Remember, taxpayers are only given an Extension to ‘file’ and are still required to pay what they owe by April 15th or incur penalties. Now if you’re still wondering if filing an Extension is a good idea or even worth it, check out my article: “Should I file an Extension for my Personal Taxes”.
And remember 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!
The next question then is typically “how much are the penalties and do I need to send in any money with my Extension, if anything at all”?
What are the penalties on my taxes not paid by April 15th
If you owe ANY money on April 15th and don’t pay the bill in full by sending in the money with your Extension, the Failure-to-Pay Penalty kicks in and is 1/2% of what you owe, per month, plus interest.
EXAMPLE 1: You owe $5,000 in taxes, file an Extension, but couldn’t send in any money. Nonetheless, you ultimately get around to filing your taxes in July. The penalty for not paying on time in this situation would be is 2% (.5% x 4 months), or $100+ interest. That’s right…not that bad! The penalty for paying late is not as brutal as not filing an Extension and getting hit with the failure-to-file penalty.
BUT, IF you owe AND don’t file an Extension it gets worse!! The Failure-to-File Penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late, plus interest. Again, check out my article: “Should I file an Extension for my Personal Taxes”.
The maximum combined penalty for the first five months is 25%, and the combined penalties can reach a total of 47.5% over time. That’s not to mention interest on the taxes AND the penalties. See my article: “The Most Common IRS Penalties and How to Avoid Them“ for more information on these penalties.
File an Extension- No Matter What!
Some of you may say…”Well, I can’t afford to send in any money on April 15th, so I’ll just forget filing an extension altogether”. NOT GOOD!! The extension (Form 4868) is MORE important than the deposit of money!!
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 even an Extension the IRS is “in the dark” and assumes the worst.
If 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, plus interest on the penalty itself.
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. 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 the IRS in the loop!
Calculating How Much to Send in With Your Extension
Let’s get real, it can get a little complicated figuring out what to send in with your Extension. If you have multiple sources of income, a small business, bought and sold assets, traded stock, ETFs, or crypto, and not sure if you. made enough deposits, we need to do some basic math.
Trying to keep it simple, here are 5 General Methods to figure out your payment for your Extension without enlisting the help of a 5th grader that knows math better than most of us.
General Method #1 – Don’t send in anything at all IF you didn’t owe anything last year in 2023 (for your 2022 tax return). If you made about the same amount of money in 2023 as you did in 2022, then follow that same protocol. Since you probably had the same withholdings or made the same deposits for the 2022 tax return as you did for 2023, DON’T STRESS…you shouldn’t need to send in a payment.
General Method #2 – You may not like this one because it requires you to do a “mock-up” of your tax return and try to figure out exactly what you owe. Some may say, well if I knew that, I wouldn’t be filing an Extension – maybe so. But in the event you do prep a draft of your tax return, you would simply pay/deposit 100% of your tax liability with your Extension for 2023 year’s tax liability (less any deposits on record with the IRS). In the end, you won’t face a failure-to-pay penalty because you would have ‘paid’ everything you were supposed to WITH your Extension.
BACKDOOR STRATEGY IF MAKING 1st QUARTER DEPOSIT: 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 2023. 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 Method #3 – SEND in the same amount you paid when you owed LAST YEAR in April with your 2022 tax return or Extension. Essentially, if you owed for 2022, and you made about the same amount of money in 2023, 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 Method #4 – If you made more money in 2023 than you did the year before in 2022, then you’re going to have to do some math and calculations. (See Method #5 before for the ‘down and dirty’ version of Method #4).
- Step 1 – Determine your highest tax rate for 2023, or what tax bracket your next dollar will be in for 2023.
- Step 2 – Multiply the amount of your increased income in 2023 over 2022 by the tax rate or rates in determined in Step 1. Remember, in the U.S. we have a graduated tax table so different chunks of money will be taxed at different rates.
- Step 3 – Add the amount of tax you calculate on this extra income in 2023 to any other tax you may have paid last year according to Method #3 above. Essentially, you are adding together the figure from Methods #3 and #4.
EXAMPLE METHOD #4.1 – Say you estimate your next taxable dollar of income in 2023 would have been in the 24% bracket and you made $50,000 more in 2023 than you made in 2022. BUT presuming the extra $50,000 doesn’t push you into the 32% bracket, you would owe approximately $12,000 more in taxes for 2023 compared to 2022 ($50,000 x 24%). On top of that, assume you had enough withholdings or made deposits where you typically wouldn’t owe anything more (similar to Method #1), then you would send in $12,000 with your Extension on April 15th and hopefully avoid any additional penalties or interest.
EXAMPLE METHOD #4.2 Now let’s assume you were previously in the 12% tax bracket, but you made $50,000 more in 2023. 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 2022 tax return you see that you ended up also owing an additional $5,000 on your tax return for 2022 and your withholdings and deposits were essentially the same in 2023 compared to 2022 (similar to Method #3). 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 Method #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 in 2023 compared to 2022, multiply it by 25%, and send it in with your extension. This is definitely a ‘guesstimate’. However, it’s better than nothing and will certainly cut down on any penalties or interest you may owe.
Frankly, most of the time Method #5 should get you relatively close to what you might owe, OR even create a refund for you when you ultimately finalize your tax return. I can’t guarantee you still won’t owe something, but Method #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. Then 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 Method #3 & #4 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.
In Conclusion
I know the math above can be a little complicated. 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 Methods 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 Methods 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. Know when they will postmark your envelope. Many taxpayers use ‘Registered Mail’ to just be safe.
Bottom line,
- 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.
Remember, 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.
* To sign up for Mark’s weekly Free Newsletter and receive his Free E-Book “The Ultimate Tax Strategy Guide – 30 Steps to Saving the Most Money on Your Taxes” 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.
