This is one of the most frequently asked questions we receive around the extended October deadline! In the spring, we just as frequently hear, “I have an extension. Why do I need to make an estimated payment?”
Unfortunately, even though an extension grants you additional time to file, it does not give you additional time to pay the tax due. That means that penalties and interest accrue on the amount of tax owed from the filing deadline until you pay the tax. We agree: this policy is confusing. We’ll discuss a few strategies on how to avoid these costs.
How can I avoid paying penalties and interest?
There are a few steps you can take to minimize the likelihood of paying penalties and interest.
First of all, if you receive a W-2, speak with your payroll administrator to adjust your withholdings to ensure that you are remitting the appropriate tax payment throughout the year. It is important to consider adjustments for life events such as changing the number of dependents you claim when one of your children begins supporting themselves.
However, withholding correctly becomes complicated for people with multiple income sources and business owners. We recommend reviewing the year-to-date financial statements for your business on an ongoing basis so that you have a good estimate of your taxable income. For our accounting and advisory services clients, we send monthly financial statements so that the data is always timely.
Do I really have to pay this?
Even with planning, surprises can come up. Larger-than-expected capital gains can result in a big tax bill since they typically do not have tax withheld. Waiting on a necessary document such as a Schedule K-1 prepared by another firm can make it impossible to know what income may be flowing from that business until the Schedule K-1 is received.
Generally, the penalties and interest assessed by the IRS must be paid. The IRS calculates the Failure to Pay Penalty based on how long your overdue taxes remain unpaid. The Failure to Pay Penalty is 0.5% of the unpaid taxes for each month or part of a month the tax remains unpaid. Importantly, the IRS applies full monthly charges even if you pay your tax in full before the month ends. They do not pro-rate the penalty. However, the penalty will not exceed 25% of your unpaid taxes.
In rare cases, you may qualify for penalty relief if you tried to comply with tax laws but were unable due to circumstances beyond your control.
If your return has been started prior to the April deadline, our tax team may reach out to you about making estimated payments. By making an estimated payment, you can avoid the Failure to Pay penalty. Your tax team will make their best estimate of the amount you owe and can even process the payments to the federal and state governments on your behalf with your authorization.
If a good estimate of the amount owed is not available due to missing information, a good place to start is ensuring that you pay as much tax for the current tax year and you did for the previous year. However, if you expect to receive a refund, no action is required.
The best way to avoid unnecessary penalties and interest around the extended deadline is to regularly communicate with your accounting firm. If you are interested in learning more about our tax planning or business advisory services, call our office at 480-294-4967 to set up a consultation.