Can a Taxpayer Apply an Extension Payment in 2021 That Results in an Overpayment to the First Quarter Estimated Tax Payment for 2021?
Let’s start this article by noting that this is an issue that likely costs more in wasted time to research and resolve than the dollars that might be saved by finding the tax payment can be pushed back a month. But many advisers are stressing quite a bit over trying to answer this question: “If a taxpayer pays money with an extension filed on May 17, ends up with an overpayment when the return is finally filed and applies the amount to the 2021 return, will that overpayment be treated as paid as part of the first estimate due on April 15?”
Some advisers have gotten used to “beefing up” the payment with extensions, expecting the taxpayer to be overpaid when the return is completed. That expected overpayment is meant to cover the first estimated tax payment due for the following year. Two reasons are offered for going this route:
It eliminates the need to prepare both an extension and an estimated tax voucher at the original due date, as well as allowing the taxpayer to make a single payment and
It provides some protection to the client from a failure to pay penalty and interest on the return being extended if it turns out there’s more income than expected (albeit at the potential cost of now incurring some underpayment of estimated tax penalty on the following year’s return).
Recently Michael Busa, CPA posting to a discussion on NJCPA’s Connect site stated he had read an article that pointed to Rev. Rul. 99-40 to indicate that this strategy won’t work. In particular, the ruling contains language that states:
[I]f an overpayment of income tax for a taxable year occurs on or before the due date of the first installment of estimated tax for the succeeding taxable year, the overpayment is available for credit against any installment of estimated tax for such succeeding taxable year and will be credited in accordance with the taxpayer’s election. If the overpayment occurs after the due date of the first installment of estimated tax for the succeeding taxable year, it may be credited only against an installment of estimated tax due on or after the date the overpayment was made. Under these circumstances, section 6655(b)(3) provides that a payment of estimated tax by a corporation is credited against unpaid required installments in the order in which the installments are required to be paid. Section 6654(b)(3) provides the same rule for individuals.[1]
That paragraph was part of the supporting analysis for that particular Revenue Ruling, so technically it isn’t formally holding this out—just saying the IRS already told us this.
The document that provides support for that conclusion is Rev. Rul. 77-475 which was revoked then reinstated by the IRS in the mid-1980s. The relevant part of Rev. Rul. 77-475 provides:
If an overpayment of income tax for a taxable year occurs on or before the due date of the first installment of estimated tax for the succeeding taxable year, the overpayment is available for credit against any installment of estimated tax for such succeeding taxable year and will be credited in accordance with the taxpayer’s election.
If the overpayment occurs after the due date of the first installment of estimated tax for the succeeding taxable year, it may be credited only against an installment of estimated taxes due on or after the date the overpayment was made.[2]
The ruling was dealing with a situation that doesn’t exist any longer—the ability for a corporation to pay the tax it expects be due on extension in two installments. Specifically, these were the facts in question:
On March 15, 1977, X, a calendar year corporation, filed a Form 7004, Application for Automatic Extension of Time to File Corporation Income Tax Return, showing a tentative 1976 income tax liability of 6x dollars and elected to pay the tax in installments by depositing 3x dollars as the first installment. On June 15, 1977, X deposited 3x dollars as the second and final installment payment of the tentative 1976 income tax liability. X then requested and was granted an additional three month extension of time to file. On September 15, 1977, X filed a Form 1120, U.S. Corporation Income Tax Return, for 1976 on which it reported an income tax liability of 4x dollars. X elected to apply the 2x dollar overpayment shown on the return as a credit against its 1977 estimated income tax.[3]
The ruling holds that the overpayment of 2x dollars could not be applied to the first estimate in this case. Note that since the second installment payment was 3x dollars, the entire overpayment related to funds paid after the due date of the first quarter estimated tax payment. But also note that the original due date of the corporate return was on the date the first estimate was due.
Note that the ruling that reinstated Rev. Rul. 77-475 also modified it (Rev. Rul. 84-58). That later ruling technically controls the situation and it states:
For returns filed after December 31, 1983, the Service will apply overpayments arising on or before the due date of a return against the first installment payment of the next year’s estimated tax, unless the taxpayer notifies the Service that the overpayment should be applied against another installment.[4]
But this year we have a bit of a quirk—the actual due date of the Form 1040 for 2020 now occurs one month after the due date for the first 2021 estimated tax payment. So what if the taxpayer, between timely 2020 estimated tax payments and tax withholding, had enough paid in at April 15 to have paid off the entire 2020 tax liability and enough left over to cover what would otherwise be an underpayment on the first quarter 2021 estimate?
Unfortunately, it appears the IRS can argue the overpayment in this case occurs at May 17, 2021 (the due date for the 2020 return under Notice 2021-21) even though the government had the funds on hand at all times and the taxpayer could have filed early in tax season, received the cash refund, and then paid the first estimate at April 15, 2021—a situation that puts the government in a worse cash flow position than if that taxpayer had applied the overpayment. But it appears the fact the taxpayer could have filed back in February and gotten the cash isn’t relevant.
It’s also not clear what happens if the taxpayer had sent in the return electronically prior to April 15, applying the overpayment to the following year. Normally a return filed prior to April 15 is treated as having been filed on April 15, and the overpayment would have come into existence on that date. But with the pushing back of the due date to May 15, which may have occurred after the taxpayer filed their return, it seems possible the IRS could argue that the overpayment is no longer available to offset against the first quarter estimate.
In this case, though, I think the taxpayer has a reasonable argument that he/she did not take advantage of the postponement of the due date granted by the IRS under the authority of IRC §7508A in any form, and thus should not be required to apply Notice 2021-21 to the overpayment in question. At least I believe enough support exists to allow the taxpayer to take this position on the 2021 return when computing an underpayment of estimated tax for the first quarter of 2021. Whether that support is sufficient to avoid requiring disclosure is something the adviser preparing the 2021 return will need to decide, though arguably there seems little harm in making the disclosure.
Now, since many of you won’t like the answers implied in this article, you can have fun building the counter-arguments. Of course, if you actually take the position you can apply a May 17 payment on a Form 4868 eventually for the first quarter estimate and the IRS challenges the position, you should remind the client about the cost of fighting the IRS to get rid of the $40 of underpayment penalty the agency will be after. Sure, the amount can be more, but until the taxpayer’s payment gets to multiple six figures range I don’t see how the math works out that the cost of fighting would possibly be less than the penalty being asserted by the government.
We could get lucky—the IRS might announce that overpayments resulting from payments made with extensions filed on May 17, 2021 will count against first quarter estimates, though given the IRS’s reason for not extending the estimate date I wouldn’t count on it. As well, and maybe more likely, the IRS might just not challenge the issue when 2021 returns are filed. But right now it appears far from sure that taxpayers who rely on such overpayments will not end up with notices asking for underpayment penalties on 2021 returns.