It’s that time of year again: when birds chirp, buds grow on trees and you lose sleep over the April 15th tax deadline. It doesn’t have to be that way: You should have peace of mind to enjoy springtime. This year, the individual 2015 tax return deadline is April 18, 2016 (April 19, 2016 if you live in Maine or Massachusetts), and a six-month extension is available until Oct. 17, 2016.
Six-month extension of time to file
Take charge of your relationship with the IRS: Request an automatic six-month extension of time to file your federal and state income tax returns. Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required.
It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. In good faith, estimate and report on the extension form what you think you owe for tax year 2015 based on your tax information received.
Try to pay at least 90% of your actual tax return liability with the extension filing to avoid a late-payment penalty of 0.5% per month, up to a maximum of 25%. Filing a timely extension avoids the more onerous late-filing penalty of 5% per month, up to a maximum of 25%. Refer to Form 4868 for further details.
Here’s an example. Assume your 2015 tax liability is $50,000. You file an extension by April 18 but don’t pay any of your tax liability. You file your actual tax return on the extended due date of Oct. 15, 2016 with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 18. The late-payment penalty is $1,500 (6 months late x 0.5% per month x $50,000). Some traders view a late-payment penalty like a 6% margin loan. I’ve seen traders skip an extension payment to trade the tax money longer, only to lose it and cause bigger tax penalties. That’s risky.
By simply filing the extension on time in the above example, you avoided a late-filing penalty of $11,250 (6 months late x 5% per month (25% max), less late-payment penalty factor of 2.5% max, equals a net late-filing penalty of 22.5% x $50,000). Interest is also charged on taxes paid after April 18.
Pay extra with your tax extension
Profitable traders should consider making quarterly estimated tax payments due during the year to avoid underestimated tax penalties. I recommend the following strategy for traders and business owners: Overpay your tax extension on April 15 and apply an overpayment credit toward Q1 current-year estimated taxes. Most traders don’t make estimated tax payments until Q3 and or Q4, when they have more visibility on trading results. Why pay estimated taxes for Q1 and Q2 if you incur large trading losses later in the year?
It’s a better idea to add a cushion to your 2015 tax liability and payment with the extension filing. That gives you three good choices: You’ll have a cushion on 2015 if your estimates of tax liability are low, you can apply an overpayment credit toward 2016 taxes or you may request a tax refund for 2015 if no estimated taxes are due.
Benefits from filing extensions
Sophisticated and wealthy taxpayers know the real tax deadline is Oct. 17, 2016 for individuals and Sept. 15, 2016 for pass-through entities, including partnership and S-Corp tax returns.
You don’t have to wait until the last few days of the extension period like most wealthy taxpayers. Try to file your tax return in the summer months, when IRS and state auditor’s are on vacation. I think audit percentages drop after April 18.
I’ve always advised clients to be aggressive but legal with tax-return filings and look conservative with cash (tax money). Impress the IRS with your patience on overpayment credits and demonstrate you’re not hungry and perhaps overly aggressive to generate tax refunds. It’s a wise strategy for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you’re going to be successful in the current tax year.
The additional time helps build tax positions like qualification for trader tax status in 2015 and 2016. It may open opportunities for new ideas on tax savings. A rushed return does not. For example, a large trading gain or loss during the summer of 2016 could affect some decision-making about your 2015 tax return. It’s like having the stock market results of April 18 a day early on April 17.
The extension also pushes back the deadline for paying money into qualified retirement plans including a Solo 401(k), SEP IRA and defined benefit plan. If you did a Roth IRA conversion in 2015, you’ll have six months of additional time to recharacterize (unwind) the conversion. That may come in handy, if the stock market drops in Q2 and Q3 2016.
Working with accountants
Your accountant can prepare extension forms quickly for a nominal additional cost related to that job. There are no fees from the IRS or state for filing extensions.
Your accountant begins your tax compliance (preparation) engagement and he or she cuts it off when seeing a reliable draft to use for extension filing purposes. Your accountant will wait for final tax information to arrive after April 18 to complete your tax return. Think of the extension as a half-time break. It’s not procrastination; accountants want tax returns finished.
