April 29, 2003

Chances are it’s not what you think. Most people think an extension is a grace period to avoid paying taxes for a period of time.

“Wrong,” says Millian Toms, our local CPA. “While it’s true you cannot be denied an extension, that is, you don’t need an excuse for one, you do have to pay 90 percent of what you owe in taxes by April 15.

“The only thing extended is the filling out of the form. For example, you may be waiting for a K1 form if you’re in a partnership, and they may not have yet filed. You must use your best guess.

“Other than that, it’s just procrastination,” Millian says.

So while getting an extension is a cakewalk, and they all last exactly four months, meaning if you have an extension now the return is due Aug. 15, it doesn’t give you free time to blow.

“I make every effort to get each of my clients done and in on time – so long as they brought me their information on time, and complete,” Millian says. “I’m like any other businessperson. If I know you’ve had difficulties, such as a heart attack, and couldn’t get your paperwork to me until close to April 14, I’ll work very hard for you.

“But if everything was OK and you bring me a box of disorganized papers on April 14, I’ll do the best I can, but the other people who made an effort with their records will receive priority,” she said.

The penalties imposed by the Internal Revenue Service are not the sort of thing to wave off, like a meeting with a relative that went sour.

“Once you get the extension, it’s yours, unless you missed by more than 10%, then it’s void,” Millian says. “The most important thing is carefully calculating your taxes. You have to estimate to within at least 90 percent on April 15. If you did your best guess, you need to find out and file as soon as possible after the extension.”

There are a host of penalties for missing that 10 percent, you are considered to not have filed timely, and for many other things associated with not paying the proper amount at the proper time. As a matter of fact, volumes have been written about it. Here’s just a taste:

• There’s a 5 percent penalty for each month, or fraction of the month, you fail to file – up to a maximum of 25 percent. Millian notes if people would just get their information to her, they at least could file on time and avoid this penalty. If the return is not filed within 60 days, the penalty will not be less than the lessor of $100 or 100 percent of the tax due on the return.

• There’s nothing mysterious about when penalties start, Millian says. “They always start on the day after the taxes should have been paid and filed.” If the IRS later decides you owe additional tax, the penalty period begins to run after the 21^st calendar day up to the day of payment (Make that the 10^th business day if the amount is over $100,000.)

• If the fraud or accuracy-related penalties apply, the failure-to-file penalty is increased to 15% for each month, up to 75%. This is why accuracy is so important.

By the way, Millian adds a deal often can be struck with the IRS over the penalty, the amount of it and perhaps bringing that amount down, the IRS never negotiates interest rates. Of the penalties you’ve read so far, and will read about, each accrues interest for which you are responsible. “The only two ways the IRS will release its hold on interest is if it resulted from incorrect advice from the IRS itself, or you happen to be in a presidentially declared disaster area.”

• You also can be penalized for improper valuation of an object, such as giving a junker car to Mother Waddles and then claiming it as $10,000 deduction. Remember, you received an extension for 10 percent. If you actually come in higher than that – say $5,300 – that throws out the 10 percent rule, which means in the eyes of the law, you didn’t file on time, and the penalties associated with that problem are all yours.

A substantial understatement exists when the understatement for the year exceeds the greater of (1) 10% of the tax required to be shown on the return or (2) $5,000 ($10,000 for C corporations). Two penalties apply to underpayments of tax: the accuracy-related penalty and the fraud penalty. The accuracy-related penalty consolidates all of the penalties relating to the accuracy of tax returns. It is equal to 20% of the portion of the underpayment the is attributable to one of the foll

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Millian M. Toms is a Royal Oak-based CPA and business advisor. She is also an active member of the community including The Optimists and Greater Royal Oak Chamber of Commerce. 

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