Extension, Anybody?

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By Roy Lewis
April 12, 2001

Tick... tick... tick...

That's the sound of the tax-filing clock winding down to the annual mid-April filing deadline (April 16th this year, but usually April 15th). What if you don't think you'll make the deadline. What then?

Well... IRS Form 4868 could be in your future.

If properly completed, Form 4868 ("Application for Automatic Extension of Time to File U.S. Individual Income Tax Return") will allow you an automatic four-month extension to file your tax return -- until August 15th (this date can vary slightly if it falls on a weekend or holiday). But, there are some strings attached.

To Pay or Not To Pay...
If you've already determined that you'll receive a refund from Uncle Sammy when you finally file your tax return, then you've got it made. Uncle Sammy doesn't mind holding your refund (without paying you any interest) for an additional few months until you get your "stuff" together. So, simply file Form 4868 by the mid-April deadline and you're in business. Easy as that.

But what if you owe money? Form 4868 only extends the time to file your return. It does not extend the time to pay your taxes. The IRS might claim that the extension won't be valid unless you make full payment with Form 4868. In fact, in the article -- "I Can't Pay Uncle Sam. Now What?" -- I basically implied the same thing. We were trying to scare you straight. But, that's not really the whole story.

Prior to 1993, the official IRS position was "No payment... no extension." In 1993 Uncle Sammy decided to accept Form 4868 as valid, even if you can't pay all (or any) of the tax due as shown on the extension. However, to receive a valid extension without payment, Form 4868 must reflect a "proper estimate" of your tax liability. Simply filing Form 4868 without a reasonable attempt to determine your "proper estimate" of tax liability might cause additional penalties. (We'll discuss penalties a bit later.)

As with all important documents, I strongly suggest that you send your extension (and any payment you make) via certified mail (or other IRS-approved delivery services from carriers such as FedEx, UPS, Airborne, or DHL) with a dated return receipt that you can use to prove timely filing of your extension. You can read more about alternative delivery services in the "Background Information for Using the Tax Calendars" in IRS Publication 509. (We also cover the topic in the Tax Center article "Timely Mailed = Timely Filed.")

Extensions Made Easy
The IRS now has a special toll-free phone line for extension requests. The number is 1-888-796-1074. If you use this extension line, be prepared to use Form 4868 as a worksheet and have a copy of your 1999 tax return in front of you. Just another way that the new IRS is trying to save trees and reduce paper. This is the first year for this program, and you might want to give it a try rather than going through the time (and expense) of paper filing your extension request.

The Out-of-Towners
For people residing out of the country, special rules apply. An automatic two-month extension for filing your return and paying your tax is given to U.S. citizens and residents whose tax homes "in a real and substantial sense" are outside the U.S. and Puerto Rico, and to military personnel assigned to duty outside the U.S. and Puerto Rico.

Understand that this special provision won't apply to you if you are simply on vacation out of the country or decide to jump across the border for a day or two including the tax-filing deadline date. This used to be a common ploy to receive the automatic filing and payment extension, but that little scam is no longer available (drat!!). Now, to secure the filing and payment extension for taxpayers residing abroad, your residence must be abroad, and you'll need to explain to Uncle Sammy where you live and why you live there.

So, what form do you use to request this filing and payment extension? No special form is required. You simply file your tax return by the extended due date (June 15th) and attach a statement to the return explaining how and why you qualify for the two-month extension. If you live abroad, read more about your extension and payment options in IRS Publication 54 and Publication 593 available at the IRS website.

(Note: Students or professors who receive income from teaching or while studying abroad should also read Publication 520 covering "Scholarships and Fellowships.")

Special Circumstances
If you're serving in the U.S. armed forces (or are employed in support of the armed forces) in a Presidentially declared combat zone, you'll receive a broad extension to file and pay that applies during your time of service. If you're wounded, you could have additional time. These extensions to file and pay the tax also apply to spouses of those serving. If this might apply to you, read more about it in IRS Publication 3 and Publication 516. The relief from filing and/or payment can be substantial.

