October 15 is right around the corner, so now is the time to finalize that tax return you pushed off in April by filing an extension.
Here are three things you need to know as you wrap up your 2024 taxes and start thinking about tax year 2025.
1. Common misconceptions about penalties and interest
Contrary to popular belief, filing an extension in April does not allow you to delay paying any tax you owe for last year. You were still supposed to pay the entire amount you owed (or thought you owed) by April 15.
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Filing the extension just saves you from the late filing penalty (5% of the tax owed for each month you are late, up to 25%). If you still owe taxes that you did not pay before April 15, you will have late payment penalties of 0.5% of the tax owed each month you delay, plus additional daily interest.
On the flip side, if you did pay any balance owed before April 15, and/or you expect to get a refund when you file the return, you would not have any penalties regardless of whether you file the extension and the return on time or not.
This is because the tax penalties are percentages of taxes owed, and if taxes owed are $0, you cannot have a penalty.
Bottom line: Filing that extension back in April didn't allow you to delay paying taxes, but it hopefully has given you time to finish preparing the return and perhaps identify some additional deductions that you didn't have all documented properly before April.
2. Is it too late to take advantage of additional deductions?
While most opportunities for deductions ended on December 31 for tax year 2024, there are a few things you can do even now to lower your tax burden.
For example, if you filed an extension, you are permitted to make SEP IRA or solo 401(k) contributions (not regular IRA contributions) before October 15 and have them count for 2024.
If you file as an S corporation, the extension deadline passed on September 15, so you would not be able to contribute to the SEP for 2024 at this point.
Whether it is a good idea to contribute to the SEP is a more complicated question. Even though you might save money this year (or for the 2024 tax year) by contributing to a SEP or a solo 401(k), those contribution dollars (and future growth) will still be taxed at some point.
Many taxpayers find that they are not in a lower tax bracket in retirement as they might have expected, especially if they saved substantial amounts in tax-deferred buckets during their working years.
It is often better to pay tax on the seed and not the harvest. For example, utilize Roth IRAs or life insurance-based strategies. You can contribute to a solo 401(k) as a Roth contribution (after-tax) as long as you do it before October 15.
In theory, SEP IRAs are now allowed to accept Roth contributions as well, due to provisions in the SECURE 2.0 Act, but very few, if any, custodians have the back-end systems set up to allow Roth contributions.
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You can also do a "backdoor Roth" by contributing to a SEP and then converting that SEP to a Roth account the following year.
In short, don't be afraid to pay a little more tax now if it can save you a lot more tax in the future. Utilizing Roth, life insurance and other tax-free strategies can be very advantageous for the long term, even though you still have the short-term pain of the tax bite today.
3. Planning ahead for filing your 2025 taxes
Once you've finished and filed your 2024 tax return, there are some important decisions to make for the 2025 tax year, including windows of opportunity that close on December 31.
Here are a few:
Roth conversions. Unlike some types of Roth or traditional IRA contributions, you cannot backdate a Roth conversion, so any conversions need to be done in calendar year 2025.
The good news is, because of the One Big Beautiful Bill (OBBB) that became law in July, most taxpayers have quite a bit more room to do Roth conversions without going into a higher bracket, due to increased deductions and other factors.
Capital gains. With the market continuing to hit all-time highs, many taxpayers are considering cashing in on the big gains from this year. Because of the new tax law changes, there is more room than ever in the 0% capital gains bracket.
But be careful that the capital gains do not cause a cascading effect on other taxable income. Sometimes it is better to reposition qualified money (IRA/401(k) accounts) because there are no immediate tax consequences to buying and selling within those accounts.
Banks/Treasuries/money market accounts. With interest rates having been so high the last couple of years, many people have large cash holdings in CDs or money market accounts, which are generating taxable interest.
As interest rates decline, it may be possible to defer the interest with a fixed annuity. You can potentially lock in a higher rate for a much longer time than a CD, but you don't pay any tax until you withdraw the funds someday (after age 59½).
So, if you don't need to access the funds any time soon, but you want to keep it safe from market losses and taxes, this could be an ideal strategy. It would also give you more room for Roth conversions.
As you finalize your 2024 tax return and look ahead to tax year 2025, remember that smart tax planning is an ongoing process.
By understanding common misconceptions about penalties, exploring available deductions and strategically planning for Roth conversions, capital gains and cash holdings, you can optimize your financial future.
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