With tax season upon us, an almost universal question that many CPA’s and tax professionals get asked, “should I extend my tax returns” is in the air.
Like the answers to many of life’s questions, the response is “it depends”, but let’s discuss the variety of factors that go into analyzing the best answer for you. We will categorize these factors as tax and non-tax.
Tax Factors to consider:
1) Does extending affect the chances my tax returns will be audited?
2) Will I have interest and penalties for extending?
3) Does extending get me more time to pay tax owed,
4) Does extending slow down my receiving an anticipated refund?
5) How does the IRS feel about extensions?
6) Does extending mean I will get more deductions to reduce my taxable income?
7) Does extending mean my return will be accurate/more accurate?
8) Are there any pending tax legislation at the federal and/or state level that may pass during or just after-tax season but would be retroactive?
Non-tax Factors to consider:
1) If my business return is extended and I have partners or shareholders in the business with me, will they be upset if they get their k-1’s after the March 15th due date for these entities, and if they get them after April 15th they have to extend their personal returns?
2) Does my business have a bank loan or investors where the note or agreement requires the business to file and issue K-1’s by a certain time?
3) Is extending just a way to procrastinate what should have been done more timely, in terms of bookkeeping? Will extending just rationalize a bad habit, and keep pushing the tax return filings off?
4) My kids are needing the FAFSA form completed by a certain deadline and it asks for certain tax information, can I still get this info?
5) Peace of mind
There are a lot of misconceptions around the pros and cons of extending your business and/or personal tax returns. We will address these issues right here, right now!
But first, we need to lay out a few things: this article is intended for small business owners who’s business is taxed as a partnership, an S corporation or a sole proprietorship. Your business might be making a product, providing a service, or owning rental real estate. While many of these business types file a separate income tax return, any income or loss passes through to the owner’s personal tax return, which is where any income taxes are ultimately paid. We just want to be clear to whom this article applies.
Tax Factors to Consider When deciding to Extend:
Does Extending my tax return increase my risk of being audited?
The evidence seems to be the opposite – filing an extension for your tax return actually reduces your odds of being audited. The reason being that the IRS selects most tax returns for audit by the end of April, so if your tax return hasn’t been filed, you are not part of the initial pool of taxpayers who are potential audit targets.
Does Extending my tax return get me more time to pay my taxes?
No – filing an extension gets you just that – extra time to file your tax return. Our tax system is what is called pay as you go – which is why employees have federal and state income taxes withheld from their regular paycheck. Filing your business and personal income tax returns is really just doing a true-up of your tax situation for the prior year. Filing an extension does NOT get you extra time to PAY your taxes. Taxpayers are supposed to determine how much they owe and pay it to the IRS and their respect
ive state (if their state has an income tax) by the original due date. That said, if you extend your tax returns the IRS doesn’t know how much you may owe, so they cannot send you a notice for tax owed when they don’t even have a tax return to base it on.
How Does the IRS Feel About Extensions? Do I need a Reason?
The IRS seems to be agnostic when it comes to extensions. The extension form (whether paper-filed or efiled) does not ask for a reason for the extension. Extensions are automatic – anyone can get one as long as the form is submitted properly and on time. The IRS makes filing an extension easy.
Does extending mean I will get more deductions to reduce my taxable income?
It can – if one of the reasons you file an extension is so you and your tax professional can do a more accurate job of finding tax deductible expenses for your business, this can certainly help lower your tax bill.
Does extending mean my return will be accurate/more accurate?
Similar to the above question, if you use the additional time to do a better job of collecting tax-related items it certainly can help you and your tax pro file a more complete and accurate return. It should be noted that certain tax forms you receive from third parties, while technically due to be sent to recipients by Jan 31st, often are not ready until later, and sometimes after they are sent a correction is made and they are revised. Forms 1099 and 5498 related to health savings accounts, and tax-deductible IRA contributions are a couple of examples of forms that are often issued well after the Jan 31st due date. If any third party issued tax documents are not included on your business or personal tax return it can lead to the IRS sending a tax notice to you, with a proposed tax adjustment. And keep in mind that you can contribute to a Health Savings Account (HSA) until the original tax due date of your personal return, for the prior year. Same for contributions to an IRA
Are there any pending tax legislation at the federal and/or state level that may pass during or just after tax season but would be retroactive?