A similar broad extension is available for taxpayers affected by a Presidentially declared disaster. If you find yourself in such an unfortunate circumstance, you might find some small relief in filing and paying your taxes. Don't overlook it. Read more about it in IRS Publication 547.

Extension Strategies
There are some cases in which you might have your tax return prepared and ready to go, don't have a balance due, and might still want to file Form 4868 for an automatic extension. Why? To extend the time limit for funding self-employment retirement plans like the Simplified Employee Pension (SEP) or Keogh.

While the mid-April tax filing deadline is the drop-dead date for IRA contributions (both traditional and Roth) for the prior calendar year, a valid filing extension will also extend the time you have to fund your SEP or Keogh retirement plan. So, if you would like to make a contribution to your SEP or Keogh, but don't have the funds right now, an extension will allow you to defer making that contribution until August 15th and still let you take that contribution as a deduction on your tax return. That could be helpful from a cash flow standpoint, and is something you might want to consider.

But, if you decide to do this, make sure you won't be surprised with a balance due when you file the return, or make sure you have at least properly estimated any balance due with the extension. Why? If you didn't make a "proper estimate" of your tax liability, the IRS can retroactively deny your extension back to mid-April. If your extension is denied retroactively, your due date to make a SEP or Keogh contribution also reverts back to April. If you make a contribution later, the IRS could deny your contribution, remove your deduction, and also try to assess taxes on your SEP "excess contribution."

You could place a number of other tax elections that must be made on a timely filed return in jeopardy by having your extension denied, too. So make a valid effort to compute and (hopefully) pay any balance due when filing Form 4868. If you overpay, you can always get a refund. But, if you underpay or even undercompute your total expected tax liability, you could buy yourself some big problems.

Getting back to why you might want to file an extension... many people (including a number of tax pros) believe that filing an extension will reduce your chances for audit. The theory is that the later you file, the more likely the IRS will have their computers loaded with other people's tax returns and will begin the audit process using those "early" filed returns.

I'm not sure I necessarily buy into this theory. Over the years, I've been involved in a number of audits of returns that were filed on extension. The number of returns filed on extension is tiny compared to those filed by the required due date, so it only makes sense that the number of returns audited would also be comparatively small.

But, if you believe that an extension will reduce your audit chances, go for it. As long as you make your payments (if any) by the required due date, you'll incur no penalties or interest. Just remember that partaking of the extended filing date likewise extends the normal three-year statute of limitations on an IRS review (read: audit) of your tax return.

Penalties
As mentioned earlier, late penalties only become an issue for returns where there is a balance due. One of the consequences of filing Form 4868 without making a reasonable effort to determine your tax liability is that the IRS can deny the extension retroactive to the original mid-April deadline for filing your taxes, and they can assess penalties accordingly.

There are late-filing penalties and late-payment penalties that might apply. By filing a valid extension, you'll avoid the dreaded late-filing penalty, which accrues at 5% per month (or portion of a month) and can top out at 25% of the total tax liability. The late-filing penalty hits its maximum fairly quickly (five months), so avoiding it with a timely filed return or valid extension is recommended.

While this is good news, filing an extension without paying the tax due will not avoid the equally dreaded late-payment penalty -- which can accrue at 0.5% per month (or portion thereof) and can also amount to 25% of your total tax liability.

Before you do the math and think, with 50-odd months before you hit the maximum penalty, that this is a much better deal, remember that an extension without payment will not stop the running up of IRS-imposed interest on the balance due. So, if you plan to file an extension without paying the tax due, be prepared for an additional penalty and interest "hit" from the folks at the Treasury Department. You can read more about these (and other) penalties in IRS Publication 17.

What happens if you manage to incur both the late-filing and late-payment penalties in the same month? The combined maximum for the two penalties is 5% per month (or portion of a month), so the late-filing penalty is reduced to 4.5% and the late-payment penalty remains 0.5%. (Interest also still applies for the late payment.)

So, there you have it... the short course on extensions. If you must (or simply desire) to use 'em, make sure that you've got all the facts down for your particular situation. Screw it up, and Uncle Sammy will have his hand out for additional penalties and interest.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

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