First, I want to tackle a very popular myth in the world of tax preparation and tax filings, which is, that a tax extension increases your risk of being audited by the IRS. This is a MYTH.
Many taxpayers are misled to believe that there is a direct relationship between tax extensions and tax audits, or that a tax extension raises a red flag to the IRS. This is incorrect. In fact, there is plenty of evidence that getting a tax extension can actually reduce your chances of facing an IRS audit.
While no one outside the IRS can say for sure how the audit selection process works, it is safe to say that a tax extension does not do anything to trigger an audit. Most tax professionals agree that there is a threshold/quota for auditing, but it tends to be filled by the time April tax season ends! So, why file inside that window?
The IRS makes it easy to request an extension because they do not mind if you get one. With millions of people filing tax extensions each year, there is no reason why you should not get an extension for yourself.
A lot of taxpayers want to know if the IRS frowns when people file tax extensions. That is a myth. The IRS is very busy during tax season, so anything that lightens their load is fine with them. With a tax extension, you’re communicating to the IRS that you plan on filing after the April 15 deadline. As long as your tax balance is paid by the original due date, the IRS will leave you alone.
Benefits of Filing an Extension
- 6 extra months to finish up your tax return.Having extra time to finish your return is often necessary, especially if you are still waiting for tax documents to arrive in the mail or you need additional time to organize your tax deductions. Extensions also provide extra time to file your gift tax return if that is something you need to do. And let’s be honest, if you are rushing through it, that’s not smart.
- Helps reduce late penalties.There’s two basic penalties the IRS typically imposes: a late filing penalty of 5% per month on any tax due plus a late payment penalty of half a percent per month. If you file an extension and then file by the extended deadline of October 15th, you’ll avoid the 5% per month late filing penalty. If you file after October 15th, the late filing penalty will begin from October 15th, which creates a free deferral on this penalty.
- Can preserve your tax refunds if you file after the extended deadline.Some people end up filing several years late, and there’s a three-year deadline for receiving a refund check from the IRS. This also comes to fruition a lot when it comes to certificated tax credits, which are credits that can be purchased and used retroactively. I often have credits for clients, and we find that they cannot use them and get the benefits because they filed their returns too early in the year. That’s hard news to deliver, because there is usually no logical reason that they filed before October 15th.
- Provides extra time for self-employed persons to fund a retirement plan.Self-employed persons may want to fund a SEP-IRA, solo 401(k) or SIMPLE-IRA plan for Filing an extension provides these taxpayers with an extra six months to fund their retirement plan. Note: solo 401(k) and SIMPLE plans need to be set up during the tax year, but actually funding the plan can occur as late as the extended deadline for the previous tax year. With a SEP-IRA, however, entrepreneurs can open and fund a SEP-IRA for the previous year by the extended deadline as long as they filed an extension.
- Additional time to recharacterize an IRA contribution.As long as your IRA is funded by the April deadline, you can change the nature of the IRA by the October extended deadline. Essentially, you can turn your traditional IRA contribution into a Roth IRA, or a Roth IRA contribution into a traditional IRA contribution. This is helpful if you’re not sure if you are eligible for one type of IRA. You can even use this provision to recharacterize a Roth conversion back to a traditional IRA.
- Provides additional time to make various elections on your tax return.There are a wide variety of decisions that can be made on the tax return, such as deciding whether to depreciate equipment or take a Section 179 deduction, and whether to carryback or forward any business losses. Those decisions must be made when the tax return is filed. Filing an extension gives you extra time to make those decisions. By October 15th, often times you have a pretty good idea of what your tax picture will look like for the current year, which helps in tax planning immensely.
- Filing an extension can improve the accuracy of your return.Let’s be honest – there’s an inevitable rush to get tax returns finished by the deadline, and taxpayers and accountants alike can make mistakes when rushing. With an extension, this gives you and your accountant extra time to go over the return and make sure everything is complete before sending in the return.
- Extensions can help reduce your tax preparation fees.Many accountants raise their fees in the weeks leading up to the deadline, only to drop their fees during the slow spring and summer months. Price-sensitive taxpayers may be able to save money by shifting their tax preparation to a time when their accountant is charging a lower fee.
Let’s be fair: Are there any downsides to filing an extension?
- Extra time to file doesn’t mean extra time to pay.An extension will give you extra time to file your return, but any tax is still due by the original deadline. An extension can help reduce penalties, but any outstanding balance will still be charged a late payment penalty (0.5% per month) and interest (right now at 3% annually).
- Some people aren’t eligible for extensions.Taxpayers who were approved for an offer in compromise must file by the April deadline during their five-year probationary period. If you don’t file by the April deadline, the IRS can revoke your offer-in-compromise and re-instate the original amount you owed.
- If you file an extension, be sure to file a return, even if you don’t think you need to.Now, this is rare, but I still want you to know about it. If you file an extension, the IRS might think you need to file a tax return. If you end up not filing a tax return (perhaps because you don’t meet the filing requirements), the IRS might get confused and ask you to file a return anyway, on the presupposition that you filed an extension to ask for additional time to file. This can be a frustrating and time wasting exercise.
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