Extension - the REAL reasons

[buzzardbreath]

After undergoing a slew of extensions this year, the IRS statement that it is an "extension to file and not an extension to pay" is quite naive.

People who claim they just don't have the money have been asking me to file extensions. I advise them that not only will they incur a failure to pay penalty, they will also incur a penalty for failure to estimate their liability.

This doesn't phase them, seemingly. They know that if they file, the IRS will begin hounding them for money in a matter of a couple weeks, and after sending them 2-3 requests for payment, will turn it over to collections. This will typically happen prior to October 15th, so all they are doing is buying time.

I'm sure the IRS would prefer that we analyze the taxpayer's situation and forbear filing of an extension. That doesn't help, because we usually don't have enough information to analyze at the point of an extension, and even if we didn't file it, they would just go down the street.

My specific question to this group might be: "Do you have means or methods to discourage taxpayers from filing extensions just to postpone payment?"

The double-whammy penalty doesn't phase these people. In some cases they say they can't pay the IRS but I will notice purchases of new cars, June weddings, etc.

[Burke]

street.

My specific question to this group might be: "Do you have means or methods to discourage taxpayers from filing extensions just to postpone payment?"

Doesn't bother me at all. Most of mine are due refunds, but it really is not an issue for the preparer. It's theirs.

[Koss]

Extension of Time

My office had one client request this type of extension. After we explained that it is not an extension of time to pay, he articulated very well the reasoning set forth in the original post. In his own words, he wants to use the six month extension "to get the money together," and he doesn't want to get bills from the IRS between now and October 15. He fully understands the interest and penalties for late payment.

We filed an extension for him. His tax return was actually complete, so the figures on Form 4868 were very accurate. Even though he did not submit a payment with the extension, he accurately estimated the tax due.

I certainly agree that this is not the intended purpose of an extension. But I don't see it as unlawful or unethical. The extension is automatic, which means, among other things, that the taxpayer does not have to have a reason.

If we refused to file the extension on ethical grounds, a sophisticated client could easily come up with some other reason for needing an extension, e.g., I'm out of town on a remote island with no fax or internet access, or my wife is not available to sign the return, etc.

A really smart client could even just opt out of electronic filing, leave the office with his paper return, and then file a paper extension on his own.

It is not an accident that an extension without payment, whether on paper or electronic, does not require a signature from the taxpayer or the preparer.

It may be a little unorthodox, but it doesn't bother me.

BMK

[geekgirldany]

Well about half of my extensions are as described in original post. They want the time to get the money up to pay.... they do not want the IRS after them until they have some money to pay.

I really do not mind as long as they understand, an extension to file not pay. I have one client that hasn't filed in 5 years. Every year he called wanting an extension until the second year I told him I could not send in another blank extension form. So he done them himself but never brought the returns on time for me to file. I prepared all the returns at one time and he still has not mailed them. I told the client that they will just come after him through garnishment. He said he would deal with it when it comes. I think it is the head in the sand mentality... they haven't come after me yet... maybe they won't for a little while longer.

[JohnH]

OF COURSE the 4868 is an extension of time to pay, in spite of the wording on the form. IRS uses that wording to scare people into paying if they possibly can, but in fact it does offer additional time to pay. They even manage to spook some tax preparers into spouting the party line. The only cost for taking more time to pay is what I consider a reasonable effective interest rate for someone who doesn't have the funds.

As a practical matter I think the current system works pretty well, and it actually increases compliance. Back in the "old" days, when an extension was invalid if 90% of the eventual tax liability was not paid, many people would simply not file. Some would then be overcome by fear or paralysis, and would drop out of the system for years. When IRS finally caught up with them, the accumulation of several years of tax, penalty, and interest would be overwhelming.

Under the current system, they can avoid the 5% FTF penalty completely at the price of paying about 1% to 1-1/4% per month in combined interest and FTP penalty on the unpaid balance. That is an effective interest rate of about 12-14% per year, which is less than credit card rates and about on par with the rate someone with low-to-moderate credit would pay for an unsecured loan (assuming they could get one)

But something else happens - they are putting themselves into the system by signaling who and where they are, they are acknowledging that they have a debt to the government, and they are gaining about 6 months to get things in order. That's a pretty good trade-off for the IRS because it gives them lots of useful information, and for the taxpayer who finds themselves in this situation.

And then, if things don't go according to plan, IRS allows them another bite of the apple by granting an automatic installment agreement if they owe less than $25K and agree to pay it off over 5 years or less. They will even let someone do this for a couple of years running without too much hassle if they manage to keep the total under the $25K. All in all, it's a fairly compassionate system for those who don't abuse it too much.

[taxea]

suggest the return be filed and an installment agreement be filed with the first payment attached to the installment agreement and paid by 4/15. At least this might stop a failure to pay. He can set the installment payments to 72 months and in the mean time can pay as much or pay it off at any time.

[JohnH]

Nope.
Won't work.

