You are correct that an extension is only an extension of time for filing your tax return, it does not extend the time to pay any balance due. As such, when you are filing an extension, you should estimate your income and deductions, calculate what your anticipated balance due would be, and pay that amount with your extension. Of course, as you pointed out, that can be very difficult in situations where your income is derived from a business or from other sources such as partnership or S Corporations that also filed extensions and therefore probably won't issue the K-1 to you until well after the original filing deadline.
With respect to how interest and penalties are calculated on an individual return, Form 1040:
- Penalty for late filing of return. Generally, a penalty is charged if a return is filed after the due date (including extensions) unless you can show reasonable cause for not filing on time. The penalty is 5% of the tax due (less any tax paid on time and available credits) for each month or partial month the return is late. The penalty accrues up to a maximum of 25%.
- Penalty for late payment of tax. Generally, a penalty of ½ of 1% of any tax not paid by the due date is charged for each month or part of a month that the tax remains unpaid. The penalty cannot exceed 25% of the amount due. The penalty will not be charged if you can show reasonable cause for not paying on time.
- Interest. Interest is charged on any tax not paid by the regular due date of the return from the due date until the tax is paid. It will be charged even if you have been granted an extension or have shown reasonable cause for not paying on time. The interest rate for individual tax returns changes quarterly, and is calculated as the Federal short-term rate plus 3 percentage points.
As you can see, the penalty for failure to FILE on time is significantly higher than the failure to PAY on time, so it is always a best practice to file extensions to minimize any penalties you may be subject to. It is also important to note that the IRS may waive penalties if you can show reasonable cause for not filing/paying on time, but note the IRS will not waive interest.
So, what to do in your situation? Again, the best advise is to try to estimate your tax return as best as possible, and then add an additional amount to your extension payment just in case your estimates were a little short. If you make estimated quarterly payments, here is one strategy you could use: Consider making a significantly larger extension payment to absolutely make sure you won't be in a balance due position. Then, when you file your current year tax return, use the option to have the refund apply to the NEXT tax year, and subsequently reduce your next quarterly estimated tax payment by that amount. By doing this, you will be front loading your estimated tax payments for the next tax year, and can adjust the amount you pay for the remaining quarterly tax payments once you file the current year return and know for sure how much is being applied to the next tax year.
I hope that helps you to avoid/minimize penalties in future tax years! Good luck, royalrareness!
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