in 2020, due to the Covid Pandemic, Taxpayers are allowed to file their tax return by July 15th without penalties or interest if they pay the full amount of their taxes due (presuming the taxpayer made any estimated payments required over the past year.
However, if you still need time to file, an Extension can be filed for and automatically granted allowing taxpayers until October 15th to file. Now with that said, just as in years past when April 15th came around, an Extension was NOT an “extension” to pay any taxes you may owe, but an “extension” to file. This is still the rule in 2020. Thus, it’s important to consider if you ‘owe’ and should send in some money with your extension.
So if you don’t want to pay any penalties or interest to Uncle Sam, here are a few tips to make sure you understand the rules when it comes to filing a personal extension.
First, some of you may say… ”Well, I can’t afford to send in any $$ so I’ll just forget filing the Extension all together”. NOT GOOD!! The Extension (Form 4868) is more important than the deposit of $$!!
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, 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.
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.
Second, if you file the Extension, remember, you MAY still need to pay a certain amount with the Extension to avoid the Failure-to-Pay Penalty. Now…I know YOU CAN wait until October 15th to pay what you owe and the damage isn’t too bad, but at the same time I want you to know what you are facing so there aren’t any surprises. This issue plays out in two parts: Penalties AND Interest!
Interest due – 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.
Penalty due – This falls under the “Failure to Pay” 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. So if you file an Extension, and owe the Feds $10,000, and don’t pay until you ultimately file your 2019 tax return on or before October 15th, 2020 you will owe 2% in penalties, and interest of 6% per annum on the balance from July 15-October 15th. The damage to the IRS should be less than $300 in this Example.
So…how much should YOU pay with your Extension…if anything at all??!! This is the golden question. Here are some general guidelines:
General Guideline #1 – If you pay at least 90% of your actual tax liability, for 2019, with the Extension, you will not face a Failure-to-Pay Penalty if the remaining balance is paid by the extended due date. So 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 don’t 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 $$ last year, and you made about the same amount of money, and had the same withholdings or made the same deposits… DON’T STRESS…just SEND in the same amount you paid LAST YEAR with your 2018 Extension.
General Guideline #3 – If you didn’t owe last year (for 2018), and you made about the same amount of money (in 2019), and had the same withholdings or made the same deposits (in 2019)…DON’T STRESS…you shouldn’t need to send in a payment.
General Guideline #4 – If you made more money in 2019 than you did in 2018, then you need to do a little math. First, find what the tax bracket is for ‘your next dollar of profit is in’ (2019 Tax Bracket Below). Then multiply the amount of your increase in income by the bracket your last dollar made is in. Say you’re in the 25% bracket and you made $50,000 more in 2019 than you made in 2018, that would be $12,500 ($50,000 x 25%). Send in the $12,500 with your Extensions after taking into account any additional tax you may have already withheld or deposited in some other way during 2019.
General Guideline #5 – If you just aren’t sure what to do at all, pressed for time, and confused by all this crazy math….then just estimate about how much more money you made in 2019 compared to 2018, and multiply it by 25% and send it in with your Extension. The majority of the time this will be really close to what you might owe, most certainly reduce penalties and interest if there is any at all, OR even create a refund for you when you actually finalize your tax return.
And FINALLY, make sure you tell US what you are planning to do ASAP. We need to put this dollar amount on your Extension and get it out to you so you can mail it with to IRS with your payment BEFORE the deadline. All of this estimating and planning doesn’t do anything for you if you don’t get the $$ in the mail by July 15th…WITH your Extension.
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!!
What about your State? With your State taxes, follow the same method above. Run the numbers and if using Safe Harbor #3 probably use an estimated percentage rate of 8% as a good round number for most states. As for the extension, MOST States don’t require their own extension. Just do a quick Google Search for your State’s rules regarding your extension.
I hope these Guidelines help and if you end up filling out the Extension 4868 Form yourself…download it here. I know the math above can be a little complicated, but if you go through it slowly and have your 2018 tax return in front of you, you should be fine.
* 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 Radio Show “Refresh Your Wealth” and author of the new book “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”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.