From the April 2006 issue of Wealth Manager Web • Subscribe!

Down to the Wire

A Wall Street Journal story of Jan. 11, 1985, told of a woman who asked the IRS for more time to file her return, saying: "My husband and my forms have been misplaced. Please send replacements." Unfortunately, the IRS replied, we "could only replace the tax forms."

But an understanding IRS wants to help; the "service" says there is no need to panic if you need additional time to complete your return. File easy-to-complete Form 4868, known officially as Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, by April 15 and receive an automatic six-month extension to Oct. 15. Failure to file for an extension and submit Form 1040 by April 15 can result in stiff, non-deductible penalties and interest charges. (See The Penalty Box on page XX.)

Datewise, consider yourself and your clients fortunate. Returns for 2004 and prior years received an automatic extension of just four months. To obtain an extension for an extra two months, you had to file an additional form and provide an acceptable excuse which, by the way, the IRS did not have to accept.

Remember this, however: Form 4868 extends the time to file--not the time to pay. The accompanying payment does not have to equal the exact amount of tax due, as noted below, but it must be there or its absence justified. (The law authorizes an exception when the due dates of April 15 and Oct. 15 fall on a Saturday, Sunday or state legal holiday such as Patriots' Day in Maine and Massachusetts. Taxpayers in those states receive an extension until the next succeeding weekday.)

Form 4868 is available through several channels: by calling 800-TAX-FORM or 800-829-3676 (figure on 10 work days for delivery); by faxing a request for the form to 703-368-9694 (not a toll-free number); or by downloading it from the agency's Internet site-- http://www.irs.gov. Then mail it to the address given in the form's instructions.

You can also file electronically for an extension by calling toll-free 888-796-1074; using tax-preparation software like TurboTax or TaxCut on your own computer, through a tax professional or by using a credit card. Upon completion of the e-filing transaction, you will be assigned a ten-digit confirmation number. Keep it with your records. (On a personal note, I e-file by phone--a piece of cake for do-it-yourselfers.)

File later, pay now

Of course, the big hitch with Form 4868 is that it extends the time to file, not pay. The payment you submit should cover what you estimate you will owe, after subtracting taxes previously paid through withholding from salaries and estimated payments. Remember, too, to subtract any overpayment of the previous year's taxes that you elect to apply to the current year's bill-- say, 2005 to 2006. That estimate of the balance due must be in good faith.

If you're paying by check--payable to the IRS--include on it all the information necessary to credit the money properly: Social Security number, daytime phone number, the tax year and the form number.

Form 4868 does not require you to explain why you seek to postpone the inevitable. The IRS couldn't care less whether you have misplaced your records, become hopelessly ensnarled in a briar patch of tax regulations, are promptness-challenged or simply prefer to sip wine in your hot tub rather than labor over your return. When you eventually do file your return, pay any balance actually due or claim a refund for all or part of the amount you submitted with the automatic extension or earlier. Enter any extension-related payment on the Form 1040 line for "amount paid with request for extension to file" (line 69 of the 1040 form for 2005).

True, the IRS does not require payment by April 15 of the tax you estimate as due. But if it turns out that you underestimated the amount sent with Form 4868, you will be charged interest from April 15 on the balance due with your delayed return. Even worse, unlike the deductions of most other kinds of consumer interest payments, such as charge account and credit card balances and car loans, there is no deduction for interest on overdue taxes.

In addition to collecting interest, the IRS can charge a late-payment penalty if the balance due is either more than 10 percent of the tax shown on your return or it is not paid by Oct. 15. Generally, the late-payment penalty is one-half of 1 percent of the unpaid amount for each month or part of a month, up to a maximum of 25 percent--unless you can show reasonable cause for late payment. However, when the IRS assesses penalties for both late filing and payment, one partly offsets the other.

The IRS relaxes the rules for anyone unable to pay the balance due when submitting Form 4868. At one time, the agency usually considered the application request on Form 4868 to be invalid and the return delinquent. Consequently, it assessed the late filing penalty. Now, however, the IRS usually waives the penalty.

But there still is that Oct.15 deadline. By that date, you also need to make full payment or arrange for partial payments in installments by requesting Form 9465 (Installment Agreement Request) and attach it to the front of your return. Be sure to indicate the amount of your proposed monthly payment and the monthly due date.

Usually, the IRS automatically approves installment agreements for taxpayers who owe less than $25,000; who satisfy their liabilities for taxes, penalties and interest charges within five years; and are current with all previous tax obligations. There is a set-up fee of $43 for using Form 9465 which the IRS wraps into the agreement.

