Sunday, April 17, 2011

The Need for Increased Due Diligence in Filing Extensions

The complexities associated with return preparation, tax law, and the April 18 deadline have required taxpayers to devote more time to preparing returns. As a consequence, more extensions of time to file are being filed. The IRS has indicated that taxpayers should file a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. The instructions for filing a Form 4868 require taxpayers to:
  • Properly estimate their tax liability using the information available to them;
  • Enter their total tax liability on line 4 of Form 4868; and
  • File Form 4868 by the regular due date of their return.
Normally, filing this form results in an automatic six-month extension of time to file without any late-filing penalty. However, filing the form does not extend time to pay any income tax liability due. The estimated taxes due should be paid with the extension application. Interest is charged on a material underpayment of tax from the original due date of the return until the tax is paid, and a late payment penalty may also be due. The interest rate varies quarterly with the federal short-term interest rate.
Regulations provide relief from penalties only if the balance due on Form 1040 is less than 10% of the total tax shown on that form and is remitted with the return. If the balance due is more than 10% or is not remitted with the return, the penalty may apply to the total of the balance due from the original due date of Form 1040 to the date of payment, unless the taxpayer establishes reasonable cause.
In addition to these concerns with the federal extension, applicable state extensions and the rules and regulations associated with them require the same careful consideration. The requirement to electronically file some state extensions raises the due diligence required.
First, there is the need to accurately estimate tax liability when an extension is filed. Second,  if an extension is filed, it is an extension of time to file only and not an extension of time to pay. Some taxpayers have the misconception that the filed extension extends not only the time for filing but the time for paying the tax due. Taxpayers should also know that penalty and interest apply to any balances due in excess of 10% of the total tax shown on the tax return. If an extension of time to file is required, any tax due with this return must be paid with the extension. Any amounts not paid by the filing deadline may be subject to interest and penalties.

In Crocker, 92 T.C. 899 (1989), the Tax Court held that the IRS could void the automatic extension because the taxpayers “did not make a bona fide and reasonable estimate of their tax liabilities nor did they make a bona fide and reasonable attempt to secure the information necessary to make such an estimate.”