Commonsense CPA: Understanding Tax Extensions and Underpayment Penalties in the US
As we grind through the last few days of the Spring 2023 Tax Season, tax CPAs everywhere are in Extension Mode. For taxpayers who can’t (or won’t…you know who you are!) get all of their tax info gathered by April 15th, tax extensions are an annual rite of passage involving harried CPAs, last minute payments, and mad scramble to produce the tax documents that were thrown away back with January’s junk mail.
Despite their ubiquity for sophisticated taxpayers, however, most Americans remain blissfully unaware of how tax extensions work at both the federal and state levels, as well as the penalties associated with underpaying taxes.
So what is an extension, exactly?
Federal Tax Extensions
The Internal Revenue Service (IRS) administers the federal tax system in the United States. Federal income tax returns are typically due on April 15th of each year. However, taxpayers may request an extension if they need more time to prepare and file their tax returns.
To request a federal tax extension, taxpayers must submit Form 4868 (Application for Automatic Extension of Time to File U.S. Individual Income Tax Return) to the IRS by the original due date of the tax return (usually April 15th, but April 18th in 2023). This form can be filed electronically or mailed to the appropriate IRS address. Upon approval, taxpayers receive an automatic six-month extension, pushing the deadline to October 15th.
It is important to note that an extension to file your tax return is not an extension to pay your taxes. You must still pay any taxes you owe by the original due date to avoid interest and penalties. If you cannot pay the full amount, it is best to pay as much as possible and explore the available payment options with the IRS.
State Tax Extensions
Each state has its own tax agency and rules regarding tax extensions. While some states automatically grant an extension when a federal extension is filed, others require separate forms or processes. It is crucial to check your state's specific guidelines and requirements to ensure that you are filing for a state tax extension correctly. The following examples illustrate how state tax extensions can differ in Maryland, Virginia, and the District of Columbia:
Maryland: Taxpayers must submit Form 502E (Maryland Application for Extension of Time to File Personal Income Tax Return) to the Comptroller of Maryland by the original due date. Maryland grants a six-month extension, which moves the deadline to October 15th. Taxes owed must be paid by the original due date to avoid penalties and interest.
Virginia: Taxpayers must submit Form 760IP (Virginia Automatic Extension Payment Voucher for Individuals) to the Virginia Department of Taxation by the original due date. A six-month extension is granted, moving the deadline to November 1st. Any taxes owed must still be paid by the original due date to avoid interest and penalties.
District of Columbia: When you file a federal tax extension, the District of Columbia Office of Tax and Revenue automatically grants a six-month extension for your D.C. income tax return. However, you must still pay any taxes owed by the original due date.
Professional Judgment by your Harmony Tax Team
An essential aspect of the professional judgment exercised by your Harmony Tax team is to help project amounts to pay in with your extensions. This process involves analyzing your financial situation, including income, deductions, and credits, to estimate your tax liability accurately. Most of the time these numbers haven’t all been determined yet because you’re waiting on K-1 forms or you are missing other tax documents. Harmony uses its professional judgment - and conversations with you - to determine an appropriate amount to pay in with the extension. This amount is often designed to cover your prior year tax balance due, plus the first quarter estimated tax payment for the current year (if required). By paying the correct amount with your extension, you can avoid underpayment penalties and potential interest charges.
Penalties for Underpayment of Taxes
The IRS and state tax agencies impose penalties on taxpayers who fail to pay the proper amount of taxes by the original due date. There are two main types of penalties: failure-to-pay and failure-to-file penalties.
Failure-to-pay penalty: This penalty is imposed when a taxpayer does not pay the full amount of taxes owed by the due date. The penalty is typically 0.5% of the unpaid taxes for each month or part of a month that the tax remains unpaid, up to a maximum of 25%. This penalty rate may be reduced to 0.25% if the taxpayer has an approved installment agreement with the IRS.
Failure-to-file penalty: This penalty applies when a taxpayer does not file their tax return by the original due date or the extended due date (if an extension was requested). The penalty is generally 5% of the unpaid taxes for each month or part of a month that the tax return is late, up to a maximum of 25%. If the tax return is more than 60 days late, the minimum penalty is the smaller of $435 or 100% of the unpaid tax.
To avoid these penalties, it is crucial to file your tax return and pay the taxes you owe by the original or extended due dates. If you cannot pay the full amount, you should still file your tax return and pay as much as possible to minimize penalties and interest.
tl; dr
You have the option to extend the FILING due date of your tax return by six months each year, but you still have to PAY your taxes on time. Your Harmony Tax team is here to help you navigate the complexities of tax extensions and underpayment penalties. We’re here to advise you on the best course of action based on your unique financial situation, assist you in accurately estimating your tax liability, and ensure that you make the best decisions regarding your tax situation, helping you stay compliant and minimize your overall tax liability.
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