Good Faith

The IRS insists that you make a good faith estimate of the liability shown on Form 4868 based on information available at the time of its submission. This stipulation underscores the need to carefully estimate the tax you owe, especially if you have income from sources not subject to withholding, such as earnings from self-employment, interest, dividends, and profits from sales of mutual fund shares, individual shares and other investments. Other possibilities include alimony payments, unemployment compensation, pension payments and, for some, Social Security benefits.

If you are too casual, expect the IRS to respond harshly. It has the authority to retroactively revoke your extension, notwithstanding that the agency originally accepted your application, and it can then tack on those penalties for late filing and payment.

There is little guidance in the form of IRS regulations or court rulings to spell out what constitutes an acceptable estimate. What is clear is that you do not have to "assemble an exact picture of your income" before asking for an extension.

On the plus side, a widely noted Tax Court decision found that a sizable error does not make an estimate improper. Paul E. Harper successfully challenged the revocation of his extension. His Form 4868 stated he owed no further taxes and was unaccompanied by any payment, although it turned out that he still owed more than $90,000. For the extension's preparation, Harper had relied on an accountant who had underestimated the tax due because full business records were as yet unavailable. That, noted a federal district court in Oklahoma, was precisely why Harper had requested the extension. The court ruled it had been filed in good faith and was valid.

On the other hand, the court approved the revocation of an extension obtained by Otis Crocker, a Mississippi attorney. To challenge a revocation, warns the court, there must be evidence to show that you searched your records, attempted to find missing documents and gathered the data needed to make a good-faith estimate. It found that the attorney had failed to make a credible estimate of how much tax he actually owed.

Clients often misunderstand that an extension of time to file a return does not extend the April 15 deadline to open and fund an IRA, whether the payment is deductible (traditional IRA) or nondeductible (Roth IRA). However, a filing extension can give you additional time to decide whether to make a payment to a Keogh or other retirement plan for a self-employed person.

Remember, too, that requirements for state tax returns vary. Some states accept Form 4868 for extending a state return's due date; others require a separate application. Check the rules of the state in which you are required to file returns, including penalties for any underpayments of state taxes.

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Julian Block is a syndicated columnist and attorney based in Larchmont, N.Y. For information about his latest book, Marriage And Divorce: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes To The Legal Minimum, contact him at julianblock@yahoo.com.

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The Penalty Box

The law empowers and encourages the Internal Revenue Service to assess stiff, nondeductible penalties and interest charges against late filers who overlook the need to obtain filing extensions and submit their 1040s after the filing deadline of April 15.

For openers, there is a late-filing penalty. Generally, this penalty amounts to 5 percent of the balance due (the amount that remains unpaid after subtractions for taxes previously paid through withholdings from wages and quarterly payments of estimated taxes) for each month, or part of a month, that the Form 1040 is late. The maximum penalty is 25 percent of the balance due--a truly steep charge. On a balance due of, say, $10,000, that works out to $500 per month. The penalty can reach as much as $2,500 when more than four months elapse before your return reaches the agency.

Much harsher rules apply if agency sleuths are able to establish that the late filing is fraudulent. That monthly penalty is 15 percent up to a maximum of 75 percent.

A special rule applies when a Form 1040 is at least 60 days late. The late-filing penalty is $100 or the balance due with the return, whichever is the lesser figure. Translation: No late-filing penalty when there is no balance due.

It is still important to file on time, notwithstanding calculations that show you owe no tax now. After all, as so many taxpayers have learned the expensive way, a routine IRS verification of your computations could convert a supposed refund into a balance due. Or a subsequent audit might result in additional taxes being assessed. Either scenario sends you back to the penalty box and allows the IRS to retroactively impose the penalty.

Sometimes, the IRS will forget about a late-filing penalty. To get the agency to waive the penalty, you have to convince it that the delay was "due to reasonable cause and not due to willful neglect." For example, you are unable to complete the return by the deadline because your residence, place of business or records are destroyed due to a fire, flood, other casualty or civil disturbance, or burglary. Another acceptable excuse is the death or acute illness of an immediate family member or your own serious illness.

Taxpayer Elizabeth R. Gravett was able to avoid a penalty by showing she timely turned over her records to a professional preparer who placed them in the trunk of his car, which was borrowed by his grandson, who did not return it until two months after the filing deadline. The United States Tax Court held in 1994 that her temporary loss of records was a reasonable excuse for the late filing.

Not having enough cash on hand to settle the tab at filing time, even if you are able to prove it, is not reasonable cause to get you off the hook for a penalty. After all, the service usually allows installment payments. But worse yet, a flagrant procrastinator might even wind up facing criminal charges. --JB

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