I Said Extend, Not ExtenZe

Editor’s note: The City Wire has invited David Potts, an accountant with more than 25 years of experience, to provide a series of detailed commentaries on the accounting side of starting and maintaining a business.

guest commentary by David Potts

April 15 is approaching. Many of you are waking up in the middle of the night anxious and frustrated. You haven’t prepared your income tax return yet and you don’t even know where you put all your 1099s. You can’t go back to sleep so you turn on the television. Every third channel is the ExtenZe infomercial telling you that size matters, and that just adds to your anxieties. Those anxieties I can’t help you with. You will have to call Dr. Drew. But I can advise you how to deal with the April 15 income tax deadline.

Extending the due date to file your individual income tax return is easy. It is one of the few easy things you can do with the IRS. All you have to do is complete Form 4868 Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. The only information you need is your name, address, and social security number(s); an estimate of your 2008 tax liability; how much you have paid the IRS toward your 2008 tax liability, and how much you are going to pay with the extension form. You don’t even have to sign the form. Once the extension is filed, you have six months or until Oct. 15, 2009 to complete and file your Federal income tax return. Arkansas and Oklahoma accept the extended Federal deadline as long as you filed a valid Federal extension.

Filing Form 4868 is an extension of time to file, not to pay. If when you file your income tax return you owe money, you will have to pay a late payment penalty and interest on any balance not paid by April 15. The late pay penalty is equal to half of 1% of the unpaid balance and the penalty is assessed monthly. The interest rate for underpayment of individual income tax is currently 5%, but this interest rate changes quarterly. So if you file an extension for six months and you haven’t paid all your 2008 income tax liability, and if you wait until Oct. 15 to file your return and pay your income tax due, you will have to pay an additional 3% late-payment penalty plus interest expense. The late payment penalty tops out at 25% of tax due.

What happens if you don’t file your income tax return on time and you fail to file for an extension? It depends. If you owe money and it is not paid by April 15, the penalty for late filing is 5% per month up to 25%. That gets expensive. But it you overpaid your income tax liability, nothing happens. Penalties for late filing are based on how much you owe. If you owe nothing, there is no penalty. But you won’t get your refund until you file your return.

Many taxpayers believe they are asking for an IRS audit if they file for an extension of time to file their income tax return. Relax, this isn’t true. The IRS has so stated.

There is folklore however that says that if you file an extension it will reduce your chance of being selected for an audit. Now note the most important work in that previous sentence: folklore. There is no IRS policy or written acknowledgement that this is true. However, years ago I asked an IRS agent if there was any truth to this. He said there was probably some truth in that as the year progressed his load of open audit files increased. Toward the end of the audit cycle, he had so many case files opened that when new cases arrived he could only open maybe two out of 10. He would then review these files, select the returns he thought would result in the largest income tax adjustments, and send the rest back.

But like I said, it’s just folklore that filing an extension could reduce your chances of your income tax return being audited. But the IRS has said that filing an extension doesn’t increase your audit risk. So what’s the harm (as long as you pay all your taxes by April 15). Have mercy on your CPA and file an extension to file your income tax return.

David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas. You can follow his blog at ThePottsReport.com.