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How and Why to Carefully Estimate the Tax You Owe

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If your clients got an extension on filing taxes this year, make sure they know the rules in order to avoid late-payment penalties and interest charges. In this article, tax guru Julian Block explains why it's important to make a "good faith" estimate of the tax one owes and ensure the rules are being followed.

Apr 20th 2022
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If you’re just joining us, parts one and two in this series explained why the filing deadline for 1040s for calendar year 2021 was April 18 for most filers. Those who submitted Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, by that date will receive an automatic six-month extension to Oct. 17. Parts one and two also explained late-filing penalties and interest charges.

Good faith. The Internal Revenue Service insists that you make a good faith estimate of the liability shown on Form 4868 based on information available at the time of its submission. This stipulation underscores the need to carefully estimate the tax you owe, especially if you have income from sources that usually aren’t subject to withholding. Some examples are earnings from self-employment, interest, dividends and profits from sales of mutual fund shares, individual shares and other investments. Other possibilities include unemployment compensation, pension payments and, for some, Social Security payments.

If you’re too casual, expect the IRS to respond harshly. The law authorizes the agency to retroactively revoke your extension, notwithstanding original acceptance of your Form 4868; it can then tack on those penalties for late filing and payment discussed in part two. There’s little guidance in the form of IRS regulations or court rulings to spell out what constitutes an acceptable estimate. What’s clear is that you don’t have to “assemble an exact picture of your income” before asking for an extension.

On the plus side, a widely noted Tax Court decision found that a sizable error doesn’t make an estimate improper. Paul E. Harper successfully challenged the revocation of his extension. His Form 4868 stated he owed no further taxes and was unaccompanied by any payment, although it turned that he still owed more than $90,000.

For the extension’s preparation, Harper had relied on an accountant who had underestimated the tax due because full business records were as yet unavailable. That, noted a federal district court in Oklahoma, was precisely why Harper had requested the extension. The court ruled it had been filed in good faith and was valid.

On the other hand, the IRS persuaded a court to not overturn the revocation of an extension obtained by Otis Crocker, a Mississippi attorney. To challenge a revocation, warns the court, there must be evidence to show that you searched your records, attempted to find missing documents and gathered the data needed to make a good-faith estimate. It found that the attorney had failed to make a credible estimate of how much tax he actually owed.

Retirement accounts. Clients often misunderstand that an extension of time to file a return doesn’t extend the April deadline to open and fund an IRA, whether the payment is deductible (traditional IRA) or nondeductible (Roth IRA). However, a filing extension can give you additional time to decide whether make a payment to a retirement plan for a self-employed person.

State tax returns. Finally, remember that requirements for state tax returns vary. Some states accept Form 4868 for extending a states return’s due date; others require a separate application. Be proactive; check the rules of the state in which you’re required to file returns, including penalties for any underpayments of state taxes.

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Theo L. Morson, JD, LLM
By tmorson3
May 9th 2022 22:44 EDT

It's not always easy to estimate what the tax obligation will be especially when records are missing.
T.L. Morson and Associates
www.tlmorson.com

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