STRETCHED FOR TIME? GET AN EXTENSION!

The dog ate your W-2? Still waiting for 1099s? Getting an extension from the IRS is easy. Just be aware that you still have to pay whatever you owe.

It’s April, and you’ve started to sweat. Because you know our tax return is due really soon, and your accountant won’t answer your calls. Not that it would do you much good, anyway. You’re still waiting for a K-1 form from that partnership you were persuaded to invest in. And yesterday you got a corrected 1098 from your bank amending the amount of interest that was reported in January.

Regardless, the return is due now and there are penalties for late filing. The Internal Revenue Service can hit you with a late filing penalty of 5% of the tax not paid by the due date for each month or part of a month your return is late. Generally, the maximum penalty is 25%. But if your return is more than 60 days late, the minimum penalty is $100 or the balance of the tax due on your return, whichever is smaller.

On top of the late filing penalty, there is a late payment penalty. This is usually 0.5% of any tax not paid by the due date. It is charged for each month or part of a month that the tax is unpaid. The maximum penalty is 25%.

The late-payment penalty can be excused if you have and can show “reasonable cause” for not paying on time. You are considered to have reasonable cause if at least 90% of your actual liability is paid before the regular due date of your return through withholding or estimated tax payments.

However, you’ll owe interest on any tax not paid by the due date of your return. This interest runs until you pay the tax. Even if you have a good reason for not paying on time, you’ll still owe the interest.

Form 1127 Gives You Six Extra Months to Pay

All that having been said, one of the IRS’s best-kept secrets is the fact that the law provides for an extension of time to pay your taxes. While the IRS denies this, the agency has nevertheless gone to the trouble of creating a form on which to make the application. It is Form 1127, Application for Extension of Time for Payment of Tax. I have always found it peculiar that IRS has a form to engage a procedure the agency says does not exist.

Unlike Form 4868 (discussed below), the payment extension is not automatic. Most payment extension requests are denied because the few people who file them do not know how to prove they are entitled to an extension.

To win the extension, you must demonstrate that you exercised reasonable business care and prudence in providing for your taxes, but through no fault of your own and due to circumstances beyond your control, you are unable to pay on time. You must also show that paying on time will cause an economic hardship. Hardship exists when, because of enforcement action, it is impossible to pay necessary living expenses. Finally, you must agree to give the IRS security for the unpaid tax. The IRS achieves this by filing a tax lien — which most taxpayers find distasteful. Although that might not sound like a good idea, the fact is that when you do not pay in full, the IRS almost always files a lien anyway.

If the extension is granted, you may receive up to six additional months to pay your taxes — without penalties. Interest accrues during the extension period. However, by avoiding penalties, you cut in half the amount of additions the IRS imposes. More important, while on the payment extension, the IRS cannot execute enforcement actions. This means no levies on your wages and other cash resources as long as you pay the tax by the extended due date.

If IRS denies your Form 1127, you can still avoid enforcement action by filing Form 9465, Installment Agreement Request. You will find more coverage of this form in my article, What if you can’t afford to pay?

Moreover, just submitting Form 1127 puts you in a better position to seek abatement of the failure-to-pay penalties later. This is because filing the extension is the quintessential act of good faith. You put the IRS on notice of the problem and take affirmative steps to resolve it rather than waiting for the IRS to chase you down for payment.

Form 4868 Allows an Instant Four-Month Reprieve

The IRS has a simple form that allows you an automatic four-month extension to file your income tax return — but not to pay the taxes due. It’s Form 4868 and it’s easy to complete — even without an accountant. All the form asks is your name, address and Social Security number. It asks you to estimate your tax liability and send any balance due. If you make this payment and hit at least 90% of your real liability, you win. You don’t pay a late filing or late payment penalty.

You can also pick the form up at any IRS office or order it toll-free at 800-TAX-FORM (1-800-829-3676). You can also file for an extension over the phone. You’ll need last year’s return and this phone number: 1-888-796-1074.

You must file Form 4868 by the regular due date of your return, usually April 15. (In 2005, that’s a Friday. So you’ll have the weekend and a few days before to get the paperwork done.) Form 4868 is an automatic extension. You don’t have to give the IRS any reason. You can get it even if the only reason you haven’t filed is you were lazy or didn’t want to think about it.

Form 4868 gives you another four months — until August 15 — to complete and send in your return. If you’re still not ready, all is not lost.

Form 2688 Allows Still More Time

You can get a second extension by filing Form 2688 on or before the day that the first extension expires. This extension gives you another two months, until October 15, to file your return.

But here you must provide a reason for the request. For example, waiting for missing records such as a late 1099 or if your accountant has become ill or has died have all been acceptable reasons. Any “reasonable” explanation should be OK. (Don’t try “my dog ate my W-2.”) Even if your request for an extension is denied, the IRS usually will allow you five to 10 days from the date of denial to get your return in. The IRS has been very “consumer friendly” in this area.

Remember, however, that these extensions only extend the date for filing, not for paying. If you don’t pay the amount due by the due date, you’ll owe interest and, potentially, a penalty for late payment. So even if your return isn’t complete, estimate the taxes due and send in any balance with Form 4868. Don’t think that the automatic extension for filing also extends the date for paying. It doesn’t work that way and many people get caught.

So how are you going to estimate how much you owe? The best way would be to use MSN Money’s Tax Estimator, which will give you a solid ballpark figure of what you owe. A little less complicated to use is the Quick Tax Estimator from H & R Block — but be warned, less complicated can mean less accurate, too.

That bears repeating. The reliability of any tax estimator depends strictly on the completeness of the information that you provide it — garbage in, garbage out. And, if you have all the information, why delay filing your return and paying your tax, huh?

In the past, if you didn’t estimate and send a sufficient payment with the request for an extension, you could be denied even the automatic four-month extension for filing. That’s no longer the rule. If you file the Form 4868, even if you don’t send in the payment of the tax you estimate as due, you still qualify for the extension and avoid those failure-to-file penalties.

After Three Years, Your Return Stands — Regardless!

You should also be aware that the statute of limitations runs from the date you actually file, not the original due date. The statute of limitations is a law that limits the amount of time the IRS has to audit your return. Normally, that is three years from the due date of the return (usually April 15, even if you filed on January 1).

If the IRS doesn’t audit you within that three-year period, the government is legally prohibited from challenging your deductions. If the IRS can prove you committed fraud, all bets are off. Here, the burden of proof is on the IRS. They must prove that you intended to cheat — a difficult burden. If you file an extension, the statute of limitations doesn’t begin until the return is actually filed.

If you’re a U.S. citizen or resident and were out of the country, you automatically get a two-month extension to file your return. “Out of the country” means either:

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You live outside the United States and Puerto Rico and your main place of work is outside the U.S. and Puerto Rico, or;

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You’re in the military or naval service outside the U.S.

By filing the Form 4868, you get an additional two months (for a total of four) to file your return.

Always file Form 4868 before Form 2688. Only in cases of undue hardship will the IRS approve your request for an additional extension without receiving Form 4868 first.