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File an Extension to Lower or Hedge Your Tax Bill

Think filing an extension is only if you haven’t finished your taxes? Think again! An extension is actually a powerful tool to lower your tax bill, or place a hedge against your taxable income next year.

Tax Extension

Taxes are due on April 15, but an extension will get you an extra six months to file. You still need to pay the taxes due on April 15, but your filing can wait. Once you’ve filed an extension, the filing is due October 15, 2009.

How to File an Extension

I used TaxCut [1] to prepare my taxes, but the cost to e-file an extension was $19.95. No thanks. Luckily, there are plenty of other options to e-file an extension for free:

I used the free fillable forms. Just create an account and select “file an extension.” It took about 5 minutes. It was very easy to copy my information from TaxCut to the fillable forms. There was a spot to put in the automatic deduction from my checking account for our taxes due.

If you want to print and mail the form, you can use IRS Form 4868: Application for Automatic Extension of Time to File [5].

Lower Your Tax Bill

For the self employed out there, we know that solo 401k [6] contributions reduce your taxable income. However, if you found yourself stuck with a big tax bill and wanted to put more money in your solo 401k, but don’t have access to the money yet, the extension will be a great help.

The great part about a tax filing extension is that it also extends the date that contributions are due for a solo 401k [6]. This is different than the rules for IRAs [7]. It also allows you a unique strategy to lower your tax bill with a very late contribution to your retirement plan.

Just think, you can put the following possible sources of income to use for your 2008 tax year, even if you receive them after April 15:

How to Hedge Your Tax Bill

In addition to being able to make a contribution later in the year, chances are by October 15, you’ll also have a better idea about how much income you’ll bring in for the year.

Our self employment income is extremely variable, so we never know where we’ll end up at the beginning of the year. However, by October, we have a pretty good idea. Many of you with small businesses fall into the same trap.

The great part about the tax extension, is that you can wait and see if your taxable income will be lower or higher next year, and make the contribution earmarked for the solo 401k in the year you need it most.

Even if you end up in the same tax bracket [10] both years, you may find yourself able to reclaim more of the phase-outs of some common traps, like the student loan deduction or child tax credit.

Action Plan

I actually have a new set of vacation pay that I won’t get until September when my employer will settle up from when I left my job last year. I’ve earmarked it to put into my solo 401k to lower our taxes.

I want to wait and see which year, 2008 or 2009, that the deduction would benefit most. With the tax extension, I’ll have the option to apply it to either year.