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.

A Cannabis Business Offer In Compromise

 

Let’s talk reasonable collection potential (RCP).

If the conversation turns to RCP, chances are good that you owe the IRS and are hoping to settle for less than the full amount. A couple of programs come immediately to mind:

• Offer in Compromise

• Partial Payment Installment Agreement

 As you might guess, the IRS requires paperwork before agreeing to this. The IRS wants to look at your:

• Income

• Expenses

• Assets

• Liabilities

• Future Income Potential

Yes, the process is intrusive. I have had clients balk at the amount of disclosure involved, but in truth it is not much different from what a bank would request. I rarely work with OICs or partial pays these days. Some of it is the client base, but some also reflects past frustration. I have started this process too many times with a client and the first wave of documentation comes in quickly enough; the second wave takes longer. The last wave may take long enough that we must start the first wave over again, and sometimes we never even receive the last wave. It has happened enough that I am now reluctant to get involved, unless it is a client I have known for a while and am confident will follow instructions. The IRS is going reject a partially completed application anyway, so there is no upside to submitting one.

COMMENT: This is a repetitive tactic of the reduce-your-tax-debt mills. They will assemble and file whatever, knowing (or at least should know) that the application will be rejected. That does not matter to them, as they are paid in advance.

The IRS is trying to pin down how much you can pay: the RCP.

And it is not what you may think.

Assets are relatively easy: you must list and value all your assets. You may not want to disclose that restored Corvette or gun collection, but you really should.

Liabilities are tricky. You will submit all your liabilities, but the IRS may not allow them. Credit card debt comes to mind. Let’s just say that the IRS is not overly concerned whether you fail to repay your credit card balances.

Income again is easy, unless you have unusual sources of income. In practice, I have found that the IRS also has difficulty with erratic (think gig) income, sometimes to the point that one cannot get a plan in place.

Expenses can break your heart. Just because you have an expense does not mean that the IRS will allow it. Examples? Think an expensive car lease, private school tuition, even veterinary expenses for an aging dog. For some expense categories, the IRS will look to tables listing normalized allowances for your region of the country. You supposedly can persuade the IRS that your situation is different and requires a larger number than the table. I wish you the best of luck with that.

Future income potential has disqualified many. Let me give an example:

·      A retiree has substantial health issues. It is unlikely that the retiree will (or can) return to work, meaning that current income (sources and amount) is likely all there is into the foreseeable future.

·      A young(er) nurse practitioner is bending under the weight of credit cards, car loan, day care, and aging parents.

The IRS is not going to view the retiree and nurse practitioner the same. One’s earning power is behind him/her, whereas the other likely has many years of above-average earning power remaining. Granted, both may be in difficult straits and both may receive relief, but it is unlikely that the relief will be the same. The retiree may receive an OIC, for example, whereas the nurse practitioner may receive a temporary partial-pay with a two-year revisit. Even then, I anticipate that getting a partial pay for the nurse practitioner is going to be … challenging.

Let’s talk about a recent RCP situation that irritates me. It involves a business.

Mission Organic Center (Mission) is a state legal marijuana dispensary in California.

COMMENT: Two things come into play here. The first is the federal Controlled Substances Act, which classifies cannabis as a Schedule 1 substance. The second is a Code section (Sec 280E) that prohibits businesses from deducting ordinary business expenses from their gross income if the business consists of trafficking in controlled substances. This gives us the odd result of a state-legal business that cannot deduct all its expenses on its federal tax return. Perhaps the state will allow those expenses on its return, but there is no federal equivalent. An accounting firm can deduct its payroll, rent and utilities, by contrast, but a cannabis business cannot (there is an exception for cost of goods sold, but let’s skip that for now).

This raises the question: what is the reasonable collection potential of that cannabis business?

Did you know that there are different accounting methods for different purposes?

Let’s say that you are auditing a Fortune 500 company.  You probably want to keep the accounting on the pavement, something the accounting profession refers to as “generally accepted accounting principles.” Leave the pavement too long or too far and you might have liability issues.

Switch this to the tax return for the Fortune 500, and it is a different matter. The IRS is likely telling you which bad debt – or inventory, or asset capitalization, or depreciation, or deferred compensation, or (on and on) - accounting method to use. The profession calls it “tax accounting,” and that is what I do. I am a tax CPA.

Here is the Supreme Court in Thor Power Tool distinguishing generally accepted accounting income from taxable income:

The primary goal of financial accounting is to provide useful information to management, shareholders, creditors, and others properly interested; the major responsibility of the accountant is to protect these parties from being misled. The primary goal of the income tax system, in contrast, is the equitable collection of revenue; the major responsibility of the Internal Revenue Service is to protect the public fisc. Consistently with its goals and responsibilities, financial accounting has as its foundation the principle of conservatism, with its corollary that "possible errors in measurement [should] be in the direction of understatement rather than overstatement of net income and net assets." In view of the Treasury's markedly different goals and responsibilities understatement of income is not destined to be its guiding light. Given this diversity, even contrariety, of objectives, any presumptive equivalency between tax and financial accounting would be unacceptable.”

Got it: financial accounting provides useful information to stakeholders and tax accounting funds the fisc. Both use the word “accounting,” but they are not the same thing.

Question: what does a business pay bills with?

With cash. Unless somebody is throwing in equity or loaning money, profit is the sole remaining source of cash.

Mission owed a lot of taxes. It submitted an OIC. An IRS Settlement Officer reviewed the OIC and disallowed the Section 280E expenses. The reasoning? The IRS has a policy of disregarding for RCP purposes those business expenses nondeductible under Code Sec. 280E.

I do not see this is an issue of discretion. I see it as a matter of economic reality. Mission needed cash to pay the IRS, and merely making something nondeductible does not create cash. The IRS missed a step here by conflating RCP (an economic measurement of cash) with taxable income (which might mirror cash by luck or accident but then only rarely).

Mission however had a history of filing tax returns without paying. We are not making friends and influencing people here, Mission.

The Tax Court looked at this and decided that the policy was within IRS discretion, and the Settlement Officer did not abuse her discretion by following that policy.

I disagree.

We now have a precedential case that Congressional tax-writing caprice will override an economic evaluation of a business’ ability to generate and retain the cash necessary to pay its tax obligations to the IRS. Let me restate this: Congress - via tax law - can bankrupt you.

Bad facts.

Bad law.

Our case this time was Mission Organic Center v Commissioner, 165 T.C. 13 (2025).