What Makes A Tax Extension Valid?

 

You file an extension on April 15th for your personal tax return.

Is the extension valid if you wind up owing money but entered zero (-0-) on line 6?

What if you entered a balance due on line 6 but entered zero (-0-) on line 7?

A couple of things come immediately to mind:

(1)  There are clients – numerous clients – who have no intention of fully paying their taxes by April 15^th. The best the CPA can do is get them to pay something - anything - to take the pressure off the tax due (plus interest and penalties) when they finally file. I have heard the scold many times over the decades: the tax should be fully paid-in by April 15; the extension is for time to file not time to pay; yada yada. This is not a classroom, folks. This is real life, and I cannot control people. I think that I do some good just by nudging clients closer to compliance with the tax law.

(2)  Are you trying to get me sued? What if I (i) enter a number on line 4 but (ii) file the extension with no payment due (line 6)? Will the IRS bounce the extension? This is where procedural consistency is critical. I need high confidence in how the IRS will process this extension.

Let’s look at Karp.

The Karps wanted the IRS to apply a 2016 tax overpayment (of $336,558) to a later tax year.

Problem: The Karps were not diligent about filing tax returns on time. They were counting on that huge overpayment/carryover to keep them out of trouble. While true, there are ways this can blow up.

The IRS told the Karps that the 2016 overpayment could not be applied to 2017 because they filed the 2016 return in April 2021.

COMMENT: That’s how it blows up: you have to get that return in within 3 years (plus the extension, if you obtained one). The 2016 return was due April 15, 2017. Three more years is April 15, 2020. The IRS did not receive the return until April 2021 - a year late.

The Karps responded with proof that the IRS received their 2016 return on October 15, 2020.

COMMENT: Good! That is why practitioners recommend certified mail (which is becoming a dinosaur as we move to electronic filing) with proof of mailing.

FURTHER: We are not told whether the Karps actually waited until the last day for filing or were instead impacted by IRS closures during COVID.

The IRS backed down when presented proof. The IRS refunded $154,720 and credited the remaining 2016 overpayment to 2022.

The IRS then changed its mind.

Huh?

The IRS argued that the 2016 extension was invalid.

Because it was invalid, there was no extension until October 15, 2017.

Which means that the 2016 return filed October 15, 2020 was outside the three-year window (without the extension, that date was now April 15, 2020). The IRS wanted its $154,720 back. Oh, the IRS also reversed the portion of the overpayment that was credited to 2022.

“No soup for you” snarled the IRS.

Let’s catch our breath.

First, what was the IRS’ reasoning to blow up the 2016 extension?

The IRS looked at Form 4868 and saw zero (-0-) on both lines 5 and 6.

Mind you, the Karps had a sizeable overpayment from 2015 to 2016 (in fact, the Karps had reported sizeable overpayments for years). There was enough there to pay a subsequent year’s tax and send the Karps a refund check for 2016.

The IRS was relying on a Tax Court case (Crocker) where the taxpayer did not appear to even try to estimate the tax due on the extension. When finally filed, the return showed significant additional income and tax (because: of course). The Court agreed with the IRS that the extension was void. The return was late. Penalties. Interest. Brussels sprouts and lima beans. It was catastrophic.

Second, how was the IRS to know?

The 2015 return had not been received or processed by the time the 2016 extension arrived. Maybe - if the Karps ever got around to filing a tax return on time - the IRS might have had a clue of knowing what they intended for 2016.

While I disagree, I do have some sympathy for the IRS.

First, the Court noted that the Karps had a track record of (a) huge overpayments that (b) they repetitively applied to the following tax year.

COMMENT: I personally think this was THE factor that saved the Karps here.

The Karps looked at that overpayment and said: we do not owe anything for 2016. They then put zeros all over that Form 4868. Technically, they should have put (1) estimated gross tax on line 4; (2) the overpayment on line 5: and the (resulting) negative amount on line 6. The Karps did not do that, explaining that they mistakenly thought that the tax estimate was the amount they would be required to pay upon filing. The Court considered it a ministerial error, and they had conflated gross tax with net tax.

The Court also pointed out – devastatingly, I think – that the IRS initially accepted the 2016 return, including the extension as filed. That is why the IRS now wanted the refund check back.

Second, the Court noted that the IRS was put in a tough spot, as it did not have a 2015 return when processing the 2016 extension.