Please don’t overwhelm your accountants the last few weeks and days before April 18 with minor details on your tax return in a rush to file a complete tax return. Accounting firms with high standards of quality have internal deadlines for receiving tax information for completing tax returns. It’s unwise to pressure your accountant, which could lead to mistakes or oversights in a rush to file a complete return the last-minute. That doesn’t serve anyone well.
Broker 1099-Bs often come late
It’s difficult for securities traders to file a complete tax return by April 18 considering that many brokers send original and corrected Form 1099-Bs late. In some cases, this occurs just days before April 18, or even after.
In a blog post earlier this tax season, I pointed out how securities Form 1099-Bs are apples vs. oranges when it comes to applying Section 1091 wash sale loss rules for taxpayers. It’s a challenge to reconcile your own trade accounting with 1099-Bs so why stress over this reconciliation before the tax deadline? (Read my blog post Securities Brokers Don’t Tell The Full Story About Wash Sale Losses.)
It’s unwise to rush to file a complete tax return based on a 1099-B that could be corrected after filing. Corrected 1099-Bs based on complex cost-basis regulations have been par for the course the last few years. Why incur the cost and risk of filing an amended tax return? If you don’t reconcile your Form 8949 with the 1099-B, IRS computers will likely send you a tax notice, spotting differences under their matching program. (Read my blog post Traders: Don’t Talk To An IRS Agent Until You Read This.)
Traders should focus on trade accounting
If you know you’ll have a capital loss limitation of $3,000, it doesn’t matter if your capital loss is $50,000 or $75,000 at extension time. Either way, you’ll be reporting a capital loss limitation of $3,000 against other income. In this case, don’t get bogged down with trade accounting and reconciliation with Form 1099-Bs until after April 18.
Consider wash sale loss rules. If you know wash sale loss adjustments won’t change your $3,000 capital loss limitation, you can proceed with your extension filing. But if you suspect wash sale loss adjustments could lead to reporting capital gains rather than losses, or if you aren’t sure of your capital gains amount, focus your efforts on trade accounting well before April 18. Trade accounting software downloads original transactions, not 1099-B information, so you won’t be held up waiting for 1099-Bs.
For Section 1256 contracts, you can rely on the one-page 1099-B showing aggregate profit or loss. For forex, you can rely on the broker’s online tax reports. Wash sales don’t apply to Section 1256 contracts and forex.
Some states don’t require an automatic extension if you’re overpaid; they accept the federal extension. Generally in all states, if you owe taxes, you need to file a state extension with payment. States tend to be less accommodating than the IRS in waiving penalties, so it’s usually wise to cover your state first if you’re short on cash. Check the extension rules in your state.
U.S. citizens and resident aliens abroad
Excerpt from the IRS website: “If you are a U.S. citizen or resident alien residing overseas, or are in the military on duty outside the U.S., on the regular due date of your return, you are allowed an automatic two-month extension to file your return and pay any amount due without requesting an extension. For a calendar year return, the automatic two-month extension is to June 15. If you qualify for this two-month extension, penalties for paying any tax late are assessed from the two-month extended due date of the payment (June 15 for calendar year taxpayers). However, even if you are allowed an extension, you will have to pay interest on any tax not paid by the regular due date of your return (April 15 for calendar year taxpayers).”
Extensions for entities
Tax extensions for pass-through entities are March 15, 2016 for S-Corps and April 18, 2016 for partnerships with an extension due date of Sept. 15, 2016. (Note that the IRS recently changed the rule for next year: 2016 partnership tax returns will be due March 15, 2017 to synchronize with S-Corps.)
Pass-through entities are tax filers, not taxpayers, so the federal extension is simple to prepare without any tax liability. Be sure to file it on time because the late-filing penalty for missing the election is $195 per month per partner or shareholder up to a maximum of 12 months.
Some states have nominal franchise taxes, minimum taxes or excise taxes so check with your state or tax advisor. The state taxes are generally due with the extension filing. March 15 is also the deadline for an existing entity — LLC, C-Corp or general partnership (in most states) to elect S-Corp tax status. And March 15 is the date for existing S-Corps to elect Section 475 MTM treatment.
Click to read Green’s blog post in Forbes. It’s a prior and different version.