In 2021, due to the Covid Pandemic, Taxpayers are allowed to file their personal 1040 tax return by May 17th without penalties or interest. However, this is assuming you pay any remaining taxes in full when you file your 1040 or Extension before May 17th. So many then ask, how much should I send in with my Extension to avoid any taxes or penalties.

First, IF you had enough withheld from your paycheck or made enough estimated payments throughout the year with your business…don’t worry!! If you don’t owe, you don’t owe! You can just file an Extension and not worry about penalties or interest, AND most importantly not worry about sending in any more money with your Extension.

But what if you STILL do owe taxes for 2020, for whatever reason, and the May 17th deadline is really concerning you? 

Here’s what you need to do in order to minimize any penalties and 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 15th, EVEN IF you can’t pay what you owe

File an Extension No Matter What!

First, an Extension (Form 4868) IS NOT an “extension” to pay any taxes you may owe, but an “extension” to file…And although the Filing Deadline is moved to May 17th, this is still the rule in 2021. 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 $$ on May 17th, so I’ll just forget filing an Extension all together”.  NOT GOOD!!  The Extension (Form 4868) is more important than the deposit of $$!!

HERE’S WHY:  The failure-to-file penalty (if you fail to file an Extension) is more expensive than the ‘Failure-To-Pay Penalty’ and when you don’t file an Extension that’s exactly what happens: 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!!

Pay what you can with Your Extension

If you owe ANY money on May 17th 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 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. The penalty accrues at the rate of only one-half a percent (1/2%) per month or part of a month (to a maximum of 25%) on the amount actually shown as due on the return.

EXAMPLE OF FILING EXTENSION, BUT NOT PAYING: So if you file an Extension, and owe the Feds $10,000, and don’t pay until you ultimately file your 2020 tax return on or before October 15th, 2021 you will owe 2% in penalties, and interest of 6% per annum on the balance from May 17th – October 15th. The damage to the IRS should be less than $400 in this situation.

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%.) Then it starts to really snowball 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 interest you will be charged for late payment!! 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 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 below and you should be able to avoid just that. 

General Guideline #1 –  If you pay at least 90% of your actual tax liability with your Extension for 2020 (less any deposits on record with the IRS), you won’t face a Failure-to-Pay Penalty if the remaining balance is paid by the extended due date. However, if you go with this method, it can be challenging because you have to basically generate a rough draft of your tax return and what you think you are going to owe…but you may not have the time or information to do it, and that’s why you’re filing an Extension in the first place!! 

General Guideline #2 – 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 you paid when you owed LAST YEAR with your 2019 Taxes (paid in 2020 with your Extension or your 1040 Tax Return). 

General Guideline #3 – If you didn’t owe last year (for 2019), and you made about the same amount of money (in 2020), and had the same withholdings or made the same deposits (in 2020)…DON’T STRESS…you shouldn’t need to send in a payment.

General Guideline #4 – If you made more money in 2020 than you did in 2019, then you need to do a little math. First, find what the tax bracket is for ‘your next dollar of profit is in’ (2020 Tax Bracket Below). Then multiply the amount of your increase in income by the bracket your last dollar is made in.

  • Example 4.1 Say you estimate your taxable income (after all deductions, including the standard deduction) is in the 24% bracket and you made $50,000 more in 2020 than you made in 2019…BUT luckily the extra $50,000 doesn’t push you into the 32% bracket. In sum, you would owe approximately $12,000 more in tax ($50,000 x 24%) in 2020 and would want to send in at least that much more with your Extension before May 17th (less any additional deposits you made during 2020). 
  • Example 4.2 Now let’s assume you were previously in the 12% tax bracket, but you estimate that your 2020 taxable income is $50,000 higher (after all deductions, including the standard deduction) and it now kicks you into the 22% bracket. If you look 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%) and would want to send in at least that much more with your Extension before May 17th (less any additional deposits you made during 2020). 

General Guideline #5 – If you just aren’t sure what to do at all, pressed for time, and confused by all of this crazy math….then just estimate about how much more money you made in 2020 compared to 2019, and multiply it by 25% and send it in with your Extension. The majority of the time this should be relatively close to what you might owe, and most certainly reduce penalties and interest if there is any at all, OR even create a refund for you when you actually finalize your tax return.  

Communicate with Your Tax Preparer.

Make sure you tell your accountant/CPA what you are planning to do ASAP. 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 $$ 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.

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 frankly be brutal. If you don’t send in the proper amount with their own 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 Safe Harbor #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.

And FINALLY, all of this estimating and planning doesn’t do anything for you if you don’t get the $$ in the mail by May 17th…WITH your Extension. I know the math above can be a little complicated, but if you go through it slowly and have your 2019 tax return in front of you, or even. a rough draft of your 2020 tax return, you should be fine.

Of course, a brief DISCLAIMER: This is important!!  When using any of the Safe Harbor’s 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 in order to reduce or eliminate the chance of any penalties.  Again, try to deposit 90% of your estimated taxes and you’ll be doing great!!

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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.