While it was easy for the Court to point out that the Karps had applied their prior overpayments, the IRS could not automatically predict that they would do so again. This dance was getting close to: heads you win, tails I lose for the IRS.

The Court pointed out that the Karps were still within procedural guardrails. They pushed it, but they got it done within three years.

Technically correct, but not an optimal real-world approach to tax filing.

The Court ordered summary judgement for the Karps and instructed both sides to sort the dollars involved and report the results back to for judgement.

I point out that this was not a Tax Court case. It was heard in the Court of Federal Claims, which hears civil claims against the federal government. While specialized (cases against the U.S. government), it is not the same specialization as the Tax Court (which hears only tax cases).

The cynical part of me wonders if the verdict would have been the same had the case gone to Tax Court. The Karps had an advantage: many cases go to Tax Court because one does not need to pay the tax before bring suit in Tax Court. Here, the Karps had already paid the tax (hence the huge overpayment), so filing outside the Tax Court was an option.

Our case this time was Karp v United States, U.S. Court of Federal Claims, No. 23-926, filed May 21, 2026.

Paying Personal Expenses Through A Business

I am looking at a tax case.

It reminds me of something.

There is a too-common belief that paying an expense through a business can somehow transmute an otherwise personal expenditure into a tax deduction.

Here are common ways I have heard the question:

(1)  My spouse is going to replace her car. Should we buy it through the business?

(2)  I run my business from my home. That makes my home a “headquarters,” right? Can’t I deduct all the expenses related to my business headquarters?

(3)  I am going to borrow money to [go on vacation/pay college tuition/buy a boat I’ve been wanting]. Should I have the business borrow the money to make it deductible?

Do not misunderstand, many times there is a more tax-efficient way to accomplish something. There may still be some tax though, and the goal is to minimize the tax. Making it disappear may not be an option, at least for a responsible practitioner.

Let’s look at the above questions.

(1) Realistically, if there is no business use of the vehicle, you are not allowed to deduct any of the ownership or operating expenses of a vehicle. Despite that, does it happen routinely? Of course. Practitioners do what they can, but it is like fighting the tide.

(2)  I consider this quackery, but it is a true story. No, working from home does not make your house fully deductible. You might get a home office deduction out of it, but that is a fraction of some – and not all – expenses. No, your house is not Proctor and Gamble. Get over it.

(3) This one might have traction, but in general the answer is no. Even if the interest is deductible, how is the company getting you the money? Is it going to lend it to you? If so, you will have to pay interest to the company, although you may be able to arbitrage the rate. Will the company bonus you the money? If so, I see FICA and income taxes in your future. Explain to me the win condition here.

Let’s look at Justin Maderia (JM).

JM lived in Florida and owned 50% of Lindy Inc (Lindy).

Lindy must be a C corporation, which is the type that pays its own taxes. I say this because the Court refers to earnings and profits (E&P), which is a C corporation concept. The purpose of E&P is to track a corporation’s ability to pay dividends. When it pays dividends, a corporation is sharing its accumulated profits with its shareholders. The corporation has already paid taxes on these profits (remember: a C corporation pays taxes). When it pays dividends, you are personally taxed on that previously taxed profit. This is the reason for “qualified dividends” in the tax Code: to cut you a break on that second round of taxation.

The IRS was looking at JM’s 2018 personal return. It was also looking at Lindy’s 2018 business return.

COMMENT: It is not unusual to include a closely held company with the audit of an individual tax return.

The IRS wanted to increase JM’s 2018 income by $192 grand of “stuff” that Lindy paid on his behalf.

COMMENT:  Sounds to me like Lindy was paying for EVERYTHING.

Let’s talk procedure here.

The IRS identified personal transactions in Lindy. Lindy was the type of corporation that could pay dividends, and the IRS argument was – to the extent Lindy paid for personal stuff – that such payments represented constructive dividends to JM.

Fair. Consider that the serve.

JM gets to return.

He would argue that the payments were not personal because … well, who knows why.

JM did nothing.

Huh?

JM did nothing because he had a previous audit, and the IRS never pursued the issue of Lindy payments. JM believed he was immunized.

Mind you, there is a kernel of truth here, but JM has googled the concept beyond all recognition.

IF the IRS looks at an issue AND makes no change to your tax return for that issue, you can challenge a later proposed assessment based on that same issue. You might not win, mind you, but you have grounds for the challenge.

