If you’re dreading filing your tax returns, tax extensions may be your ticket out of tax day. But what does it really mean for your returns? Do you get more time to pay your taxes? What is the impact of a tax extension on your refund, if you’re owed one? In this post, we will answer these questions and more.
A tax extension extends the deadline for filing returns typically by six months from the original due date. The tax filing due date - tax day for individual taxpayers - also serves as the deadline for filing a request for tax extension.
So, if an extension request is filed by April 15 (which was April 18, 2023, for your 2022 returns), the date would typically get extended to October 15 (October 16, 2023).
The benefits of getting a tax extension are numerous:
- Additional time for accuracy: A tax extension provides extra time to meticulously gather and review your financial information, ensuring accurate reporting and reducing the likelihood of errors or omissions on your return.
- Thorough tax planning: The extended period allows for comprehensive tax planning, giving you the chance to explore potential deductions, credits, and strategies to minimize your tax liability.
- Reduced stress: You can avoid the pressure of rushing through the tax-filing process by having more time to organize your documents and consult with tax professionals if needed.
- Better documentation: With the extension, you can ensure you have all necessary records in order, maximizing your ability to claim eligible deductions and credits.
- Avoiding penalties: While the extension postpones the filing deadline, it doesn’t extend the deadline for paying owed taxes. However, filing an extension can help you avoid the higher “failure to file” penalty if you were to miss the original deadline without an extension.
- Flexibility: Life events or unexpected circumstances may have impacted your ability to file on time. A tax extension offers the flexibility to adjust your filing schedule accordingly.
- Convenience for complex returns: For individuals with intricate financial situations or multiple income sources, an extension provides the time needed to navigate complexities without compromising accuracy.
- Less chance of audits: Filing an accurate return through an extension can potentially lower the chances of errors that could trigger an audit.
Even after you are granted an extension for filing your tax returns, it’s still essential to:
a) make an estimation of, and
b) clear any outstanding taxes by the initial deadline to avoid incurring possible penalties (such as the failure to pay penalty) and interest charges.
In the event that you fail to file your returns by the original due date (if you have not requested an extension) or by the extended due date, the IRS levies what is called the failure to file penalty.
The calculation of the penalty depends on the delay in submitting the tax return and the outstanding tax amount as of the initial payment deadline (not the extended one, even if you got an extension). Unpaid tax is the overall tax obligation indicated on your return, minus payments made through the following:
- Estimated tax payments
- Eligible refundable credits
This late-filing penalty is calculated as follows:
- The penalty equals 5% of your unpaid taxes for each month or portion of a month your tax return is overdue. However, the penalty does not exceed 25% of your unpaid taxes.
- If the failure to file penalty and the failure to pay penalty (which we will cover next) are applied in the same month, the failure to file penalty decreases by the failure to pay penalty amount for that month. This results in a combined penalty of 5% for each month or portion of a month your return was delayed.
- After 5 months without payment, the failure to file penalty reaches its limit. (Yet, the failure to pay penalty persists until the tax is settled, up to a maximum of 25% of the unpaid tax by the due date).
- In 2023, for returns delayed by over 60 days, the minimum failure to file penalty is $450 or 100% of the tax on the return, whichever is less.
However, do note that if you are anticipating receiving a tax refund and haven’t yet submitted your tax return, the IRS won’t impose a late-filing penalty on you.
Similarly, if you fail to pay your taxes by tax day or an approved extended deadline (e.g., if the IRS grants tax relief to disaster-stricken areas), you will incur the failure to pay penalty (even if you got the tax-filing extension you requested). The penalty you’re required to pay is a percentage of your unpaid taxes.
The IRS calculates the failure to pay penalty based on the duration for which your overdue taxes remain unpaid. The calculation is determined by the following circumstances:
Failing to pay the tax amount that you state on your return
The penalty is 0.5% of the unpaid taxes for every month (or part of a month) that the tax remains unpaid. This penalty will not exceed 25% of the unpaid taxes.
As mentioned in the previous section on the failure to file penalty, where both a failure to pay and a failure to file penalty are applicable in the same month, the failure to file penalty will be reduced by the amount of the failure to pay penalty for that month.
For instance, a 5% failure to file penalty would become a 4.5% failure to file penalty and a 0.5% failure to pay penalty combined.
If you, as an individual, filed your tax return on time and have an approved payment plan, the failure to pay penalty is reduced to 0.25% per month (or partial month) during the validity of your approved payment plan.
If you fail to pay your taxes within 10 days after receiving an intent to levy*, the failure to pay penalty becomes 1% per month (or partial month).
Full monthly charges apply even if you make a full tax payment before the month concludes.
Failing to pay the tax that you didn’t report on your return
- If the IRS identifies that you owe taxes that were not reported on your return, the IRS will send you a notice or letter specifying the amount owed and the due date for payment. Generally, due dates are set 21 calendar days from the notice date or 10 business days if the owed tax is $100,000 or more.
- If you don’t pay the tax by the specified due date in the notice or letter, the failure to pay penalty is 0.5% of the tax amount that was not paid on time for each month (or partial month) of non-payment after the due date.
