Most people know that Roth individual retirement accounts (IRAs) have a “5-year rule,” that is,…
Minimize Stress During Tax Time—File an Extension!
The Internal Revenue Service (IRS) allows taxpayers to file for a 6-month extension if they need more time to prepare their tax returns. You can obtain a tax extension for any reason—the IRS grants them automatically and without penalty as long as you complete the proper form on time. Both Maryland and Pennsylvania accept the Federal extension when there is no tax payment; a state extension is only needed for these two states if you are sending a payment.
Not only will you gain 6 months to file, you also will relieve the stress associated with pulling everything together by the April tax deadline. More time and less stress means that you and your tax preparer will be able to thoroughly review your return and ensure that you are taking advantage of all the tax benefits available.
You will also avoid failure-to-file penalties, which can add up to 25% of the tax due. If you file an extension but miss the extended deadline, then you will be subject to this penalty. Keep in mind that filing an extension gives you only more time to file, not more time to pay—required payment is still due at the time of the April deadline. In addition, some tax professionals theorize that filing an extension will decrease your odds of being audited, because IRS auditors must meet audit quotas and try to do so early in the year. Although the IRS does not disclose its process for selecting returns for audit, the earlier a return is filed, the longer it is in the system and thus more apt to be subject to review.
You cannot file an accurate return if you do not have all the information that you need or if the information is incorrect. It is not unusual for some information returns, such as a Schedule K-1 or Form 1099, to arrive too late to allow you to complete your tax return by the April deadline. Financial institutions and investment companies typically send 1099s to their customers to report interest, dividends, capital gains, and sale proceeds. These 1099s are often corrected, especially if they are based on information from multiple investments.
By filing an extension, taxpayers who take advantage of certain tax strategies can gain time to make more informed decisions and possibly reduce their taxes. For example, taxpayers who convert funds from a traditional IRA to a Roth IRA can later recharacterize the conversion back to a traditional IRA at any time before the tax-filing deadline. The deadline is usually April 15; however, filing an extension actually extends the deadline to October 15 to recharacterize the conversion without the need to amend the original return.
The extension effectively buys the taxpayer an additional 6-month period to both monitor the value of the Roth IRA and to determine whether it makes sense to either pay taxes on the Roth conversion or to undertake a recharacterization to save on taxes. For example, if the market crashes after converting to a Roth, you are normally better off undoing the conversion through a recharacterization and then reconverting the post-crash amount. In addition, sole proprietors and LLC members can benefit from the additional time to make SEP and individual 401K contributions with an extension.
In summary, filing for an extension can be a smart choice for many taxpayers. Filing for an automatic extension allows for an additional 6 months to gather your documents, prepare accurate tax returns and to better ensure that all tax advantages are maximized, K-1s are received, and broker 1099s are correct.