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By Dr. James M. Dahle, WCI Founder
There's a funny thing about taxes. When you're an employee with a relatively simple financial life, you usually have too much withheld and so you file about the first of February to get your refund ASAP. The self-employed generally end up filing much closer to April 15. As you become a self-employed investor with a complicated financial life, you can't even do that anymore. A few years ago, my financial life finally caught up to me so that I couldn't get my tax return completed by April 15, and I had to file for an extension for the first time.
What happened that caused me to have to do this? It's the usual issue—partnerships not sending me a K-1 before April 15. Although partnerships and S Corporations are required to file their taxes by March 1, they can file an extension themselves and can put off filing their tax return until September 15. C Corporations, like individual taxpayers, don't actually have to file until April 15 (and can extend until October 15). If you get a dozen or more K-1s as I do, the chance of NONE of them filing for an extension is pretty low. And if just one of them does it, well, you're going to have to do it, too.
Taxes, Penalties, and Interest Still Apply
Bear in mind that filing for a tax extension does not relieve you of the burden of paying the taxes due. Those are still due April 15 (or earlier if you didn't stay in the safe harbor). If you fail to pay them, you will pay interest in addition to the taxes due and possibly even a penalty. How can you know how much to pay if you can't even complete the return? The IRS expects you to guess. I mean, estimate. The IRS Form 4868 Instructions say this about it:
“To get the extra time, you must:
- Properly estimate your 2022 tax liability using the information available to you,
- Enter your total tax liability on line 4 of Form 4868, and
- File Form 4868 by the regular due date of your return.
Although you aren’t required to make a payment of the tax you estimate as due, Form 4868 doesn’t extend the time to pay taxes. If you don’t pay the amount due by the regular due date, you’ll owe interest. You may also be charged penalties . . . Any remittance you make with your application for extension will be treated as a payment of tax. You don’t have to explain why you’re asking for the extension . . .
You’ll owe interest on any tax not paid by the regular due date of your return . . . The interest runs until you pay the tax. Even if you had a good reason for not paying on time, you will still owe interest.
The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by the regular due date of your return, which is April 18, 2023. It’s charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. The late payment penalty won’t be charged if you can show reasonable cause for not paying on time.
You’re considered to have reasonable cause for the period covered by this automatic extension if both of the following requirements have been met.
- At least 90% of the total tax on your 2022 return is paid on or before the regular due date of your return through withholding, estimated tax payments, or payments made with Form 4868.
- The remaining balance is paid with your return.”
Basically, you have to file Form 4868 and pay any tax due by April 15 (or, in the case of 2022 taxes, by April 18, 2023). If you underpay, you WILL owe interest on the money. If you underpay by a lot, you will also owe a penalty of up to 3% (0.5% x six months). What is the IRS interest rate? It is the federal short-term rate plus 3%, currently a total of 7%.
Of course, those penalties pale in comparison to the failure to file penalty, which increases the penalty from 0.5% a month to 5% a month. Yes, that's right. Five percent a month, and with a minimum of the smaller of $135 or 100% of the unpaid tax. Whatever you do, make sure you either file a tax return or file an extension, whether you can pay the taxes or not.
More information here:
IRS Form 4868
How big of a deal is this form? Let's take a look.
Yup. That's it. Your identifying information plus four lines—how much you owe, how much you've paid, the difference, and the amount on the check you included with this payment. (Hint: Lines 6 and 7 should be the same number.) See, I told you this was super easy.
What About State Tax Returns?
Of course, if you're going to file an extension on your federal returns, you can't very well file your state returns, can you? You will also need to file an extension for each of those. The first time I had to file that extension in 2019, I had to file returns in Utah, Minnesota, and California. Here's what I learned about those particular states.
Utah State Tax Extension
It turns out Utah has the most lenient rules of the three states. In fact, Utah's tax situation is very good compared to those others for many reasons.
First, the maximum tax rate is 4.85% vs. 13.3% in California and 9.85% in Minnesota.
Second, Utahns don't have to make any estimated tax payments. The self-employed can just pay all the tax due on the tax return due date. That gives you use of your tax money for up to an extra 15 months. Employers (including S Corps) do have to withhold taxes for wages, of course.
Third, the interest rate is only 5%, lower than the IRS rate of 7%. That's a pretty good rate. There are even real estate investors and others in need of a short-term loan who prefer to borrow from the Utah State Tax Commission by underpaying their taxes rather than go to a bank or hard money lender.
Fourth, you don't even have to file an extension. You just have to pay the taxes. The extension is automatic. You just send a check in with this coupon.
Fifth, Utah has a clearly defined safe harbor to avoid penalties on late payments. The safe harbor (no penalties due if you meet it) consists of either 90% of what you will owe this year or 100% of what you paid last year. If your tax bill went up dramatically, an extension gives you a six-month, 4% loan on the difference between your tax bills.
