Considering whether to file an income tax extension

As practitioners throughout the United States reflect on tax season 2017, the last detail they might consider is whether more clients should be encouraged to file an extension. For some taxpayer clients, an extension is a regular, yearly occurrence. For others, the notion of requesting time beyond the original due date is outlandish. And there also are those for whom the decision to extend comes down to the wire, determined by whether the return can be filed by the original due date. However, an extension of time to file generally should be considered for every taxpayer and for every tax period for which an extension is available, regardless of whether the taxpayer intends to file on or before the original due date of the relevant income tax return.

IRS processing of extensions

Taxpayers can file extensions of time to file income tax returns electronically or by paper. When the extension is filed electronically, the IRS will post the extension to the appropriate taxpayer's account under the relevant tax form and tax period. If the IRS rejects the electronic filing because of, for example, a mismatch of information, the taxpayer can resubmit or file by paper. When an extension is paper-filed (and proof of mailing is retained by the taxpayer or representative), it is input by IRS personnel to the taxpayer's account.

Protection from a late-filing penalty for individual taxpayers

Even when an extension is filed, any balance due must be paid by the original due date of the return to avoid a failure-to-pay penalty and interest. For corporate taxpayers, if at least 90% of the tax shown on the filed return is not paid with the filing of the extension by the original due date, the extension will not be approved, possibly causing a failure-to-file penalty to be assessed—in addition to the failure-to-pay penalty and interest.

For individual taxpayers, however, an extension may be approved regardless of payment of any balance due by the original due date (although reasonable efforts should be made to complete the amounts included on Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return). While a failure-to-pay penalty (at 0.5% of the tax shown or assessed on the return, per month (or portion of a month), with a 25% cap) will be imposed until the tax is paid, the higher failure-to-file penalty (at 5% of the tax required to be shown on the return after any earlier payments or credits, per month (or portion of a month), also with a 25% cap) will not be assessed as long as an extension is filed by the original due date and the return is filed by the extended due date. (During periods where both the failure-to-file and failure-to-pay penalty apply, the maximum for both penalties together is 5% per month, effectively reducing the failure-to-file penalty to 4.5% per month. Where both penalties apply to their maximum amounts, the total will reach a combined 47.5%.)

Individual taxpayers who are unable to pay by the original due date can file an extension, thus saving them the higher failure-to-file penalty, as long as they file by the extended due date.

Superseding returns versus amended returns

An amended return is one filed after an original return and after the due date (including extensions). A superseding return is one filed after an original return but prior to the due date (including extensions). The seminal case establishing the availability of superseding returns is Haggar Co. v. Helvering, 308 U.S. 389 (1940). In Haggar, the Court held that a " '[f]irst return' thus means a return for the first year . . . and includes a timely amended return for that year" (308 U.S. at 395). "A timely amended return is as much a 'first return' . . . as is a single return filed by the taxpayer for the first year" (id.).

A taxpayer may also file an amended return after having filed both an original return and a superseding return. While the IRS posts both the amended and superseding returns as "subsequent returns," there are important differences between them. Amended returns are filed after the return's due date has passed. It does not become the return for the year (as does a superseding return). Amended returns can be viewed as existing alongside the original or superseding return. Superseding returns, on the other hand, can be looked at as essentially bumping out any prior return, as long as the superseding return is considered filed on or before the due date (including extensions). In explaining the difference between amended and superseding returns when teaching these principles to colleagues, one of the authors often uses two sheets of paper to illustrate: For amended returns, he shows both papers next to each other; for superseding returns, he discards the first sheet of paper and replaces it with the second sheet.

The option of filing a superseding return has several benefits. The most common is its facilitation of a tentative carryback. If, for example, a calendar-year taxpayer incurs a tax loss in 2016 that it may carry back to 2014 and 2015 (both of which have tax liabilities), the taxpayer may want to generate cash from the carryback at the earliest moment and file its 2016 return as soon as possible in early 2017. The taxpayer, however, may not be ready to file a complete and accurate 2016 return until much later in 2017. Without the availability of superseding returns, the taxpayer must either wait until it is ready to file a complete and accurate 2016 return, or it risks the earlier filing of a possibly incorrect or incomplete return. In the typical tentative carryback scenario for a corporation, a taxpayer will file a preliminary or "barebones" Form 1120, U.S. Corporation Income Tax Return, that includes income, deductions, credits, forms, and schedules that are necessary to compute its tax for its 2016 loss to be available for carryback. (The authors recommend including a disclosure with such a preliminary return, advising the IRS that it may contain estimates and that the taxpayer plans to file a superseding return.) Along with Form 1120, the taxpayer will likely include Form 1139, Corporation Application for Tentative Refund, to have its carryback processed as soon as possible.

