Can't beat the buzzer for your tax return? An extension can give you overtime, but you need to ... [+]
Tax Day 2021 is May 17 (Monday). If you haven’t yet filed your federal tax return, you need to decide whether to go for it now or wait. If you can’t beat the buzzer by May 17, you can let the clock run out and go into overtime via an extension of your filing due date, without any questions asked. However, you must understand the rules to avoid getting hit with IRS penalties, particularly if you don’t have the money to pay taxes owed with your 2020 Form 1040 tax return.
Many situations can lead you to file an extension. For example, stock compensation income—e.g. from an NQSO exercise, an ISO or ESPP early sale, or the vesting of restricted stock units (RSUs)—can raise your income tax and make your return complex.
You may just need a little extra time, especially with everything else going in the world right now. Before you file for an extension, below are 8 crucial things to know. One new issue related to extensions for 2020 tax returns concerns estimated taxes for 2021, as explained below in #8.
1. Extension Does Not Need IRS Approval
To gain an automatic extension for the due date of your tax return (to October 15), you can use IRS Form 4868, Application For Automatic Extension Of Time To File. Alternatively, you can file for an extension through the IRS Free File system.
The IRS automatically processes a tax-return filing extension if you pay all or part of your taxes electronically by the deadline. You don’t need to file a paper or electronic Form 4868 when making a payment with IRS Direct Pay, the Electronic Federal Tax Payment System, or with a debit or credit card. Simply select “extension” as the reason for the payment.
2. Extension Does Not Delay Taxes Owed Or IRA Deadline
The extension to October 15 applies only to the filing of your tax return. It does not delay any tax you may owe beyond what you already paid the IRS in withholding and/or estimated taxes. To avoid penalties, be sure to pay taxes you expect to owe by the May 17 IRS filing deadline. Note that the extension also does not delay the deadline for making 2020 contributions to IRAs and HSAs beyond May 17.
3. File Your Tax Return Even If You Cannot Pay Taxes Owed
If you are ready to file, you may want to file your tax returns on May 17 even if you cannot pay taxes due right now. To avoid a late-filing penalty, file your return on time and pay as much as you can. The IRS will then send you a bill or notice for the remaining amount you owe, including any penalties and interest. If you can’t pay that now, see #4 below.
4. You Can Work Out A Deal With The IRS
If you lack the money to pay your income tax, consider asking to pay by installments or working out with the IRS an online payment agreement, an offer in compromise, or a temporary delay in collection until your financial situation improves.
“It is an extension to file and NOT an extension to pay,” notes Beth Logan, EA, who works with Kozlog Tax Advisers and is a past president of the Massachusetts Society of Enrolled Agents. “If you’re filing an extension to avoid your tax bill, you are only hurting yourself.”
Logan recommends that you send the return and then contact the IRS or get a tax return professional (an Enrolled Agent and/or CPA) to contact the IRS for one of these payment methods. Many states, she explains, also offer a delay in paying for hardships, such as unemployment. A delay doesn’t make the taxes go away, but at least the tax authorities will leave you alone for a while (up to two years in Massachusetts).
“For most people, the interest rate on their credit cards far exceeds the interest rate charged by the IRS or the states,” Logan warns. “Therefore, you are usually better off on a payment plan than using a credit card for unpaid taxes.”
5. IRS Has Different Penalties For Failure To File And Failure To Pay
As outlined on its website, IRS has different penalties for failure to file your tax return and for nonpayment or underpayment of taxes owed. To avoid an underpayment penalty, when you file a tax-return extension you need to have paid at least 90% of the total actual income tax for the year of the return. This means that if you end up paying more than 10% of your total tax owed with your actual return after the deadline, interest and penalties will apply.
The penalty for failing to file is generally more costly than the penalty for failing to pay, explains Susan Allen of the AICPA, the member association representing the accounting profession. The penalty for missing the initial filing due date or the extended deadline is 5% of the balance due for each month, or part of a month, up to a maximum of 25%. The IRS does not assess penalties for both failure to file and failure to pay for the same period, she says.
6. Remember To File An Extension For Your State Tax Return
Don't forget about your state tax return. Most states also shifted their tax-return deadlines to May 17. For example, if you pay tax to the state of California and cannot file by the due date, you get a filing extension. As with your federal return, you will still need to pay a specified percentage (e.g. 90%) of any tax you owe by the filing deadline.
7. Extension Does Not Increase Risk Of IRS Audit
This is a myth, as explained in a quiz on tax-return extensions at the AICPA website: “The IRS’s audit selection process is based on what is included (or not included) on the return, not when it’s filed.”
“A rushed-through return is more likely to contain mistakes,” warns the AICPA. “An error-riddled return—or one that’s intentionally missing information—is far more of a red flag [for the IRS] than a carefully prepared and reviewed return that’s filed by the extended due date.”
8. Estimated Tax Payments
If you make estimated tax payments, such as for an income spike from equity compensation or substantial capital gains from a stock sale, the payment for the first quarter of 2021 was still due at the usual time on April 15. (For the various approaches to this, see my Forbes.com article The 2021 Estimated Tax Dilemma: What Tax-Return Pros Are Doing And Telling Clients.) To avoid any penalties on your tax return next year, be sure you pay the IRS in 2021 either 90% of your expected tax bill or 100% of last year's taxes (for adjusted gross incomes over $150,000, it is 110%).
In a typical year, when the due dates for tax returns and the first estimated tax payment are the same, if you file an extension of your tax return on IRS Form 4868 one approach is to overpay the IRS the amount of additional taxes you expect to owe when you file your return. You overpay by what you approximately calculate will be needed for the first estimated tax payment due on April 15. Then you have the amount of the refund go to the first quarter's estimated tax payment (see Form 1040 line 36).
Paying the first quarter’s estimated tax indirectly through the extension could also provide some extra funds should the final tax amount due with the actual return be larger. This is an approach followed in the past by Jonathan Gassman, a CPA with the Gassman Financial Group in New York, whom I spoke with while researching my estimated tax article.
However, in this unusual year, with a month-long difference between the due dates, the IRS issued additional guidance. It clarified that the extension filing with the overpayment needed to occur by April 15 to get it credited to the first quarter estimated tax payment, unless that overpayment of 2020 taxes existed as of April 15, 2021 (i.e. withholding and/or estimated taxes in 2020 exceeded the 2020 tax liability). The IRS repeatedly stated, with examples, that “an extension of time to file has no effect on either the date of payment or the date on which an overpayment exists.”
For guidance about tax returns and estimated taxes on stock options, restricted stock/RSUs, ESPPs, and SARs, see the Tax Center at myStockOptions.com.