Not often, but sometimes a tax bill may pass during or just after the traditional tax season that may have been retroactive to the prior year. One example is during Covid many millions of people received unemployment inc
ome, which typically is subject to federal income tax, but for the 2020 tax year only Congress made the first $10,200 of unemployment received exempt from income tax if the taxpayer met certain income criteria. Many states copied this tax exempt status for the 2020 tax year, but didn’t paxx the legislation until half-way through 2021, well after the due date for that tax year of May 17th. As a result many taxpayers wished they had filed extensions and waited a few more months to file their returns.
Non-Tax Factors to Consider When deciding to Extend:
If my business return is extended and I have partners or shareholders in the business with me, will they be upset if they get their k-1’s after the March 15th due date for these entities, and if they get them after April 15th they have to extend their personal returns?
If you are a shareholder in an S corporation or member of an LLC and you are the only owner, you can obviously ignore this potential issue. If not, you may need to check your operating agreement for your partnership or S corporation to see if this issue is addressed specifically. If the agreement indicates that you are required to have the business tax returns filed by a certain date, and you cannot make that date, you should have a frank conversation with your fellow owners to see if it would be an issue for them. Better to have a clear understanding on the front end than have unhappy co-owners who did not know they would be getting their k-1’s later than expected.
Does my business have a bank loan or investors where the note or agreement requires the business to file and issue K-1’s by a certain time?
Similar to the question above, if you have no investors or bank loans that require you to have your business and/or personal tax returns filed by a certain date, this won’t be an issue. But if you do, best to communicate with your investors and/or bankers on the front end to make sure they are not surprised that your tax returns are not going to be filed on time. Or, if they are insistent that they be filed on time, good to know that too so you can make arrangements and communicate appropriately with your tax professional. In our experience many bankers and investors are reasonable but want you to have a plan for a certain date that your returns will be filed by and shared with them or k-1’s issued to them.
Is extending just a way to procrastinate what should have been done more timely, in terms of bookkeeping? Will extending just rationalize a bad habit, and keep pushing the tax return filings off?
If you are looking to extend because your bookkeeping or record keeping leaves something to be desired, work with your tax professional to develop a plan to get your returns done by some meaningful, yet realistic deadline. If procrastination is the driver for extending in our experience it doesn’t end at the original due date/date of extension. As the expression goes, plan the work and work the plan. Yes, bookkeeping or record keeping may not be why you are in business or got into business, but doing the above poorly can be a reason you wind up having to close your business. If need be, ask your tax professional if they, or anyone they can recommend, could help you get your bookkeeping cleaned up and stay on top of it, to prevent this becoming an issue the next tax year.
My kids are needing the FAFSA form completed by a certain deadline and it asks for certain tax information, can I still get this info?
We are not experts on the FAFSA form and policies, but often get asked questions about income tax amounts when personal tax returns are not completed. You will need to ask yourself this question, but at any rate be aware that if you are applying for financial aid for kids in private high schools or college you may need to have your tax returns done to complete the FAFSA forms.
Do you need Peace of Mind?
Many people get nervous when they think about the IRS, or get any mail from them. If you are one of these people then there may be some value for you to get your returns filed by the original due date. Get them done on time and avoid the potential stress of having to worry about them for any longer than necessary.
As you can see, there are a variety of factors to consider when deciding if you want to get your tax returns filed on time or get an extension. Every taxpayers’ situation is different, and changes from year to year. Make sure to talk with your tax professional to help decide if you are going to extend (or not), and if you do extend, put together a plan to make the best use of your additional time to file a complete and accurate return. Set progress due dates and a target time to file, in advance of the actual extended due date.