Is this what happened to JM?

Let’s look at it.

The IRS examined his prior year return.

Score one for JM.

The IRS never looked at Lindy.

We are done.

There is no immunity. JM cannot challenge a proposed 2018 assessment on an issue the IRS did not examine in a prior year.

JM had to return on different grounds. He did not. He - procedurally speaking - automatically lost.

JM had $192 grand of additional income.

The IRS next wanted the accuracy-related penalty.

Well, of course they did. If they were any more predictable, we could just put it on a calendar.

The Court said “no” to the penalty.

Why?

Because the IRS had looked at JM’s previous return. The IRS either did not bring up or dismissed the Lindy issue, so JM kept reporting the same way. While this would not protect him from a challenge of additional income, it did provide a “reasonable basis” defense against penalties.

Our case this time was Maderia v Commissioner, T.C. Summary 2024-5.

IRS Collection Alternatives: Pay Attention To Details

 

I was glancing over recent Tax Court cases when I noticed one that involved a rapper.

I’ll be honest: I do not know who this is. I am told that he used to date Kylie Jenner. There was something in the opinion, however, that caught my eye because it is so common.

Michael Stevenson filed his 2019 tax return showing federal tax liability over $2.1 million.

COMMENT: His stage name is Tyga, and the Court referred to him as “very successful.” Yep, with tax at $2.1-plus million for one year, I would say that he is very successful.

Stevenson had requested a Collection Due Process (CDP) hearing. It must have gone south, as he was now in Tax Court.

Why a CDP hearing, though?

Stevenson had a prior payment plan of $65 grand per month.

COMMENT: You and I could both live well on that.

His income had gone down, and he now needed to decrease his monthly payment.

COMMENT: I have had several of these over the years. Not impossible but not easy.

The Settlement Officer (SO) requested several things:

·      Form 433-A (think the IRS equivalent of personal financial statements)

·      Copies of bank statements

·      Copies of other relevant financial documents

·      Proof of current year estimated tax payments

Standard stuff.

The SO wanted the information on or by November 4, 2021.

Which came and went, but Stevenson had not submitted anything.

Strike One.

The SO was helpful, it appeared, and extended the due date to November 19.

Still nothing.

Strike Two.

Stevenson did send a letter to the SO on December 1.

He proposed payments of $13,000 per month. He also included Form 433-A and copies of bank statements and other documents.

COMMENT: Doing well. There is one more thing ….

The SO called Stevenson’s tax representative. She had researched and learned that Stevenson had not made estimated tax payments for the preceding nine years. She wanted an estimated tax payment for 2021, and she wanted it now.

COMMENT: Well, yes. After nine years people stop believing you.

Stevenson made an estimated tax payment on December 21. It was sizeable enough to cover his first three quarters.

COMMENT: He was learning.

The SO sent the paperwork off to a compliance unit. She requested Stevenson to continue his estimated payments into 2022 while the file was being worked. She also requested that he send her proof of payments.

The compliance unit did not work the file, and in July 2022 the SO restarted the case. She calculated a monthly payment MUCH higher than Stevenson had earlier proposed.

COMMENT: The SO estimated Stevenson’s future gross income by averaging his 2020 and (known) 2021 income. Granted, she needed a number, but this methodology may not work well with inconsistent (or declining) income. She also estimated his expenses, using his numbers when documented and tables or other sources when not.

The SO spoke with the tax representative, explaining her numbers and requesting any additional information or documentation for consideration.

COMMENT: This is code for “give me something to justify getting closer to your number than mine.”

Oh, she also wanted proof of 2022 estimated tax payments by August 22, 2022.

Yeah, you know what happened.

Strike Three.

So, Stevenson was in Tax Court charging the SO with abusing her discretion by rejecting his proposed collection alternatives.

Remember the something that caught my eye?

It is someone not understanding the weight the IRS gives to estimated tax payments while working collection alternatives.   

Hey, I get it: one is seeking collection alternatives because cash is tight. Still, within those limits, you must prioritize sending the IRS … something. I would rather argue that my client sent all he/she could than argue that he/she could not send anything at all.

And the amount of tax debt can be a factor.

How much did Stevenson owe?

$8 million.

The Court decided against Stevenson.