- Just like the previous scenario, if you filed your tax return on time and have an approved payment plan, the failure to pay penalty is reduced to 0.25% per month (or partial month) during the duration of your approved payment plan.
- If you don’t pay your taxes within 10 days of receiving a notice indicating the IRS’s intent to levy, the failure to pay penalty becomes 1% per month (or partial month).
- The full monthly charges are applied irrespective of whether you pay your tax in full before the month ends.
Like with the failure to file penalty, interest is accrued till your dues are cleared.
Note: An “intent to levy” refers to a formal notice issued by the Internal Revenue Service (IRS) to inform a taxpayer (who has failed to pay their taxes) of their intention to seize the taxpayer’s assets to satisfy an outstanding tax debt. This notice is a legal step taken by the IRS to indicate their intent to levy, or take possession of, a taxpayer’s property, bank accounts, wages, or other assets as a means of collecting the unpaid taxes. An individual is given a 30-day period to either settle the taxes, contest the levy, or come to an arrangement with the IRS. The IRS may demonstrate flexibility by permitting payment schedules or alternative settlements. If there is no response from the individual within the 30-day timeframe, the IRS will proceed to seize the taxpayer’s possessions to fulfill the tax obligations.
You can dispute the penalty amount owed by calling the IRS on the toll-free number mentioned in your notice or writing them explaining why the penalty imposed should be reevaluated. However, you need to attach supporting documents and keep the following information ready:
The notice or letter you received from the IRS
The specific penalty you wish the IRS to reevaluate
An explanation for each penalty, detailing why you believe it should be removed
Reconsider seeking a tax extension if you anticipate getting a refund. The more you delay filing your return, the longer the wait for your refund will be. If immediate funds are a priority, it’s advisable to file your return promptly.
If you find yourself unable to pay your taxes, you can opt for one of the IRS’s payment plans, which will enable you to pay off your tax balance over an extended period. While penalties and interest will apply to you even if you secure a payment plan, the failure to pay penalty will be lower if you file your return on time. Therefore, it is advisable to file your return on time and pay as much as you can.
Your options besides full payment are as follows:
- Short-term payment plan: Under this plan, you have the option of paying off your tax obligations in 180 days or less.
- Long-term payment plan: This type of plan is also called an installment agreement. If you need more than 180 days to pay off your tax liability, this option allows you to pay it off in monthly installments.
If you satisfy the following criteria, you have the option to utilize the IRS Online Payment Agreement tool to submit an application for either a short- or long-term arrangement:
- You can apply for a long-term payment plan (installment agreement) if you owe $50,000 or less in combined tax, penalties, and interest; filed all required returns; and need more than 180 days to pay it off.
- You can apply for the short-term payment plan if you owe less than $100,000 in combined tax, penalties, and interest; have filed your returns; and can pay off your taxes in 180 days or less.
Your payment option besides full payment is the long-term payment plan (installment agreement) where you pay off your taxes in monthly installments.
You can use the IRS Online Payment Agreement tool to apply for either a short- or long-term arrangement if you fulfill the following criterion:
- Long-term payment plan (installment agreement): You owe $25,000 or less in combined tax, penalties, and interest and have filed all your returns.
Applying online is the fastest way. You can also apply for an IRS payment plan by mail (by filling out IRS Form 9465 - the Installment Agreement Request) or by phone (call the IRS’s main number). Do note that the setup fees may be higher if you apply offline.
- A tax extension prolongs the deadline for filing tax returns, usually by six months from the original due date.
- To request an extension, individuals use Form 4868, while businesses use Form 7004.
- The benefits of a tax extension include extra time for accuracy, comprehensive tax planning, reduced stress, better documentation, penalty avoidance, flexibility for life events, and assistance with complex returns.
- It’s crucial to estimate and pay outstanding taxes by the initial deadline, even with an extension, to avoid penalties and interest charges.
- The failure to file penalty is 5% of unpaid taxes per month (up to 25%), while the failure to pay penalty is 0.5% per month (up to 25%).
- If both penalties apply in the same month, the failure to file penalty decreases by the failure to pay penalty amount, resulting in a combined 5% penalty.
- Tax extensions don’t extend the timeline for tax payment; they only extend the filing deadline.
- For businesses and individuals with intricate situations, an extension provides the necessary time for accurate processing.
- Those anticipating refunds are advised to reconsider their decision to seek an extension, as it prolongs the refund process.
- Applying for an IRS payment plan can help manage unpaid taxes over time. However, penalties and interest do apply in the interim (although the failure to pay penalty is lower if you file all your returns).
- Payment plan options include short-term and long-term plans based on the tax amount owed and other considerations.
- Applying online is the quickest method for payment plan requests, but mail and phone options are available.
When it comes to tax extensions, careful consideration, planning, and proactive financial management hold the key to minimizing penalties and optimizing your returns. Balancing the advantages of extended time with the imperative of complying with payment deadlines is the cornerstone of a successful tax strategy.
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