The failure to pay penalty is assessed on the unpaid balance, period. Under an installment agreement, the FPT penalty gets a slight reduction, but it never goes away.

All things considered, filing the extension and then filing the return on Oct 15 is a far better way to handle things for anyone who truly can't pay, and for those who expect to get the money together by Oct 15 but are not sure if that will happen. It preserves the most flexibility even though there's a slight additional marginal cost. Either way, they still have the option to file the Installment Agreement either with the Oct 15 return or they can wait for the assessment and then file the I/A.

[David1980]

I file extensions for people for this reason as well.

Doesn't mean I like it - it doesn't seem to be what the extension was originally for. Why delay filing a complete tax return that could be filed 4/15 just because you can't pay? I mean, the reason the taxpayers want to do this is obvious as stated in the thread and it works. But it isn't a good system that causes them to do this - it would be better for the IRS to get the return filed on time and then delay the bills until after 10/15 even though the FTP interest and penalties accrue from 4/15.

I also don't like people who neglect their tax situation and then can away with minor penalties or interest. I especially hate OIC. Be an irresponsible person for perhaps years keeping too much of the income for yourself and then get "bailed out" with an OIC? As a taxpayer that files and pays on time it feels incredibly unfair to me what others get away with. Or the ones that whine about their tax burden being too much. Sorry, you made too much money? So I can hate these people, and still take their money for tax preparation. I'm OK with that.

[DaveO]

I don't really care why they want an extension, I'll file it. When they ask how long it's good for and I tell them 10/15 I follow that with "don't you even think about waiting a day past 9/1 to have me your stuff." Of course, some do and I bill accordingly.

[buzzardbreath]

Common comment among you

Good response on this one - thanks for your feedback. Seems like one feeling among you is very common - you are not bothered by a client's reason for an extension - you will simply do it for them.

I did not mean to imply that my level of morality is so lofty that I won't file an extension for someone unwilling to pay. But I do harbor opinions about people who make enough money and simply don't want to pay their taxes on time. And most of my extensions fall into that category.

Typical is a family who makes well over $120K every year, and refuse to increase their withholding. They are a lousy $1300 short. ($1300 may sound like a lot of money for some of us, but for $120K per year? get real) They would never admit to it, but they put pressure on me to get refunds even after refusing to do anything to pay in. In my state, sales tax is an itemized deduction, and it makes me sick to listen to their long list of big ticket items that they buy. I've shut the door on this stuff except for cars, boats, really big stuff added to the sales tax table.

It is well spoken that this is really THEIR problem. And the IRS charges interest + FTP penalty + a relatively new penalty for underestimating their tax liability on the 4868. So the IRS may in fact be happy with these people.

[Koss]

Penalty?

Two posts in this thread mention a penalty for underestimating the tax liability on Form 4868.

Can someone cite a reference to this penalty?

The instructions for Form 4868 say:

Make your estimate as accurate as you can with the information you have. If we later find that the estimate was not reasonable, the extension will be null and void.

If the extension is declared to be null and void, that would trigger a late filing penalty, because the taxpayer would be treated as if they had never filed an extension.

But I can't find any reference to a penalty for underestimating one's tax liability on Form 4868.

Is this thing real?

BMK

[JohnH]

No, there is no separate penalty for underestimating the tax liability.
I noticed that as well, but didn't comment on it.
However, there is a tiny catch, which may be the reason for this being considered a separate penalty.

There are 3 penalties and one interest assessment in play.

1) Penalty for underpayment of estimated tax. (if it applies, then it applies even for an Apr 15 filing)
2) Penalty for failure to pay (1/2 of 1% per month with a 25% max, and with a catch - see below)
3) Penalty for failure to file (5% per month with a 25% max / a proper 4868 eliminates it completely)
4) Interest on the unpaid balance (currently about 3-4% APR, I think)

The catch is that IF 90% of the tax is paid by Apr 15, and IF the return is filed with the entire balance paid by Oct 15, the FTP penalty is not assessed. So I suppose an argument can be advanced that there is a penalty for failure to properly estimate the tax. In actual practice, that usually isn't the issue with the type of clients we are talking about.

See # 6 in the article below:

http://www.irs.gov/uac/Failure-to-File-or-Pay-Penalties:-Eight-Facts

There's also another sub-catch. Once the Installment Agreement is in place, the FTP penalty is cut to 1/4 of 1% per month. That equates to an APR of 3%. Add that to the 3% current interest rate, and it turns out a taxpayer on an Installment Agreement is currently paying an effective interest rate of only about 6% APR. The taxpayer really shouldn't care whether IRS calls it a penalty or interest, since neither is tax deductible.

[BHoffman]

I love John H. It's an unrequited love, but there eternally nevertheless

[New York Enrolled Agent]

Here's a test for after tax season for the researchers on this board - find the IRS guidance from Chief Counsel that says a taxpayer can file their 1040 on April 15th and also file an extension the same day.

[JohnH]

I love John H. It's an unrequited love, but there eternally nevertheless

Gosh, I'm embarrassed.