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 in order to get your refund ASAP. The self-employed generally end up filing much closer to April 15th. As you become a self-employed investor with a complicated financial life, you can't even do that anymore. My financial life has finally caught up to me such that I cannot get my tax return completed by April 15th and will have to file for an extension for the first time ever.
What happened that caused me to have to do this? It's the usual issue–partnerships not sending me a K-1 before April 15th. Although partnerships and S Corporations are required to file their taxes by March 1st, they can file an extension themselves and put off filing their tax return until September 15th. C Corporations, like individual taxpayers, don't actually have to file until April 15th (and can extend until October 15th.) So 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 15th (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. So how can you know how much to pay if you can't even complete the return? Well, 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:
- 1. Properly estimate your 2018 tax liability using the information available to you,
- 2. Enter your total tax liability on line 4 of Form 4868, and
- 3. 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 15, 2019, for calendar year filers (April 17, 2019, if you live in Maine or Massachusetts). 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 2018 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.
So basically, you have to file Form 4868 and pay any tax due by April 15th. 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 6 months). What is the IRS interest rate? It is the federal short term rate plus 3%, currently a total of 6%.
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. 5% a month, and with a minimum of the smaller of $135 or 100% of the unpaid tax. So whatever you do, make sure you either file a tax return or file an extension, whether you can pay the taxes or not.
IRS Form 4868
So how big of a deal is this form? Well, 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 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? So you will need to file an extension for each of those. In my case, I have to file returns in Utah, Minnesota (thanks Physician on FIRE), and California (thanks Passive Income MD).
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 5%, versus 12.3% 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 4%, lower than the IRS rate of 6%. 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. So if your tax bill went up dramatically, an extension gives you a 6 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
California requires estimated tax payments if your California Adjusted Gross Income is more than $150,000.
Why Not Just Put Off Your Taxes?
So 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 seems like it would be very difficult without doing most of your taxes in April anyway. So I've done nearly everything, and in a month or two when I get my last two K-1s, I'll put the finishing touches on my federal and state taxes and send them in.
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!