Preface: A Wall Street Journal headline declared “Biden Tax-Increase Agenda Revived as Democrats Win Senate”. At the time of writing, we do not know exactly what tax increases will or will not come.
Should I Extend my Tax Return?
Tax Season
Time marches onward. Another year has ended, another year has begun. With the change of the calendar comes tax season.
Some taxpayers always file timely, some always file an extension. Which option is right for you? Read this article to consider the benefits of both timely filing and filing after an extension.
Benefits of Timely Filing
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- Clarity and Precision
- Avoid Procrastination
- Allow Partners to File Timely
- Calculate Quarterly Estimates
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A taxpayer might file timely to gain clarity and precision. Before the taxes are prepared for filing, the taxpayer likely does not know precisely how much the tax bill will be. Good tax planning, however, might give an idea of the amount. Think of tax planning as watching a deer walking through the field 250 yards away with the unaided eye. You can see it with the eye, but the clarity increases when the scope is placed between the eye and the deer. Likewise, preparing the tax return brings the tax bill into focus. A hunter catching sight of a big buck might shake with buck fever, and a taxpayer catching a glimpse of a huge tax liability might tremble as well.
Another reason to file timely is to avoid procrastination. The wise old saying attributed to Ben Franklin “Don’t put off until tomorrow what you can do today” might inspire some taxpayers to take care of their taxes quickly, even though they could delay if they chose to do so. Filing an extension causes a delay. It does not drive taxes away permanently.
One important reason for partnerships to consider timely filing is that the individual partners will need a K-1 from the partnership to file their personal tax returns. A partnership might therefore choose to file timely if some or all the partners want to file their personal tax returns timely.
A fourth reason to file timely is to calculate quarterly estimates for the next year. One factor in the safe harbor for tax estimates involves the income of the prior year. If a taxpayer wants to use that safe harbor, it helps to know the prior year income. If the taxpayer does not know it, then they may pay more estimates than necessary, or perhaps pay too little and miss the safe harbor.
Benefits of Extensions
So why would anyone ever extend a tax return? In some cases, the prudent taxpayer will file an extension. Here are some reasons.
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- Wait to See if the Next Year Looks Profitable
- Save on Accounting Fees
- Wait to See if Tax Rates Increase
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Many tax returns are filed on an annual basis. Tax accountants file scores of returns after December 31 but before April 15. As you can imagine, that provides a buildup of work for tax accountants. If you normally file timely but do not care when you file, consider asking your accountant if you can go on extension to get a discount since you are leveling out their workload. The price savings may make it worth the wait. Good things take time. Sometimes the first buck trotting along the path is not the biggest buck.
From time to time throughout history, tax rates go up. Taxpayers could be entering such a time. A Wall Street Journal headline declared “Biden Tax-Increase Agenda Revived as Democrats Win Senate”. At the time of writing, we do not know exactly what tax increases will or will not come.
If taxes increase significantly, some taxpayers may prefer to defer depreciation until future years, when tax rates are higher, rather than accelerate depreciation on new purchases this year when rates are lower. Without knowing the tax rates, that decision is more difficult. Some taxpayers may benefit from extending to see how it ends up. Patience sometimes pays.
Another reason to extend is to assess how profitable next year will be. If a taxpayer files in February, they have a small idea of how the next year will be, and they might find it difficult to make tax decisions on tax elections, such as depreciation. Alternatively, a taxpayer filing in July would have a much longer timeframe to assess how well the next year is going.
If the next year appears to be going well, the taxpayer may save some depreciation to reduce income in that year. Alternatively, if the year past was great and the next year is challenging, the taxpayer may elect to accelerate depreciation into the high-income year. The additional months may reduce the guesswork
To Extend or not to Extend?
As you read the article, did any of the points resonate with you? Different taxpayers will make different decisions. Do not automatically file on time, and do not automatically file for an extension. Consider which path makes sense in your situation. Hopefully this article brings some clarity and perspective to you as you hunt for the answers.
This article is general in nature, and it does not contain legal advice. Contact your advisors to discuss your specific situation.