Should I File a Tax Extension? What you need to know before filing.
Despite their widespread use every year, extensions are largely misunderstood. Today, we’ll discuss when you should file a tax extension, whether or not you should make a payment with that filing, and some of the trade-offs you should be aware of.
Extensions extend your time to file, but not to pay.
If you file your personal tax return after the April deadline, you will incur a 5% penalty of the unpaid tax balance per each month late, up to a maximum penalty of 25% (with few exceptions). You can avoid this penalty simply by filing an extension; however, you’ll still be hit with a failure-to-pay penalty if you do not make a tax payment with your extension to cover your remaining liability (if you have one).
How are you supposed to know how much to pay if your return isn’t prepared yet?
Well, make an educated guess! If you overpay, you will receive a tax refund—no harm done. If you still end up owing, you will reduce the penalty amount you would have owed had you not made that extra payment.
By the way, if you are short on funds, consider taking care of your state income tax liability first, as most states access higher payment penalties than the IRS!
Don’t rush your accountant—file the extension.
It’s never a good idea to rush the completion of your tax return right before the deadline. That’s a recipe for making mistakes and overlooking opportunities. Filing an extension not only extends the filing deadline, but also the opportunity to take advantage of special elections (especially for business owners) that may otherwise get overlooked while rushing to meet the original filing deadline. An extension will also extend your contribution deadline for IRAs and most retirement plans.
File your extension electronically—it’s easy.
On occasion, the IRS will have no record of a tax return, letter, or any other item mailed by a taxpayer. It’s possible the post office lost it or the IRS misplaced it. Interestingly enough, if you include a payment, the IRS will never lose that!
Regardless, if the IRS does not acknowledge your timely filed extension, and if you are unable to provide physical evidence of doing so, the extension will not be honored. It’s much easier to prove electronic delivery since all tax preparation software includes the submission confirmation upon a successful e-file. E-filing only takes a few minutes and is more secure than mail. Your accountant will already have all your information on file, and you only need to provide payment information if you are making a payment with your extension.
Will filing an extension increase your chance of being audited?
It’s very unlikely. The IRS uses a program called the Discriminant Index Function (DIF) to “score” each tax return. Tax returns with higher scores have more flags and suspect deductions, and therefore are more likely to be selected for audit. Certain flags are given more weight than others. Extensions are requested by millions of taxpayers every year and usually for a valid reason. Since filing an extension should not convey suspicion in and of itself, it is unlikely filing one will increase one’s DIF score.
Extensions give the IRS more time to access taxes.
With few exceptions, the IRS has three years from whichever is later—the original filing deadline or the actual filing date—to challenge your tax return, accessing additional tax. While this is not that big of a deal, you should at least be aware!
Not sure when you should file an extension?
Check out our filing deadline and extension calendar.
