To Extend or Not to Extend, That Is the Question

April 4, 2014

With April 15 not far off, taxpayers whose returns are not well along have a problem:  what to do if they cannot complete their returns by the 15th. This is the time to consider filing an extension.

Why the need to extend tax returns?  There are several reasons, but the most common is that the taxpayer owns interests in one or more partnerships and the reporting documents needed for preparing the return (K-1’s) are filed after April 15.  Partnerships often file these after the filing date for personal returns (April 15) and they are allowed to.  Items from the K-1 (e.g. income or loss, credits, special deductions, etc.) flow directly to the taxpayer’s personal return (Form 1040) via Schedule E, so the K-1’s are a critical part of the taxpayer’s returns

Filing an extension involves two options: file Form 4868 and pay any amount due beyond what was withheld from their wages and what they paid as quarterly estimates or file a return based upon estimates of the amount of the missing items and then amend the returns when the correct information arrives.

Now, there’s another aspect to consider:  penalties.  If you fail to file an extension and file your return after April 15, the IRS will assess a failure to file penalty equal to 5% of the liability for each month or portion thereof that the return is late filed.

There is also a failure to pay penalty to .55 of the tax due for each month or fraction thereof.  The two penalties are capped at 25% of the tax liability, so it pays to extend.

Keep in mind that with two exceptions listed below, an extension is an extension to file, not pay.  You must include an estimated payment when you file for an extension. If you owe more than 10% of the liability the IRS may retroactively disallow your extension, thus increasing the penalties.

Does filing an extension provide any relief?  First, if a taxpayer is out of the country on business, they will be able to extend the time to pay Members of the armed forces stationed overseas also have an extension to pay.  The extension to pay is good through June 15 and taxpayers must attach a statement as to why they are allowed an extension to pay.

If you do fail to file an extension, there are also limited causes that the IRS will accept for failure to file an extension:

1)    Serious illness of the taxpayer or members of their family and the taxpayer had sole authority to file the return.
2)    Serious casualties such as destruction of the business and its records by fire. 
3)    Unavoidable absence by the taxpayer responsible for filing the return.
4)    Reliance by the taxpayer on written or oral IRS advice.

Now, suppose you decide to file an extension and need to know where to start.  Go to your CPA who can file both the Federal and state extensions and advise you on the amount to pay with each extension.  If you are a do-it-yourself taxpayer, go to the IRS website and get Form 4868 and the Instructions.  Be sure and file the extension at the correct IRS and state addresses.  Some states, such as Michigan, accept a Federal extension forms.  Others, such as California require taxpayers to use the state forms.

It’s best practice to file them electronically two-three days before April 15.  However, if you use the mail, be sure to send the extension and check with return receipt requested from the post office.