Here is the door closing:

The Commissioner has moved for summary judgement, contending that the undisputed facts establish that Mr. Stevenson was not in compliance with his estimated tax payment obligations and the settlement officer thus was justified in sustaining the notice of intent to levy.”

Our case this time was Stevenson v Commissioner, TC Memo 2023-115.

An IRS Payment Plan And Tax Evasion

 

Let’s talk today about IRS payment plans. More specifically, let’s talk about common paperwork in requesting a payment plan.

A common one is Form 433-A, and it is used by W-2 workers and self-employeds.

The IRS is trying to figure out how much you earn, own, and owe.

There are questions about whether you (or your spouse) own a business, are a beneficiary of a trust or have gifted property worth more than $10,000 over the last 10 years. Yes, they wanna know stuff.

You will have to list your bank accounts, as well as other investments, real estate and other assets.

You will have to provide an accounting of your monthly income and expenses.

There is also expanded disclosure if you are self-employed (that is, a sole proprietor).

There are other ways to own a business than as a proprietor (for example, a shareholder in a C corporation). The IRS will want to know about that, too.

Part of tax practice is avoiding this series, if possible. For example, if you have personal tax debt of $50,000 or less, you can bypass the 433 series and request a “streamlined” payment plan. You are still entering into a contract with the IRS (you must stay current with your filings, make all payments as required, and so on), but in exchange the IRS lifts some of the paperwork requirements. Sometimes advisors recommend hybrid arrangements (taking out a second mortgage, for example), leaving the IRS debt at $50 grand or less. And sometimes you are simply into the IRS for more than $50 grand, leaving no choice but to run the 433 gauntlet. This can be a rude awakening, as the IRS uses standards for certain expense categories (for example, housing and utilities). You might google that you can request an increase from these standards. You can request; don’t expect to receive, though. Barring significant factors (think care for chronic medical conditions), it is unlikely to happen. Depending on the numbers, you might be forced to downgrade a vehicle or pull the kids from a private school. This is not a friendly loan.  

And you do not want to be … sly … when running the 433 hurdles.

Let’s look at someone who was too clever by half.

Kevin Crandell is a medical doctor. He contracted with two hospitals, one in Mississippi and another in Alabama, for $30 to $40 grand per month.

From 2006 through 2012 he did not file returns or pay taxes.

The IRS started garnishing his wages in 2010.

COMMENT: I find it remarkable that he still did not file or pay even when garnished.

The doctor racked up close to a million dollars in taxes, penalties, and interest.

Somewhere in there he formed a couple of corporations. He used one to receive monies earned as a contractor. The second appeared to serve as asset protection.

He finally hired someone (Blue Tax) to help out with tax returns and attendant debt.

Blue Tax drafted a 433. The first draft showed Crandell’s salary as $17 grand per month (I don’t know where the rest of the money went either). The doctor howled that the number was much too high and should be closer to $12 grand.

Oh, the 433 also left out bank accounts for those two corporations (which he controlled). And a $50,000 gun collection. And the $40 grand he drew from the corporations shortly after submitting a 433 stating that his salary was around $12 grand.

Doc, you have to know when to stop. Lying, and then lying about the lying is called something in tax.

Crandell was indicted for fraud.

That pattern of non-file and non-pay looked bad now. That “creative” 433 also gleamed like a badge of fraud, leaving off income, assets and so on.

Crandell argued that he relied on Blue Tax.

It is a good argument - an excellent argument, in fact - except that he did not fully disclose to Blue Tax. If you want to show reliance on an advisor, you have to … you know … actually rely on the advisor.

Crandell was convicted for tax evasion.

Our case this time was US v Crandell, 2023 PTC 178 (5^th Cir. 2023).

Choose The Lesser Of IRS Grumpiness

 

Let’s talk about the failure to file (FTF) penalty.

Most of us must file an annual income tax return. Unless one is an expat (that is, an American living overseas), the return is due April 15. One can extend the return for six months (that is, until October 15), but the extension is for filing paperwork and not for payment of tax.

How is one supposed to estimate the tax if a significant amount of information is unavailable? Many times, there are estimates or informed guesses; the tax preparer will extend the return using those. Sometimes there are no estimates and no informed guesses; one then does their best. I doubt there isn’t a veteran tax preparer that hasn’t been blindsided by a Schedule K-1.

Let’s continue.

You extend your return. Your K-1 comes in heavier than expected. You owe $5,000 in tax with the return, which you file and pay on October 15.

