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Thursday, April 09, 1998
Tax Q&A Extensions Anyone? Well, it's pretty close to April 15th. I'll just bet that some of you have not yet completed your tax returns and are thinking to yourself, "I'll just file an extension." Maybe you have completed your tax return, but find that you have a balance due and don't have the funds available to pay; so you say: "No problem. I'll just file an extension." My advice to you -- DON'T DO IT! Extensions are valid for the filing of the tax forms only. An extension does not extend the time for making your tax payment! If you find that you have a balance due and simply try to file an extension without the required payment, you could find yourself in the middle of a nightmare. If you DO find that you have a balance due and you don't currently have the funds available to make the payment, check out my previous article -- "I Can't Pay…Now What?" -- in the archives for suggestions as to what to do. But one of the things that you certainly don't want to do is file a bogus extension. Automatic Extensions Form 4868, "Application for Automatic Extension of Time to File U.S. Individual Income Tax Return," is the form that you need to use. You can obtain an automatic 4-month extension to file your tax return by completing and filing Form 4868 by April 15. But in order for Form 4868 to be valid, you MUST make a reasonable effort to determine your tax liability and pay any anticipated tax balance due with the Form 4868. "So what's the big deal?" you say. I'll tell you what the big deal is... If you file Form 4868 and the IRS determines that you did not make a reasonable effort to determine your tax liability, the IRS can deny the extension retroactive to April 15th (IRS Notice 93-22). If you file Form 4868 and make NO payment with the extension, and then determine that you do have a balance due with your tax return, the IRS can deny your extension and assess a late tax return filing penalty against you -- that's 5% per month (or a portion of the month) on the tax owed, not to exceed a maximum of 25%. The IRS can also hit you with a failure to pay penalty of 0.5% per month, not to mention interest. Ouch! For example, let's assume you owe $1,500 in tax. You finally file your return on June 5th. Your extension is retroactively denied. Your late filing penalty will amount to $225, and your failure to pay penalty would amount to $22.50. Add interest to these amounts, and you'll find that you are paying an effective annualized interest rate of over 1,000%! You're sure not going to make that kind of money in the bank. Moral of the story: File your tax return on a timely basis -- even if you can't pay the balance due in full. At least you'll avoid the late filing penalty. Another thing to be aware of is that a number of elections on your tax return are required to be made by "the due date of the return, including extensions." What does that mean? Let's look at an example (and this is a real live example... a client that I represented before the IRS had this very problem). For those who qualify, a contribution to a simplified employee pension plan (or SEP) can be made on the due date of the return, including extensions. Say you chose to ignore the April 15th filing date and simply file Form 4868 showing no balance due and make no payment with the extension. You finally complete your tax return in late July and find, much to your horror, that you owe the IRS $7,500, and you also need to make your SEP contribution in the amount of $3,250. So you make your SEP contribution and file your tax return, making full payment with the return. A short time later you receive a notice from the IRS advising you that they have denied your extension retroactively to April 15th. They also advise you that if you didn't make your SEP contribution on or before April 15th, your SEP contribution will be denied. Huh? Why? NO WAY! Oh, yes way. Since your extension was denied retroactively, your due date to make your SEP contribution reverted back to April 15th. The SEP contribution deduction that you took on your tax return could be removed by the IRS, and they may also try to assess taxes on your SEP "excess contribution." And there are a number of other tax elections that must be made on a return filed in a timely fashion that you may place in jeopardy by having your extension denied. So, make every effort to file your return on a timely basis, or at least make a valid effort to compute your balance due and pay that balance due with the filing of the Form 4868. If you overpay with your Form 4868, you can get a refund or apply the overpayment to your next year's taxes, but if you underpay, you could buy yourself some big problems. Additional Extension If you find, even after the additional 4-month grace period, that you still can't complete your return, file IRS Form 2688, "Application for Additional Extension of Time To File US Individual Income Tax Return," by August 15th. That will buy you an additional 2 months (until October 15th) in order to file your return. But this extension is not automatic, and you'll be required to provide a "reasonable cause" statement with the application. The IRS will then review your statement and determine if your cause is actually reasonable. They will notify you if your additional extension is approved or denied. Make sure that your statement shows a reasonable cause (generally, something beyond your control). Don't try the old "my dog ate my W-2 form" excuse. The additional extension is not there simply for your convenience. Foreign Extensions Finally, if you are residing out of the country on the due date of the tax return, the rules are a bit different. If you read this post from foreign soil and need some additional information on filing an extension while out of the country, leave me a post in the Tax Strategies message folder and I'll be glad to explain the rules to you. ============== Message Board Q&A Some questions and answers from the Tax Strategies message folder 1. RayNix wonders… Q: In general, does anyone know if there is any impact of filing an extension and the subsequent chances of being audited. A: The popular belief is that an extension will allow you less chance for audit. But all I can tell you is that in over 20 years of tax preparation experience, I haven't noticed any significant difference between timely filing and extended filing and audit issues. But I have a number of clients that believe that this is true, and file extensions each and every year in order to minimize their audit chances. At least in their own minds. So I'm not sure that there is a correct answer. I suppose that it couldn't hurt. But will it help? I'm not so sure. 2. JCR1230 asks… Q: Do I have to fill out the Capital Gains Form even tho I am not selling my funds. Can't I just list my earnings on my 1040 form as I did last year? A: If you have no sales of capital assets, you are not required to file Schedule D for stock sales. BUT... you may have received a long-term capital gain distribution from one (or many) of your mutual funds. In that case a Schedule D would be required to reduce your tax liability. 3. Finally, ForestTrak asks... Q: My wife is pregnant, and the baby was conceived in October 1997. Can we claim the baby as a dependent? A: Sorry, no. You don't get the dependency exemption until the year that Junior decides to join the rest of us here on the "outside." Please note that Roy cannot answer individual questions in e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!
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