As the tax deadline approaches, many taxpayers may find themselves not quite ready to file their personal income taxes. Whether due to missing documents, complex tax situations, or simply needing more time to gather information, filing for an extension can seem like a lifeline. But is it the right choice for everyone? Let’s explore the advantages and disadvantages of filing for a tax extension.
Pros of Filing a Tax Extension
- More Time to File: The most apparent benefit is the additional time to file your taxes. An extension provides an extra six months, moving the deadline from April 15 to October 15. This extension can be invaluable for gathering missing information or consulting with a tax professional to ensure your return is accurate.
- Reduced Stress: Rushing to meet the tax filing deadline can lead to errors, which might result in an audit or penalties. By granting yourself more time, you can approach your taxes with a clearer head and reduce the risk of mistakes.
- Potential for Higher Accuracy and Better Deductions: With the extra time, you’re more likely to accurately report all income, deductions, and credits. This thoroughness can potentially lower your tax bill or increase your refund.
- Avoid Late Filing Penalties: If you’re confident you’re not going to make the filing deadline of April 15, filing an extension can help avoid the late filing penalty if you file within the extended deadline. It’s important to note, however, while an extension gives you more time to file, it does not extend the time to pay any taxes owed. This is covered in greater detail in the cons section. If you do not file your taxes on time and do not file for extension, the IRS penalty is as follows:
- Penalty Rate: The penalty for filing late is generally 5% of the unpaid taxes for each month or part of a month that a tax return is late. This penalty starts accruing the day after the tax filing due date.
- Maximum Penalty: The penalty can go up to a maximum of 25% of your unpaid taxes.
- Minimum Penalty: If your return is more than 60 days late, the minimum penalty is either $450 (as of the tax year 2023, and subject to change) or 100% of the unpaid tax, whichever is less.
- Additional Interest: In addition to penalties, interest is charged on unpaid taxes starting from the due date of the return until the date the tax is paid. The interest rate is determined quarterly and is based on the federal short-term rate plus 3%.
Cons of of Filing for a Tax Extension
- Delayed Refunds: If you’re expecting a refund, filing for an extension means you’ll have to wait longer to receive it. For many, this delay can impact financial planning and personal cash flow.
- Interest and Penalties on Owed Taxes: An extension to file is not an extension to pay. If you owe taxes, interest and penalties will accrue from the original April deadline, regardless of the extended filing date. This situation can lead to a larger tax bill than anticipated. See an example below on how this could impact your finances.
- Complex Planning for Next Year’s Taxes: If you’re in a habit of extending your tax filing every year, it can complicate financial planning and budgeting for the following year, especially if you consistently owe money.
- Not Having a Completed Tax Return Until October: If you’re planning to make any major purchases this year, for example, buying a new home, you may need a completed tax return to qualify for a mortgage. Applying for certain government benefits also require recent tax returns. If this is in your future, it’d ultimately be easier and less stressful to file your taxes by the original deadline.
How the IRS Charges Interest on Missed Tax Payments
Let’s re-visit Con #2, as many people are unaware the IRS charges interest, considering your late payment a type of loan. Here’s a simplistic example to show how it works.
Suppose you owe $5,000 in taxes for the year but decide to file for an extension, granting you until October 15 to file your tax return. It’s important to remember that while the extension gives you more time to file, it does not extend the time you have to pay any taxes owed. The IRS charges both interest and a late payment penalty on taxes not paid by the original due date (April 15).
Interest:
- Interest Rate: The IRS sets the interest rate quarterly. For simplicity, let’s assume it’s 5% per year (or about 0.42% per month).
- Accrual Period: Interest accrues from April 16 until you pay your taxes. If you pay on October 15, that’s six months of interest.
Calculating the interest:
- Monthly Interest: 0.42% of $5,000 = $21
- Total Interest for 6 Months: $21 x 6 = $126
Late Payment Penalty:
- Penalty Rate: The penalty is usually 0.5% of your unpaid taxes for each month or part of a month that your taxes are late, up to a maximum of 25%.
- Accrual Period: This penalty starts accruing the day after taxes are due (April 16) until you pay.
Calculating the penalty for 6 months:
- Monthly Penalty: 0.5% of $5,000 = $25
- Total Penalty for 6 Months: $25 x 6 = $150
Total Additional Costs:
- Interest: $126
- Late Payment Penalty: $150
- Total: $276
So, in this example, by paying your $5,000 tax bill on October 15 instead of April 15, you would incur an additional cost of $276 due to interest and late payment penalties. This example highlights the importance of paying your tax bill by the original due date, even if you’ve filed for an extension to submit your paperwork. To avoid unnecessary interest and penalties, it’s crucial to estimate and pay any owed taxes by the original due date.
Frequently Asked Questions (FAQs)
1. How do I file for a tax extension?
To file for an extension, you need to submit Form 4868 to the IRS by the original filing deadline (April 15). You can do this electronically through tax software, with the help of an Orange County tax professional, or by mailing a paper form.
If you’re working with Evolution Tax & Legal, an Orange County-based CPA and legal firm, we will file the tax extensions on your behalf.
2. Does filing for an extension increase my chances of being audited?
No, generally speaking, filing for an extension does not increase your chances of being audited. The decision to audit a tax return is based on various factors, including the complexity of the return and any discrepancies noted by the IRS. Filing for an extension is purely administrative and does not trigger an audit.
3. Can I file for an extension if I’m living abroad?
Yes, U.S. citizens and residents living outside the country on the tax deadline are automatically granted a 2-month extension to file their return and pay any amount due without requesting an extension. However, interest still accrues on any unpaid tax from the original April 15 deadline. If more time is needed, you can still file Form 4868 for an additional 4 months, extending your deadline to October 15.
4. What if I can’t pay the taxes I owe by the extension deadline?
If you can’t pay the full amount owed by the extended deadline, it’s important to pay as much as you can to minimize interest and penalties. You should also consider contacting the IRS to discuss payment options, such as installment agreements, which allow you to pay your tax debt over time.
5. How do I know if my tax extension has been approved?
If you file Form 4868 electronically, you’ll typically receive an electronic acknowledgment. If you mail the form, you won’t receive a notification from the IRS unless your request is denied. It’s important to ensure that your form is filled out correctly and submitted on time to avoid any issues.
6. Can I still contribute to my IRA after filing for an extension?
Yes, filing for an extension also extends the deadline to make contributions to your Individual Retirement Account (IRA) for the previous tax year. You have until the extended filing deadline (October 15) to make these contributions. However, late contributions may be flagged by the IRS, potentially increasing your chances of being audited. Consult a tax attorney for more information.
Conclusion
Deciding whether to file for a tax extension depends on your specific situation. If you find yourself unprepared as the deadline approaches, an extension can provide the necessary relief and time to accurately complete your taxes. However, it’s important to weigh this decision carefully, considering the potential for delayed refunds and the accumulation of interest and penalties on owed taxes. Regardless of your choice, proactive planning and consultation with a tax professional can help navigate the complexities of tax season with confidence.
This overview should help you assess whether filing for a tax extension is the right move for you this tax season. Always consider your personal or financial situation and, when in doubt, consult with a tax advisor to make the most informed decision.