Filing An Extension Buys You Six Months
Andrew D. Schwartz, CPA
Unable to complete your tax returns by April 15th? If so, make sure to
file Form 4868, Application for Automatic Extension, with the IRS (available
www.irs.gov) by April 17th.
It's important to note that when you file for an extension, you are asking
for more time to finish paperwork, not more time to pay any money that is
due. If you owe taxes as of April 15th, expect to pay interest, and possibly
a penalty, on the amount due. Whether you're subject to a penalty depends on
the amount of taxes owed after April 15th. Let's look at
Interest: If you have a balance due to the IRS after April 15th,
expect to be charged interest by the IRS. The current interest rate
is 7%, which is a lot less than the rate charged by most credit card
Failure to Pay Penalty: If you file for an extension, and you owe
more than 10% of your final tax liability, expect to get hit with a
"failure to pay" penalty that runs at 0.5% per month. That’s in addition
to any interest you’ll owe on the balance due.
Failure to File Penalty: If you don't file an extension request by
April 15th, the "failure to file" penalty runs at 5% per month, up to a
maximum of 25% of the taxes owed.
example, let's say you earn $100,000 this year and have a total federal tax
liability of $20,000. To avoid the 0.5% per month failure to pay
penalty, you can't owe more than $2,000 when you file a tax return later
this year. By having 90% of your total tax liability paid by April 15th,
filing an extension provides for an extra six months to come up with the
remaining tax dollars owed at a relatively low interest rate.
What if you didn't bother to file for an extension? Unless you can
show the IRS "reasonable cause", expect to be assessed the failure to file penalty
of $100 per month on a $2,000 balance due.
Extensions Can Make Sense For Self-Employed
you're self-employed, you might benefit by filing for an extension even if
you can complete your tax returns by April 15th. That's because you have
until the due date of your tax return, including extensions, to fund your
retirement accounts for the year. Even if you don't have a retirement plan
set up yet, a SEP IRA can be established as late as the extended due date of
your return, or October 15, 2006.
filing a Form 4868 with the IRS, you get an additional six months to fund
your retirement plan and deduct the contribution made on your prior year's
return. One strategy common to self-employed individuals is to
pay the full amount of taxes due with an extension, and then to fund their
retirement plans prior to October 15th.
Keep in mind that an extension does not give you any
more time to fund your Roth IRAs, traditional IRAs, and Coverdell Education
Savings Accounts (ESAs) for 2005. The due date for these
tax-advantaged retirement plans and college savings accounts is April 17th.
Does An Extension Increase The Chances of An Audit?
have clients who are convinced that filing for an extension is a red flag
with the IRS. And I have others who always file for an extension because
they've heard that they're less likely to be audited by doing so.
Personally, I've never seen any connection.
Can’t Pay Your Taxes By April 15th?
What if you need more time to pay your taxes? If you owe so much taxes that
you won’t be able to pay them off by October 15th, one option is to file the
paperwork to enter into an installment arrangement with the IRS. This is
done by completing and filing a Form 9465, and attaching the completed Form
9465 to the front of your federal income tax return. On this installment
request form, you tell the IRS how much you can afford to pay each month and
the day of the month that the payment will be made.
IRS charges a fee of $43 to any taxpayer who enters into an installment
arrangement. In addition, the IRS will charge interest at the prevailing
federal rate (currently 7% per year), and a "failure to pay" penalty of
0.25% per month on the outstanding balance. Plus, failure to make a
scheduled payment will cause the remaining outstanding balance to become
immediately due. And you generally aren't allowed to enter into an
installment agreement if you have an open installment agreement for a
previous year that hasn't been paid off yet.
Always Submit Your Paperwork On Time
moral of this story is simple. Since the failure to pay penalty is so
much smaller that the failure to file penalty, always try to file all your
tax returns and extension requests on a timely basis, even if you're unable
to pay the full amount of the taxes due at that time.
Moonlighters May Face High Tax Bill on April 15
Andrew D. Schwartz, CPA
As April 15th looms, it is important for taxpayers who “moonlight” to
distinguish whether they are compensated as an employee or independent
contractor. Whether you moonlight to supplement your salary, pay down your
student loans, or build a nest egg, how you're compensated determines how
you will be taxed.
If you haven’t completed your taxes for 2005 and aren’t
sure how you were compensated last year, you could be facing a large tax
bill on April 15th. If taxes are withheld from your pay, you're considered
an employee. No taxes withheld means you're an independent contractor.
Generally, each employer has a set policy as to whether
they compensate their moonlighters as employees or as independent contractors.
