Tax Day, which typically falls on April 15th, has caused stress for taxpayers and tax preparers alike for many years as they scramble to file tax returns on time. But is all the stress necessary? Not if you file an extension. The process to file an extension is easy for taxpayers because the IRS does not penalize you for filing an extension and they will not ask you for a reason for extending; it is automatically granted if the form* is filed by the original due date.
Although the IRS offers the option to file an extension as they are aware that certain circumstances may prevent you from filing on time, there are still several misconceptions amongst taxpayers regarding extending. One common misunderstanding is that filing an extension to file your tax return will increase your chances of being audited by the IRS. However, most tax professionals agree that there is no direct relationship between filing an extension and being selected for an audit. Only the IRS holds the secret to the audit selection process, but most tax professionals believe that an extension actually reduces your chances of being audited since the pool of random audits is selected from timely filed returns.
Another misconception regarding extensions is that you have extra time to pay your taxes. Unfortunately, the tax is still due by the original due date. The IRS expects you to pay throughout the year on a “pay-as-you-go” system, which involves withholding taxes from your pay, pension or social security or making quarterly tax payments. There are different types of penalties and interest that are applied by the IRS if you fail to pay your taxes on time or fail to file your income tax return on time (without qualifying for a filing extension).
Separate penalties apply for failing to pay and failing to file. The failure to pay penalty is not as harsh as the penalty for failure to file. Failure to pay penalties are 1/2% for each month (or part of a month) the payment is late. For example, if payment is due April 15 and is made May 20, the penalty is 1% (1/2% times 2 months (or partial months)). The maximum penalty is 25%. This penalty is based on the amount due on the return after any previous payments or withholdings.
The failure to file penalty, also known as the delinquency penalty, runs at the more severe rate of 5% per month (or partial month) of lateness to a maximum of 25%. If you obtain an extension for your filing due date, you are not filing late unless you miss the extended due date, which typically falls in October. If the failure to pay penalty and the failure to file penalty both apply the total combined penalty remains at 5%. The maximum combined penalty for the first five months is 25%. Thereafter the failure to pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). The combined penalties can reach a total of 47.5%!
Interest is also assessed along with the penalties. The rates fluctuate with a rate announced by the government. If the IRS finds an abusive situation, the late filing penalty can jump to 15% per month, with a 75% maximum.
There is also a fee for not paying enough tax throughout the year on the pay-as-you-go system called underpayment of estimated tax penalty. This penalty can be avoided if your withholding and estimated tax payments during the year are at least 90% of the current year tax or 100% of the tax shown on the return for the prior year, whichever is smaller. Taxpayers with higher earnings are required to pay 110% of the prior year tax or 100% of tax shown on the return for the current year.
Penalties and interest can greatly increase your liability to the IRS. Overpaying the IRS can also be costly since they do not pay you interest for holding your money until you receive a refund. However, all of this can be avoided with proper tax planning to ensure you are paying the correct amount throughout the year. Although the IRS can be intimidating, paying and filing timely should keep you in their good favor. If you have questions regarding filing an extension or tax planning, HORNE can help.