owe…The maximum combined penalty for the first five months is 25%. Thereafter the failure-to-pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties can reach a total of 47.5% over time. Both of these penalties are in addition to the interest you will be charged for late payment!!
EXAMPLE OF FAILING TO FILE AND FAILING TO PAY: Assuming the same numbers as the example above, if both the failure-to-file and failure-to-pay penalties apply, the failure-to-file penalty drops to 4.5% per month (or part thereof) so the total combined penalty remains at 5%.)
The moral of the story is…ALWAYS file an extension, AND always file your tax return by October 15th, even if you have to amend it later.
Calculating How Much to Send in With Your Extension
IF your goal is to just buy some time to file your tax return AND NOT PAY ANY penalties or interest to Uncle Sam, then follow one of the 5 General Guidelines in calculating your Extension payment:
General Guideline #1 – You’re going to hate this, but the first straightforward guideline is to simply pay/deposit 100% of your actual tax liability with your extension for last year’s tax liability (less any deposits on record with the IRS), you won’t face a failure-to-pay penalty because you would have ‘paid’ everything you were supposed to WITH your Extension.
The reason why I say “you’re going to hate this” guideline…is because you need to know exactly what you owe, and IF you did know that, you probably wouldn’t be extending.
COOL BACK-DOOR STRATEGY: If you’re going to be making a 1st quarter estimated tax payment for this year anyway, it’s essentially the same thing if you send in a larger Extension payment because any ‘overpayment’ can be applied to the prior year and you’re back where you started. Otherwise stated, don’t make a 1st quarter estimated payment, just load up your Extension payment for the prior year. It provides a buffer if you miscalculated your Extension payment, and it’s essentially the same thing as making a 1st Quarter payment because any overpayment would/could be applied to THIS year’s tax liability.
However, if creating a ‘rough draft’ of your prior year’s tax return is out of the question, see Guideline #4 below to come up with an amount that could still do the trick with just a few calculations.
General Guideline #2 – SEND in the same amount you paid when you owed LAST YEAR with your last year’s tax return (paid last year with your Extension for your 1040 Tax Return for the year before). Essentially, if you owed $$ last year, and you made about the same amount of money, and had the same withholdings or made the same deposits… DON’T STRESS…just send in the same amount as owed for the year before.
General Guideline #3 – Don’t send in anything at all IF you didn’t owe anything last year (for your last filed tax return). Essentially, if you made about the same amount of money last year, as you did the year before, then follow that same protocol. This is because you should have had the same withholdings or made the same deposits last year for the same amount of income the year before. Again…DON’T STRESS…you shouldn’t need to send in a payment.
General Guideline #4 – If you made more money last year, than you did the year before, you’re going to have to do some math and calculations.
- Step 1 – Determine what tax bracket you were in last year for the next dollar of profit/income you would have made (see the 2021 Tax Bracket Below as an example).
- Step 2 – Multiply the amount of your increased income last year (over the year before) by the proper amount based on the bracket from Step 1.
- Step 3 – Add this amount to any other tax you may have paid last year according to Guideline #2 above. Essentially, you are adding together the figure from Guidelines #2 and #4.
EXAMPLE GUIDELINE #4.1 – Say you estimate your next taxable dollar of income in 2021 would have been in the 24% bracket and you made $50,000 more in 2021 than you made in 2020. BUT presuming the extra $50,000 doesn’t push you into the 32% bracket, you would owe approximately $12,000 more in tax for 2021 ($50,000 x 24%). On top of that, assume you had enough of other withholdings or made deposits where you typcially wouldn’t owe anything more (similar to Guideline #3), then you would send in $12,000 with your Extension on April 15th and hopefully avoid any additional penalties or interest.
EXAMPLE GUIDELINE #4.2 Now let’s assume you were previously in the 12% tax bracket, but you made $50,000 more in 2021. Furthermore, when looking closer, it appears that $20,000 of that additional income is in the 12% bracket and the remaining $30,000 is in the 22% bracket. Therefore, you would owe approximately $9,000 more in tax ($20,000 x 12%)($30,000 x 22%). However, regrettably, after reviewing your 2020 tax return you see that you ended up owing $5,000 on your tax return and your withholdings and deposits were essentially the same in 2021 (similar to Guideline #2). So in sum, and would want to send in $14,000 ($9,000 + $5,000) with your Extension before April 15th and hopefully avoid any additional penalties or interest.
General Guideline #5 – If you’re pressed for time, aren’t sure what to do, and are confused by all of this crazy math…. then just estimate how much more money you made last year compared to the year before, multiply it by 25%, and send it in with your extension. This is definitely a ‘guesstimate’, but better than nothing and will certainly cut down on any penalties or interest you may owe.
Frankly, most of the time this should be relatively close to what you might owe, OR even create a refund for you when you finalize your tax return, but of course I can’t guarantee that and Guideline #5 is just a common practice ‘rule of thumb’.
Communicate with Your Tax Preparer
Make sure you tell your accountant/CPA what you are planning to do ASAP. As a short-summarized list, here are some things to clearly communicate:
- Are you preparing your own extension, or are they?
- If they are preparing your extension, they need to put this dollar amount on your extension and get it out to you in time so that you can mail it to the IRS with the money BEFORE the deadline.
- IF YOU are preparing your own extension…it’s very straightforward on the instructions on how to fill out the form and where to include the payment, as well as where to mail it.
Just be clear about what route you are going to take and how involved your tax preparer should be.
What about Your State Taxes?
Regrettably, some States are extremely easy to work with and simply accept a copy of your Federal Extension…moreover the penalties and interest for late payments could be minimal. However, other States can be brutal. If you don’t send in the proper amount with your Extension Form the penalties and interest can be serious.
Make sure you first understand what the rule is in your particular State in regards to extensions and deposits. They are relatively easy to find on your State website- trust me…they want your money!
Once you know the rule for your State if you need to file an extension – do it!! If you need to send in a deposit, follow the same general guidelines above. Run the numbers and if using General Rule #3 probably use a percentage rate of 8% as a good round number for most States. In sum, at least do a quick Google search for your State’s rules regarding your Extension and payment requirements.
I know the math above can be a little complicated, but if you go through it slowly and have your last filed tax return in front of you, or even. a rough draft of your tax return you plan to file, you should be fine.
IMPORTANT DISCLAIMER: When using any of the General Rules above, please know there is still no guarantee that you won’t owe taxes when you file your return, OR that you won’t have penalties. These guidelines are simply tools to help you estimate the closest amount possible to what you may owe. However, this is STILL a fantastic step to take to reduce or eliminate the chance of any penalties. Again, try to deposit 90% of your estimated taxes and you’ll be doing great!!
Remember, ALL of this estimating and planning doesn’t do anything for you if you don’t get the money in the mail by April 15th…WITH your extension. Make a plan to be at the post office in your local area before they close and know when they will postmark your envelope. Many taxpayers actually use ‘Registered Mail’ to just be safe.
And Finally, it DOES NOT increase your chances of getting audited to file an Extension. Take the time to file an accurate tax return and save as much in tax as you can!
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the PodCasts “The Main Street Business Podcast” and “The Directed IRA Podcast”, and the author of “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”, as well as several other well-known books. He is also the CFO of Directed IRA Trust Company, and a senior partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP, and the accounting firm K&E CPAs, LLP.