Mar 06, 2023
Income tax return filing extensions… wow, are they convenient when something happens in your life, and you can’t meet the IRS and State annual income tax return filing deadlines. However, as with anything, there is always a “con” to most “pros.” I know our position will not be very favorable with a lot of accountants and CPAs out there. However, our viewpoint from the tax debt resolution world is that an extension does not always help our clients as we work towards resolving tax bills the IRS or State are chasing a taxpayer over and should be avoided at all costs. Hear me out…
For most W-2 employees, filing their annual income tax return on time is not a problem. They may have some deductions to claim on Schedule A that requires waiting on documentation from various sources to allow for the return to be completed. However, at the end of the day, these are pretty simple tax returns to compile and should be submitted on time. Most of our clients do not fall into this category in the tax debt resolution world.
For self-employed individuals or those who own a business and receive flow-through income, a.k.a. 95% of the individual taxpayers who have tax debts with the IRS or State, filing an extension on their personal income tax returns with the IRS and State can cause some significant hiccups while pursuing a resolution to a tax debt. Why? Compliance!
To resolve a past-due tax debt owed by a taxpayer, that individual or business must be deemed “compliant” with all current tax obligations. Compliance means that all tax filings must be submitted for the last seven tax years, and all ongoing tax payment obligations must be paid on time and in full. Without the compliance stamp of approval on a taxpayer’s account, the IRS and State will not consider a resolution to the tax balances currently reflected as owed for fear that new balances will continue to be added to the old. This practice is commonly referred to in the tax world as “pyramiding” tax debt (adding new debt on top of the old year after year).
The annual income tax returns for individuals and C-Corporations report the taxpayer’s income received and the taxes owed. As we know, income can fluctuate significantly from year to year. One year, Mr. Smith could have a net profit from his sole proprietorship of $60,000; the next year, it could be $120,000. ABC, Inc., a C-Corporation, could have a gang-buster year with a taxable income of $580,000 in one year, lose a client, and the taxable income could then drop to $200,000 the following year. As both types of taxpayers are required to submit estimated tax payments throughout the year for income received along the way, these wild variations in income from year to year could cause a real problem with ongoing compliance being maintained.
There are always workarounds: keeping meticulous records to analyze the income received every quarter, over or under-estimating ongoing obligations based on year-to-year comparisons, or worst case, “guesstimating.” Whichever option is chosen, the best tool for a taxpayer that is required to make estimated tax payments is to have the prior year’s tax return as a guideline.
For example, Mr. Smith is a salesman with a sole proprietor business, and his income fluctuates drastically from year to year. Mr. Smith has tax debts owed for 2018, 2019, 2020, and 2021, and he is determined to get on a resolution to address those debts. He is 100% committed to not accruing a balance owed for 2022 and wants to stay compliant with 2023’s estimated tax payment obligations moving forward. It’s March 15th, and his records have been turned in to his tax return preparer. The preparer replies with, “your tax return is more involved, and I don’t have time to do it until later this year… I’ll just file an extension, and you will be fine.” At this point, not only does Mr. Smith not know what his tax obligation for 2022 is, his first estimated tax payment for 2023 is due on April 18th. How does he know what he should pay? If he doesn’t make a payment, we can’t submit a resolution for consideration to address the past-due tax debts. It’s a nasty cycle!
I know, I know… he should have been keeping better records along the way, and he shouldn’t have accrued a tax debt for 2018 through 2021. Yes, in a perfect world, that may be the case. However, taxpayers aren’t perfect… they have setbacks to their businesses that carry a real dollar and cents impact that prevents them from always tending to the expenses that should technically be a priority. However, when faced with a choice of paying an estimated tax payment or paying the electricity bill, which do you think carries the most immediate weight? And this is why our viewpoint is that “filing extensions on annual income tax returns when not necessary should be avoided if possible.”
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Disclaimer: There are requirements that must be satisfied in order to qualify for some of the tax solutions we discuss on our website. Not all of our services will be suitable for every client. Golden Lion Tax Solutions is here to help you find the most appropriate solution to fit your situation.