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In other articles, I have shared the media’s interest in spreading April 15th Stress Disorder.  I have also debunked common extension-filing myths.  Now, it’s time to familiarize ourselves with the object of our fear and realize that extensions are nothing to shun.  They are, on the contrary, a powerful tool providing several benefits.  Here are a few attributes that endear the extension to filers and professionals alike:

Elimination of the Late Filing Penalty:  The extension functions to change the due date of the filer’s return.  That’s it.  Instead of having until April 15th, filers gain an additional six months – until October 15th without worrying about facing a significant penalty – the Late Filing Penalty.  The title, Late Filing Penalty, is a misnomer.  Filing Form 1040 late does not automatically generate a fine.  If the return shows a refund, there is generally no penalty.  It only applies when late-filed returns have a tax due.  But, the fine is substantial, it's 5% each month (or part of a month) the return is late.  The cost adds up quickly and maxes out at 25% of the tax due.  For 2020, 2021, and 2022 congress has enacted a minimum penalty for returns filed over 60 days late.  This minimum: The lesser of $435 or 100% of the tax due!  

Additionally, the tax and penalty are both subject to daily-compounding interest.  The general market determines the rate, which changes quarterly, but 3-6% is a fair estimate.  

Filing an extension eliminates this penalty if the return gets filed by the extended due date, October 15th.  Avoiding it is one of the reasons tax offices are overwhelmed from late March to April 15th.   Pros are fielding client inquiries and questions, receiving client materials, and dealing with April 15th Stress Disorder.  But, most importantly, they are making sure everyone files an extension to avoid this penalty. 

More Time to Gather Materials:  Filing an extension reduces the stress of those who understand their benefit.  Extensions provide more time to ensure you've received all of your tax forms and compiled all of your deductions. It is now late March, and many clients are still receiving tax forms needed to complete their returns.  Others are receiving CORRECTED brokerage statements fixing erroneous interest, dividend, and security transactions.  

Business owners, families, everyday investors, and retirees benefit the most.  I cannot tell you how often small business clients rush to meet the April 15th deadline, then realize their records were erroneous.  Retirees regularly forget about an investment or retirement account that didn’t make it to their tax folder.  Busy spouses miscommunicate, forgetting about charitable donations, medical expenses, and childcare costs.  Another common oversight occurs when partnerships (often publicly traded investments) or other businesses have filed extensions.  Investors forget about needing the information and omit the income from their taxes.  

An extension is also essential for anyone who has moved over the previous year.  Forwarding mail takes time (and does not always work).  Sold a home?  How does the previous mortgage holder know where to send your interest statement?  It’s as easy to forget the part-time job held last spring as earnings accumulating in a seldom-used savings account.  Filing an extension helps ensure correct completion.  There are no surprises, no notices from the IRS, and less need to amend a previously filed return. 

Avoiding IRS Notices: The most common audit experienced by modern taxpayers results from computer matching programs, not an IRS employee demanding receipts to justify a deduction.   Providers of income must report this income to the IRS via information returns.  As a required courtesy, you also receive a copy of these forms; 1099-MISC, 1099-INT, 1099-DIV, 1099-B, 1099-NEC, and W2s in January or February. 

Their real job is not to help you prepare your taxes.  You must report this income even if you don't receive the forms.  Their job is to tell the IRS that you received the income.  The IRS loads this information into computers to ensure you have been an honest citizen by matching it to what you reported on your tax return. 

IRS computers expect each income item to appear on a specific line on your tax return.  When an amount is missing or falls short (ironically, overreporting does not matter), they kindly adjust it and send a notice called a CP-2000 (generally 3-6 months after you file).  They also send a bill for any additional tax, which you can pay or dispute. 

Unfortunately, most of these notices are correct –the recipient made an error.  Sometimes the information reported to the IRS is incorrect, or we can offset the income with deductions.  Either way, fixing the mistake requires arguing with a computer or filing an amended return.  

What’s the easiest way to avoid these notices?  Filing an extension ensures you’ve received all information needed to file your return.

Avoid Amending Returns:  As discussed throughout this article, taxation has become exponentially more complex since adopting the April 15th deadline in 1955.  Complexity increases the likelihood of errors, especially when rushing to meet deadlines.  These errors happen for various reasons, and we’ve discussed many.  They all increase the probability of needing to file an amended return (a tedious process that tax professionals generally bill for). 

Increased complexity is not isolated to Form 1040.  Errors on initially mailed information returns (W2s & 1099s) are now commonplace.  The volume of data employers and institutions must provide staggers the mind.  Every year there are new forms, codes, and instructions for employers, banks, colleges, mortgage companies, brokerages, corporations, mutual funds, health insurance companies, third-party payees (eBay, PayPal, and credit cards), and health savings programs (to mention a few).    Most of these entities must send the required information to recipients by January 31st.  Brokerages (Form 1099-B) get an additional two weeks, but many investors do not receive them until mid-to-late March.

What do complexity and rushing foster?  Errors.  Once discovered, the reporting entity will send corrected information, typically in May and June.  What happens if the updated data is material to the recipient’s taxes?  Filers should amend their return.  What’s the easiest way to avoid amending such a return?  File an extension.

The One (slight) Extension Downside:  Filing an extension does have one downside, albeit a small one.  As you have probably heard, filing an extension provides more time to file your return but not additional time to pay your tax.  Although this is not entirely true, there is a penalty for some filers who pay their taxes after April 15th, even if they have filed an extension - the Late Payment Penalty.  The Late Payment Penalty (also called the Failure to Pay Penalty) equals ½ of 1%.  It is 1/10th of the Late Filing Penalty.  It applies each month (or part of a month) tax gets paid after its due date and tops out at 25% of the tax due.  Like the Late Filing Penalty, it is also subject to interest.   

As mentioned earlier, the Late Payment Penalty is tiny when compared to others.  It’s one of the smallest in the IRS catalog.   It equals $5 per thousand dollars owed monthly.  Compare this to the Late Filing Penalty (eliminated by filing an extension), which is $50 per thousand.   

It is important to note that owing tax with an extended return does not mean you owe the Late Payment Penalty.  When tax due is less than 10% of the total tax due on the return, it generally does not apply (assuming you pay the balance by October 15th).  

Also, the Late Payment Penalty can be challenging to distinguish from a similar penalty called the Estimated Tax Penalty.  It’s a little complicated, but if you owed tax the previous year and owe tax on the return again, you may incur the Estimated Tax Penalty regardless of when you file.  
Take Away: The core issue at hand is not the benefits of filing extensions.  Extensions simply address the following reality: The April 15th deadline has been in place since 1955, no longer makes sense, and needs to change.  I’ll let Congress haggle about the exact date, but June 15th has a nice ring.  Until then, I hope this article has helped the reader to understand that filing an extension is the easiest way to cope with this antiquated and arbitrary date.  It is nothing to fear and provides a mountain of benefits with virtually zero downside.

All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.

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