The Value of Extending a Tax Return
Imagine a scenario where the lottery jackpot is over 1 billion dollars and your goal is to win. Lucky for you, you can borrow the DeLorean for the weekend and travel into the future to get the winning numbers and win the big prize. Too bad Uncle Sam does not hand out DeLoreans. The good news is Uncle Sam does allow for 6 months of time travel each year. The IRS allows each business and individual to file for an extension on their income tax returns. These extensions have a lot of great benefits in addition to having more time to file. Buckle up in your DeLorean as we drive into income tax return time travel.
What is a tax return extension? Individuals and businesses can file for an automatic extension of time to file their federal income tax returns. In most cases an extension provides an additional six months to file. This allows you extra time to file without risk of late filing penalties. State taxing authorities also allow for extensions; however, the amount of additional time may not be the same as federal forms.
It is important to understand that paying tax due and filing tax returns are two separate issues. The extension only provides additional time to file. Any tax owing must be paid by the original due date or else you will owe late payment penalties and interest. However, the true benefit of an extension is more than just having more time to file.
In the public accounting profession, we hear many clients say they don’t want to file for an extension. They generally have practical reasons for not wanting to file an extension including: checking items off the to-do list, bank loan compliance, or simply wanting to receive their tax refund. We also hear some reasons that are not valid concerns like fear of IRS audit or incurring additional penalties for doing an extension. To calm those fears, there is no correlation between filing an extension and IRS audit rates—as long as the taxpayer has paid their taxes at the time of the extension. We understand that it feels good to get that refund in hand or check something off the list, but is filing without an extension the best tax strategy?
The three most common benefits from filing an extension are understanding future tax law developments, changes in the economic performance of your business, and reduction of errors. When business income tax returns are prepared, we generally have several elections and tax credits to consider and evaluate. The elections can be as simple as choosing how much depreciation to take or as complicated as changing when revenue or expenses are recognized. In July, we may have a better understanding what the future holds as compared to March. Empowered with this extra information, tax professionals can evaluate the long-term impacts of these elections and find opportunities to lower overall tax. The nation’s current tax structure forces most filers to file in the first portion of the year. This may not sound bad. However, many errors can be generated due to trying to meet tight deadlines and overworked tax professionals. Extensions also allow tax professionals to spread their work out and spend more time focusing on each individual return and the big picture tax plan.
Another benefit of an extension is that it also extends the three-year window in which amended returns can be filed.
Traditionally, if you were to amend your personal tax return and claim a refund, you have three years to complete the refund request. If you filed your tax return on or before the original due date without extension, you would have 3 years from the original due date to amend a tax return and receive a refund. However, if an extension was filed you could receive up to an additional 6 months of time to claim a refund. I know these rules might sound silly, but it is commonly very important when a tax position needs to be amended or a new law is passed that creates a benefit when money is on the line.
How do you start the extension process? Some taxpayers think the best way to file an extension is to call up there CPA around April 15th and request an extension be filed. However, If you do this, you are losing out on a lot of opportunity. The best time to start the extension process is in November of the tax year. In November, you and your tax advisor can review the books, pay stubs, and other tax information to create a plan for year end. By Christmas, the two of you should have everything buttoned up and know roughly how much tax will be owed on April 15th. In March, your tax advisor can validate the outcome and you can make the tax payment on or before the due date. The tax returns can be prepared in the summer months and then your tax advisor will communicate if the income was well estimated. Your tax advisor will also help you calculate any income tax estimates that might be due before the tax return is finalized.
If you are interested in checking something off your to-do list four months early and potentially reducing your taxes at the same time, a tax return extension might be the right answer for you. If you want to implement this strategy for the upcoming filing season, give your KTLLP tax advisor a call today to get on their schedule.