Here are some of the advantages and disadvantages to being compensated as an
Professional expenses can be
deducted directly against income. Let's say that you earn $10,000 moonlighting as an independent contractor, and have $6,000 of un-reimbursed professional expenses to deduct against that income. In this example, you'll pay taxes on only $4,000 of net moonlighting income. If you were paid as an employee instead, you would claim your professional expenses as an itemized deduction subject to various limitations and the Alternative Minimum Tax (AMT).
As an independent contractor, you can establish and contribute money into a pre-tax retirement account based on your net moonlighting income. Individuals have until April 17, 2006 to set up and fund a SEP IRA for 2005 (or October 15 for those filing for an extension), and sock away up to 20% of their net moonlighting income. Amounts contributed reduce your taxable income and grow tax-deferred. Other pre-tax savings opportunities available to independent contractors include SIMPLE IRAs and Solo 401(k) plans.
100% of health insurance premiums can be deducted. As long as you are not covered under an employer sponsored health insurance plan, being paid as an independent contractor allows you to write-off your health insurance premiums paid during the year.
Independent contractors are subject to an additional tax known as the "self-employment tax". When someone works as an employee, their employer withholds social security and Medicare taxes from their pay at a rate of 7.65%, and then matches the taxes withheld. So the government gets 15.3 cents for every dollar earned. When a person is self-employed, they are required to report and pay that 15.3% tax, known as the self-employment tax, as part of their federal tax return. The self-employment tax rate goes down to 2.9% once a person’s combined salary and net moonlighting income exceeds $90,000 for 2005 and $94,200 in 2006.
An independent contractor's tax return becomes much more complicated. The days of preparing the 1040-EZ are over. You now need to complete and send in the long form, along with a Schedule C, Schedule SE, and whatever other tax forms and schedules might be required.
Independent contractors may be required to prepare and submit quarterly estimates. The government generally doesn't allow you to write them a big check on April 15th. Depending on how much you earn moonlighting and what else she has going on with your taxes, you might need to remit quarterly tax payments to the IRS to keep from getting penalized. A 1040-ES form should be used to remit federal estimated tax payments.
Monitor Your Withholdings
Even if taxes are being withheld from a your moonlighting income, don't assume that enough taxes are being taken out. That's because each employer withholds taxes as if they are the only employer.
For example, if your earn $20,000 from three employers during the year, the amount of federal income taxes withheld from your pay will be significantly less than if you had earned $60,000 from just one employer.
To make matters worse, if you tell your employer you are married, they will start withholding even less taxes, since the withholding tables for a married person assume your spouse doesn't work.
The 40% Rule
Moonlighters who are paid as independent contractors have no taxes withheld. In that case, it's generally a good idea to set aside 40% of earnings for taxes. Don't forget, you'll owe federal taxes, state taxes, and self-employment taxes on your net moonlighting earnings.
The taxes you'll owe on your moonlighting income are manageable if you
plan ahead. Don't let the possibility of a surprisingly large tax bill deter
you from taking advantage of moonlighting or consulting opportunities that
TAX AND FINANCIAL PLANNING CALENDAR FOR
Saving and Investing
Personal income tax returns are due 4/17/06
Request for automatic six month extension, Form 4868, due 4/17/06
1st Quarter estimates due 4/17/06
Due date for funding your 2005 Roth or Traditional IRA, or
Education Savings Account (ESA) is 4/17/06
Due date for self-employed individuals to fund their
retirement plans is 4/17/06
Self-employed individuals who need additional time to
fund a retirement plan should file a Form 4868 with the IRS
- For 2005, the standard deduction for a single individual is
$5,000 and for a married couple is $10,000. A person will benefit by
itemizing once allowable deductions exceed the applicable standard deduction.
Itemized deductions include state and local income taxes (or sales taxes), real estate taxes,
mortgage interest, charitable contributions, and unreimbursed employee business
- For 2005,
the personal exemption is $3,200. Individuals will claim a
personal deduction for themselves, their spouse, and their dependents.
- The maximum earnings subject to social security taxes is $94,200
for 2006, up from $90,000 in 2005.
- The standard mileage rate is $.485 per business mile as of
September 1, 2005 (after being $.405 per mile through August 31, 2005), and
will then be $.445 per mile for 2006.
- The maximum annual contribution into a 401(k) plan or a
403(b) plan is $15,000 for 2006.
And if you'll be 50 or older by December 31, 2006, you can contribute an extra
$5,000 into your 401(k) or 403(b) account this year.
- The maximum annual contribution to your IRA is $4,000 for 2005
and 2006. And once you turn 50, you can contribute an extra $500 into your
IRA for 2005 and an extra $1,000 for 2006. You have until April 15, 2006 to make your
2005 IRA contributions.
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