April, 2007 Tax Tip
To Extend or Not to Extend
Extending your return allows you and your tax preparer more time to review your data in a calm and less-pressured time frame. Many brokerage houses sent out corrected tax statements to their customers late in March, after their tax returns may have already been filed. While the corrections on the vast majority of these statements probably had an inconsequential effect on the filed returns, in some instances that is not the case. If the changes are material, filing an amended return is probably in order, at additional time and expense.
I have several clients who don’t have the cash to fully fund their self-employed retirement plans (such as SEP and Keogh plans) by April 17th. By extending their tax return, they also extend the time for funding their plans until October 15th (this is not true for traditional or Roth IRA’s, which must be funded by April 17th). A SEP can even be established up to the extended due date. Often missing items or tax documents are discovered after the original April 15th deadline. There have been times when a tax development, such as a court case or tax ruling, that may be favorable to an issue on your return comes out during the late spring or summer. All of these are valid reasons why extending your return should be considered.
An automatic extension (form 4868) is now valid for six months. It must be filed on or before April 17, 2007 or you risk significant penalties and lose opportunities for various tax elections and savings, which only apply to a timely filed (including extension) return. It is important to keep in mind that an extension of time to file your return does not grant you an extension of time to pay the tax. To avoid late payment penalties at least 90% of the tax you will ultimately show on your return must be paid by April 17, 2007.
The extension form asks you to estimate the amount of your tax liability. It is important that the estimate be reasonable. You should view it as a contract – the IRS will grant you the extension provided you tell them what your liability will be. If you aren’t reasonable on your end, they have the authority to retroactively invalidate your extension. This means you will owe late filing penalties (5% per month for each month the return is late, up to a maximum of 25%) as well as late payment penalties. Therefore, you will still need to get your tax data to your preparer so he/she can properly advise you of the balance due. Zeroing in on the balance due may also be important in determining what your estimated tax payments for 2007 should be.
For some reason there seems to be a popular belief that extending increases the likelihood of an audit. There does not appear to be a shred of truth in that. In fact most practitioners, myself included, believe the opposite may be true. What causes audits are returns that are hastily and shoddily prepared, are incomplete, and have several amounts that appear to be estimates on them. However, you should be aware that an extension does extend the statute of limitations for auditing a return.
In summary, an extension can be a very powerful and useful tool. Even if you know you have a refund coming it doesn’t mean you have to wait until October to file your return. It can be filed as soon as one day after the original deadline. Now, if you’ll excuse me I need to get back to preparing my clients’ extensions.
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