You will have something called the Failure to Pay (FTP) penalty. The tax nerds know this as the Section 6651(a)(2) penalty. The penalty is as follows:

One-half of 1% for each month or part of a month

To a maximum of 25%

Let’s use our $5,000 example.

I count seven months from April through October (remember: a part of a month counts as a month).

The FTP penalty would be $5,000 times .005 times 7 = $175. It stings, but it is not crushing.

Let’s say the return was filed on October 30.

Has something changed?

Yep.

The IRS is strict about filing deadlines. If the return is extended to October 15, then you have until October 15 to file the return (or at least put it in the mail or submit the electronic file). The 15th is not a suggestion.

What happens if you miss the deadline?

You then filed your return late.

Back to our example. You file the return on October 30. You are just 15 days late. How bad can 15 days be?

It is not intuitive. If you file the return on October 30, you have blown the extension, meaning it is like you never submitted an extension at all. Any penalty calculation starts on April 16.

So what? The FTP penalty is still the same: $5,000 times .005 times 7, right?

The difference is that you have just provoked FTP’s big brother: the Failure to File (FTF) penalty. The FTF is the gym-visiting, MMA-training, creatine supplementing and aggressive sibling to the FTP.

Start with the FTP penalty. Multiply it by 10. The tax nerds know the FTF as the Section 6651(a)(1) penalty. 

Are we saying the FTF penalty is $5,000 times .05 times 7?

Nope, this is tax. There is a loop-the-loop to the FTF calculation.

• The maximum (a)(1) and (a)(2) penalty is 5% per month or part of a month.
• The math stops when you get to 25% in total.

The first loop means that the FTP penalty comes in at .005 and the FTF penalty comes in at .045 per month (or part thereof), as the maximum cannot exceed .050 per month.

The second loop means that the math stops when you get to 25%.

How does a tax pro handle this?

Easy: multiply by 25%.

Let’s go back to the math: $5,000 times 25% = $1,250.

This could have stopped at $175 had you just filed the return on October 15. Nah, you thought to yourself. What’s another couple of weeks?

$1,075, that’s what ($1,250 - $175). That is an expensive two weeks.

So, what got me fired up about this topic?

I saw the following on a tax return this past week:

Go to the bottom where it reads “Interest Penalties.” Go across to “Failure to File.” You will see $3,619.

Someone has just thrown away over three-and-a half grand by dragging their feet on filing. There goes a vacation, new electronics for the house, an IRA contribution - anything better than sending it to the government.

The client has two years of this, BTW.

But CTG, you say, maybe they did not have the money to pay.

The FTF does not mean that one is unable to pay. Granted, in real life the two issues often go together. One rationalizes. I do not have any money; if I delay filing maybe I can also delay IRS dunning letters and collection activity.

Maybe, but practice tells me it is rarely worth it. You have to go over four years with an FTP penalty before you equal just five months of FTF penalty. That money is just too expensive.

Let’s go back to our example.

Say the $5,000 is for tax year 2021. The taxpayer filed the return on or before October 15, 2022 and only now can pay the tax. What have we got?

First, the FTF penalty goes away, as the return was filed on time.

Second, the FTP penalty would be: $5,000 times .005 times 16 = $400. (I am running the penalty from April 2022 to July 2023)

Third, there will be interest, of course, but let’s ignore that for now.

$400 versus $1,075. Seems clear to me.

What can be done if one cannot get numbers together by October 15?

Here’s a thought.

I have a client who owns a successful drywalling company. We extended his return several years ago, and sure enough – closing in on October 15 – he was out-of-town, relaxed and unconcerned about any looming doom. However, I knew that he had a good year, and that any tax due was going to be significant. An FTF penalty on significant tax due was also going to be significant. We decided to file his return with the best numbers available, intending to amend whenever we obtained more precise numbers.

Did I like doing that?

That is a No.

Did he avoid the FTF?

That is a Yes, but he delayed getting us more accurate numbers. That delay created its own problems. Problems which were … completely … avoidable.

What is our takeaway?

File your return. Extend if you must, but file by the extension date. File even if you cannot pay. Yes, the IRS will penalize you. The IRS is grumpy about not getting its money. The IRS is grumpier, however, about not getting the tax return in the first place.

Remember: when given the option, choose the lesser of IRS grumpiness.