Insights & Thoughts

When to File an Extension

by | Jan 1, 2015 | Tax Planning

April 15th? Maybe just another day of the year

If it seems like every year preparing and filing your taxes has become more and more difficult, it’s because it has. There is probably no better proof of the need for tax reform than what most Americans have to go through now to simply file form 1040.  In the past, this was mostly a problem for the ultra-wealthy that had various business interests, tax shelters and an army of accountants to keep up with it all.  Not so today. Anyone with even a basic level of financial complexity in his or her life faces a myriad of changing tax rules and strategies to understand and stay current on from one year to the next.

If you’re a business, the challenges of complying with the tax code are even worse.  This is especially true of financial institutions. Whether they are banks, brokerage firms, or investment companies, any firm that is required to report investor’s activity to the IRS is being buried by those obligations. One simply has to take a look at the length of their 1099 they receive every year to get a sense of what we’re talking about.

Ten years ago, the typical client’s 1099 form was roughly 6 pages long. That same client will have seen the number of pages grow to over 50 today. The amount of information that the IRS wants from these financial institutions on you and I has simply exploded. This is clearly an effort by the government to capture any lost tax dollars it thinks may be going unreported.  In reality, though, it has created a complex chain in which a series of financial institutions have to file reports to one another so that finally your bank or brokerage firm can provide you with what you need to file your taxes.

Here’s a typical scenario: You own a mutual fund in your brokerage account. That fund invests in a variety of securities that include ETF’s, partnerships, futures or maybe option contracts.  Each of those underlying investments inside the ETF, for example, has to send their financial information to their transfer agent who then passes that along to the shareholder (the ETF manager). The ETF manager then compiles that with all of their other holdings and forwards that to their shareholders (the mutual fund company).  The fund company, in turn, compiles that data with all of their other holdings and sends that to your brokerage firm, who then collects similar information for all the activity in your account and prints your 1099.

In the past, the amount of information collected and sent a long was pretty much limited to interest, dividend and sales proceeds. There is now far more data that has to be collected and with each new data point comes the likelihood that something will be wrong or missing.  Any correction then has to get forwarded up the food chain. This ultimately shows up as a corrected 1099.

The Affordable Care Act created the biggest reporting burden by requiring financial institutions to keep up with the cost basis of most securities held in taxable accounts for the purpose of calculating your trading gains or losses. This is no easy task as the cost basis is subject to tax rules themselves. Factors affecting the cost basis are, just to name a few, the amortization of premiums and discounts, wash sale rules or accounting for multiple tax lots.

Securities subject to these requirements were fully phased in over four years ending last year. Our experience is that we’ve seen more and later corrected 1099’s (some as late as June).  Understandably, clients have become increasingly frustrated when this happens. I can’t count the number of calls I have received during the past couple of tax seasons with the question “Is this the last 1099?”  As badly as I want to answer this, unfortunately, there is no way for neither me nor the brokerage firm, in our clients’ case, Charles Schwab & Co., to know.

Through the normal course of business, we often speak to our clients’ accountants and what we’ve heard from them is that filing tax returns by April 15th is becoming a thing of the past. There just isn’t enough time by then to accurately compile all of the information the government requires and disseminate it to the end user – tax payers. Literally, every accountant we spoke to last year told us that they are advising their clients to plan on filing an extension from here on out.

Based on what we’ve experienced, we agree with this advice. If you have been receiving late corrected 1099s, it’s probably a good idea to file a tax extension. This will relieve a great deal of stress for both you and your accountant. Filing an extension with the IRS gives you an additional 6 months to file your taxes pushing back the deadline from April 15th to October 15th.  It’s important to note that this extension of time does not provide additional time to pay and payments made after April 15th are subject to penalties and interest. If you are due a tax refund, this will delay receipt, but filing an extension does not mean you have to wait until October, you can file in late June only delaying your refund slightly. On a side note, if you’re receiving a substantial refund each year, you should revisit your tax situation and adjust your tax payments instead of giving the government an interest free loan every year.

Filing an extension is easy and done so by filing Form 4868, which is a very simple and short form. The only somewhat tricky part is that you have to estimate your total tax liability for the year. To do so, you’ll need to prepare a mock form 1040. While state tax extension guidelines vary, many states do not require you to file a state extension if you already filed a federal one. Georgia, for example, applies the automatic six-month extension if a federal extension has been accepted and a copy of the federal extension is attached the return when filed. Alabama automatically grants a six-month extension and does not require tax payers to file an Alabama extension form.

If you expect to receive late corrected 1099s, filing an extension can make life easier for both you and your accountant. Please let us know if you have any questions about filing an extension or contact your CPA.


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