Minnesota State Tax Extension
Minnesota has similar rules but a less lenient safe harbor (no option to just pay 100% of last year's tax due). Minnesota charges 5% interest. Like Utah, there's no real form to fill out, just a coupon. Incidentally, Minnesota only requires estimated tax payments if your Minnesota tax liability is more than $500.
California State Tax Extension
You do have to file a form to get an extension in California, but let's be honest: the form is little more than a coupon. It is Form FTB 3519. California requires estimated tax payments if your California Adjusted Gross Income is more than $150,000.
More information here:
Should I Do My Own Taxes or Pay Someone?
Why Not Just Put Off Your Taxes?
Now that you know how easy it is to file an extension, why not just do your taxes in the fall every year? Well, the problem is the estimate. While it is pretty easy to get a good estimate if you are only missing a K-1 or two, it would be very difficult without doing most of your taxes in April anyway. Do as much as you can now and then when your K-1s finally come into your possession, put the finishing touches on your federal and state taxes and send them in.
If you need help with tax preparation or you’re looking for tips on the best tax strategies, hire a WCI-vetted professional to help you figure it out.
What do you think? Have you ever filed an extension? How come? Are you more likely to consider doing so now that you've read this? Comment below!
[This updated post was originally published in 2019.]
You pretty much hit the nail on the head with the only painful aspect of having investments that generate K-1 statements, which is the late receipt of these forms that can prevent you from filing on time.
I have been, knock on wood, receiving my K-1s before the 4/15 deadline, but they can come in pretty close sometimes (this year the last one received was 2 weeks before the deadline). It would have been nice to have a bit longer interval than 1 month between corporate tax deadlines and individual ones but as you pointed out corporations can also file for extensions too..
I will stick with my W-2 job!
oh dear…so much for you to learn…..JustSayin’
One downside of filing late is that there is wider window for a bad guy to file fraudulently with your info. Cost of doing business I suppose.
I hope they enjoy filing fraudulently with my info. Have a great time getting my incredibly negative tax refund! I guess they could change the numbers, but I think this is mostly an issue for those who actually get refunds.
Timely post. Thanks, good to know how to avoid penalty. Tax may be one big disadvantage of white coat workers when trying to get a fair shake on Wall Street. Why Amazon and several other S&P 500 companies with billions of income pay no tax? We have to pay a third of ours plus penalties if we don’t know the rules.
May be? 🙂
I assure you I pay tax on my Amazon earnings, by the way, as do the other millions of owners. There is no separate “corporation”, all taxes are paid, either directly or indirectly, by us individual owners.
“Why Amazon and several other S&P 500 companies with billions of income pay no tax?”
Because those billions go to employees and shareholders who…pay billions in tax.
Amazon pays tons of taxes. Sales taxes, employment taxes, their employees pay untold FICA, state, and federal income taxes, etc. Just no federal corporate income tax.
You can actually make it even easier, and simply make a tax payment via IRS Direct Pay or EFTPS and apply the payment to an extension. By doing so, the extension is automatic, no form to complete and mail, or e-file. If you don’t have tax due, just pay $1.
https://www.irs.gov/taxtopics/tc304
Great tip.
Thanks for the reminder about filing the state extension form as well. Completely forgot about it until your post. It turns out the Colorado paperwork couldn’t be any easier because there isn’t any!!!
“If you can’t file your Colorado income tax return by the deadline of Monday, April 15, 2019, you may take advantage of the state’s automatic six-month extension of time to file. There is no form to fill out to notify the Department of Revenue that you are taking the extension, however there is no extension for tax due.”
hey does anyone know if it has to be in the mail and postmarked before midnight on 4/15/19? They owe me some $$ so I assume if it’s a day or 2 late filing the 4868 it won’t matter.
I think it is supposed to be. Don’t know what your penalty will be if you don’t owe anything. Nothing in the three states I’m filing in, but not sure for the feds.
Have you found that K1s are difficult to file? I’ve read horror stories of 200 page K1 forms and was going to switch to a CPA for this reason alone.
Not as much doing your own rental properties IMHO, but not like a 1099 for sure.
A reminder that almost all California taxpayers are receiving an automatic extension of filing AND payment deadlines for their federal and California state returns until October 16th for their TY 2022 returns, due to the disaster area designations stemming from last year’s wildfires and other weather events.
Just a reminder for the Expat readers of WCI: if you live overseas your filing is automatically extended to June 15 without doing any extension paperwork and after that date can be extended further by filing for the extension. You still face the requirement to have all taxes due paid by the April filing deadline in order to avoid interest and penalties.
Seems obvious that the feds will charge interest on underpayment, but I was surprised to read they will pay you 7% compounded daily for overpayment. Seems like a solid guaranteed return. Am I understanding this correctly? Any downside to significantly overpaying and then getting that money back with interest when I finally file rather than having it sit in my savings account making 4%?
https://www.irs.gov/payments/quarterly-interest-rates
Interesting technique. Never heard of anyone doing that before, but I guess you could. It’s only for 6 months though. The longest you could put off settling up with the IRS is October 15.