Later in the year—but before the extended due date of the return—the taxpayer will file a subsequent Form 1120 to correct any data reported on the initial return. As a superseding return, this will become the return for the year. It will also allow the taxpayer additional time in which to process more accurate data and include forms, such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, that may have been missed on the initial return. Individuals may also file a barebones return and a subsequent superseding return to facilitate the filing of Form 1045, Application for Tentative Refund.

Extension of the time in which a superseding return may be filed

While a taxpayer may file a superseding return on or before the original due date of an income tax return, filing an extension will increase the period in which a superseding return may be filed. Consider, for example, Chief Counsel Advice (CCA) 200645019, in which the taxpayer filed its initial 2002 Form 1120 and a Form 1139 prior to its extended due date of Sept. 15, 2003, then filed a superseding return within that period.

On March 15, 2003, (two days before the original due date) the taxpayer filed Form 7004, Application for Automatic Extension of Time to File Corporation Income Tax Return,extending the time to file until Sept. 15, 2003. Before Sept. 15, 2003, the taxpayer filed its original Forms 1120 and 1139 for tax year 2002. (It is unclear from the redacted CCA whether the taxpayer filed its initial Form 1120 and Form 1139 prior to or after filing its Form 7004. However, the authors believe it should make no difference to the outcome; even if the taxpayer files the initial return before filing an extension, as long as the extension is filed on or before the original due date, it should be valid and operate to extend the due date of any superseding return.) The IRS determined that the filing of the initial Form 1120 did not revoke the remaining extension of time that it had granted through Sept. 15, 2003. The taxpayer, therefore, had until Sept. 15, 2003, to file a superseding return. Filing the extension allowed the taxpayer the maximum time in which to identify any errors or omissions or replace any estimated numbers and have the subsequent return be treated as the return for the tax year, i.e., a superseding return.

Time to catch international information returns

In recent years, the authors have seen more frequently that, in addition to needing more time to file an income tax return, a taxpayer may not have enough information to file a complete and accurate international information return. Filing an extension can allow more time to file such information returns. First, an extension of time to file the income tax return is also an extension of time to file any associated international information returns, such as Form 5471. Therefore, if an initial return was filed without such forms, whether inadvertently or because of a lack of information, an extension can provide needed time in which to file a superseding return with the proper information returns. Indeed, CCA 200645019 also concluded that Forms 5471 that were omitted from the initial return but included in the superseding return would be treated as having been timely filed.

To thwart the unexpected

In the authors' role as co-leaders of tax quality and risk management at their firm, they are well-aware of the inadvertent errors that can occur within a tax practice. These foot-faults can include, for example, late returns, missed international information returns, and missed tax elections. As in most tax practices, many returns are filed within a very short time on and before the original due date, and mistakes can and do happen. Often, these mistakes can have significant consequences, such as large penalties or untimely and therefore invalid elections. In many cases, by simply filing an extension, preparers can avoid penalties and make timely extensions.

Filing an extension does not necessarily mean that a taxpayer opts to delay filing a return—the taxpayer may intend to file by the original due date. However, once the timely extension is posted, the taxpayer now has the extended filing period in which to correct any errors. As noted above, an extension generally does not extend the time in which to pay; however, where payment of any balance due is not the issue, an extension will allow a taxpayer to file an omitted information return or make a valid tax election that may not have been an option without the extension.

The authors believe that practitioners should consider extensions of time to file for almost every client each year. In many cases, extensions provide a sort of insurance against late-filing penalties and penalties for missed international or other information returns, as well as expand the window for a superseding return.

Some clients, however, choose to file by the original due date. Some taxpayers also incorrectly believe that filing an extension can draw the IRS's attention to their account or risk their standing with the IRS. Practitioners must educate clients that filing extensions—whether or not they file their return by the original due date—presents no such risk or issues. As such, practitioners should consider advising clients of the benefits of having a timely extension posted to their account and seek permission to file one on their behalf in case additional time is needed to address a number of issues that a timely extension can afford.