Take The Stress Out Of Tax Day: 8 Key Things To Know About Tax-Return Extensions

Tax Day 2020 is July 15. If you haven't yet filed your federal tax return, you need to decide whether to go for it now or get an extension.

In any tax year, stock compensation income—e.g. from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock—can raise your income tax and make your return complex. You may just need a little extra time, especially with everything else going in the world right now. The good news is that, if you can't file by July 15, you can get an extension of your filing due date without any questions asked.

However, you must understand the rules. To avoid getting hit with IRS penalties, particularly if you don’t have the money to pay taxes owed with your 2019 Form 1040 tax return, below are 8 crucial things to know about filing an extension.

1. Extension Does Not Need IRS Approval

To gain an automatic extension for the due date of your tax return (to October 15), you can use IRS Form 4868, Application For Automatic Extension Of Time To File. Alternatively, you can file for an extension through the IRS Free File system.

The IRS automatically processes a tax-return filing extension if you pay all or part of your taxes electronically by the deadline. You don't need to file a paper or electronic Form 4868 when making a payment with IRS Direct Pay, the Electronic Federal Tax Payment System, or with a debit or credit card. Simply select "extension" as the reason for the payment.

“Extensions are typically for six months, but this year it will only be a three-month extension due to the change in the tax deadline,” explains Susan Allen, Senior Manager for Tax Practice & Ethics at the American Institute of CPAs (AIPCA).

2. Extension Does Not Delay Taxes Owed Or IRA Deadline

The extension to October 15 applies only to the filing of your tax return. It does not delay any tax you may owe beyond what you already paid the IRS in withholding and/or estimated taxes. To avoid penalties, be sure to pay taxes you expect to owe by the July 15 IRS filing deadline. Note that the extension also does not delay the deadline for making 2019 contributions to IRAs and HSAs beyond July 15.

“The best practice, assuming it does not create financial hardship, is to estimate as accurately as possible what you will owe for 2019 and pay it on or before July 15,” suggests Phyllis Jo Kubey, EA, the incoming president of the NY State Society of Enrolled Agents.

3.  File Your Tax Return Even If You Cannot Pay Taxes Owed

Susan Allen of the AICPA encourages people to file their tax returns on July 15 even if they cannot pay right now. To avoid a late-filing penalty, file your return on time and pay as much as you can. The IRS will then send you a bill or notice for the remaining amount you owe, including any penalties and interest. If you can’t pay that now, see #4 below.

4.  You Can Work Out A Deal With The IRS

If you lack the money to pay your income tax, consider asking to pay by installments or working out with the IRS an online payment agreement, an offer in compromise, or a temporary delay in collection until your financial situation improves.

“It is an extension to file and NOT an extension to pay,” notes Beth Logan, EA, who works with Kozlog Tax Advisers and is a past president of the Massachusetts Society of Enrolled Agents. “If you’re filing an extension to avoid your tax bill, you are only hurting yourself.”

Logan recommends that you send the return and then contact the IRS or get a tax return professional (an Enrolled Agent and/or CPA) to contact the IRS for one of these payment methods. Many states, she explains, also offer a delay in paying for hardships, such as unemployment. A delay doesn’t make the taxes go away, but at least the tax authorities will leave you alone for a while (up to two years in Massachusetts).

“For most people, the interest rate on their credit cards far exceeds the interest rate charged by the IRS or the states,” Logan warns. “Therefore, you are usually better off on a payment plan than using a credit card for unpaid taxes.”

5. IRS Has Different Penalties For Failure To File And Failure To Pay

As outlined on its website, IRS has different penalties for failure to file your tax return and for nonpayment or underpayment of taxes owed. To avoid an underpayment penalty, when you file a tax-return extension you need to have paid at least 90% of the total actual income tax for the year of the return. This means that if you end up paying more than 10% of your total tax owed with your actual return after the deadline, interest and penalties will apply.

As the IRS explained in its recent announcement that the tax return due date is still July 15, interest and late-payment penalties continue to accrue on any unpaid taxes after July 15. However, the penalty rate for failure to pay tax is cut to half while an installment agreement is in effect. The usual rate of 0.5% per month is reduced to 0.25%. For the calendar quarter beginning July 1, 2020, the interest rate for underpayment is 3%.

The penalty for failing to file is generally more costly than the penalty for failing to pay, explains Susan Allen of the AICPA. The penalty for missing the initial filing due date or the extended deadline is 5% of the balance due for each month, or part of a month, up to a maximum of 25%. The IRS does not assess penalties for both failure to file and failure to pay for the same period.

Alert: In 2020, the minimum penalty for the failure to file a federal tax return within 60 days after the due date is either $435 or 100% of unpaid tax, whichever is lower.

6. Remember To File An Extension For Your State Tax Return

Don't forget about your state tax return. Most states also shifted their tax-return deadlines to July 15. For example, if you pay tax to the state of California and cannot file by the due date, you get a filing extension. As with your federal return, you will still need to pay a specified percentage (e.g. 90%) of any tax you owe by the filing deadline.

7. Extension Does Not Increase Risk Of IRS Audit

This is a myth, as explained in a quiz on tax-return extensions at the AICPA website: “The IRS’s audit selection process is based on what is included (or not included) on the return, not when it’s filed.”

“A rushed-through return is more likely to contain mistakes,” warns the AICPA. “An error-riddled return—or one that’s intentionally missing information—is far more of a red flag [for the IRS] than a carefully prepared and reviewed return that’s filed by the extended due date.”

8. Looking Ahead: Estimated Tax Payments

If you make estimated tax payments, such as for an income spike from stock compensation, the payments for the first two quarters of 2020 (normally due in April and June) are also due on July 15. To avoid any penalties on your tax return next year, be sure you pay the IRS in 2020 either 90% of your expected tax bill or 100% of last year's taxes (for adjusted gross incomes over $150,000, it is 110%) through withholding and/or estimated taxes. For more on estimated taxes in 2020, see a Forbes.com article by myStockOptions editor-in-chief Bruce Brumberg: Estimated Taxes Due July 15: Tax Return Pros Warn About Special Issues For 2020.

For guidance about tax returns and estimated taxes on stock options, restricted stock/RSUs, ESPPs, and SARs, see the Tax Center at myStockOptions.com.

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