There is a common phrase that will soon be uttered by clients in many CPA firms across this country:
“I have never filed an extension...” It’s often too quickly followed by, “…and I will not be filing one this year.”
So many people are afraid to ask for help when they actually need it. This holds true when it comes to taxes. Oftentimes, people will want to rush through their tax return to meet the April 15th deadline and avoid filing an extension. Rushing to finish any project is never advisable, especially when it comes to something as important as taxes. It’s ok to ask for more time, and it may even save you money.
What is an extension?
An extension to file your tax return is just that: a 6 month extension of time to file the tax return.
It is not an extension of time to pay the taxes due.
Most people think if they have to complete the tax return to figure out how much tax they owe and need to pay, that they should just go ahead and finish the return.
While there is validity to that argument, it’s not necessarily true that you will have all the information to complete your tax return by the filing deadline. And that is okay.
If you are an investor in a pass-through entity, you may be waiting on a K-1. If you are a small business owner you may need more time to complete your books and records, especially if the first quarter of the year is a busy time for you.
Rushing around can cause you to forget about deductions you incurred during the year, or exclude a certain income amount. These mistakes could lead to increased taxes, or, worse, an IRS audit.
What is the price for asking for additional time?
If you are able to pay 90% of the tax owed, there may be no penalty at all. If you file an extension with less than 90% of the amount paid in the penalty and interest, it is usually < 1% of the balance due.
Let’s say Uncle Roy owes $10,000 in taxes at extension time and does not remit a payment. The IRS extension period is 6 months. Therefore, the penalty would be $50 - $100 per month for 6 months, with the total landing somewhere between $300 - $600.
So the question becomes: why wait to file your tax return? Besides the reasons listed above, you may be able to write off additional expenses. If you own a business and you meet certain criteria, you may be able to contribute to a Simplified Employee Pension Plan (SEP) or SOLO 401K. Contributions can be made until the tax return filing deadline and count towards the prior year.
Uncle Roy is still trying to figure out his taxes. He runs a very popular shaved ice stand near an old airport in a great American city and his busy season is May - September. He knows he will have an influx of cash during that time and the ability to make the contribution to the SEP. Uncle Roy files an extension for his tax return on April 15, 2017, makes the payment to the SEP in August 2017, takes the deduction on his 2016 tax return, and then files his tax return in August of 2017.
Uncle Roy has just decreased his tax liability by using the extension the way it was intended.
Does filing an extension increase your audit risk?
There is absolutely zero proof that it does. But rushing around and making mistakes can very well lead to increased audit risk. If you need additional time, it’s ok to ask for help and it may save you money.
Bottom line: An extension isn’t scary. It’s a tool for taxpayers. Check it out.
Still want to try to avoid filing an extension?
Well, ok. Then make sure you do these things:
Getting organized and staying organized throughout the year is highly important.
See Your CPA Often
Visiting with your CPA in November/December (or maybe even more often than that) to review your books and records is a good idea.
Review Your Prior-Year Forms
Reviewing the tax forms you received last year and comparing them to the ones you received this year is a good step. Many places no longer mail out tax forms as they are available online.Even the best laid plans go awry. This year, don’t worry about that taboo word, ‘extension.’ Instead, maybe try to add it to your tool belt when filing time rolls around. Getting your taxes done correctly is worth it.