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 Lesser Known Statute Of Limitations

The last time I checked, IRS Appeals personnel count was down by approximately 20% and – no surprise – getting a case through Appeals is taking over a year.

There is danger – and potentially an immediate one – to taxpayers and tax advisors.

Take a look at this cheerful composition:

26 U.S. Code § 6532 - Periods of limitation on suits

(1) General rule

No suit or proceeding under section 7422(a) for the recovery of any internal revenue tax, penalty, or other sum, shall be begun before the expiration of 6 months from the date of filing the claim required under such section unless the Secretary renders a decision thereon within that time, nor after the expiration of 2 years from the date of mailing by certified mail or registered mail by the Secretary to the taxpayer of a notice of the disallowance of the part of the claim to which the suit or proceeding relates.

(2) Extension of time

The 2-year period prescribed in paragraph (1) shall be extended for such period as may be agreed upon in writing between the taxpayer and the Secretary.

(3) Waiver of notice of disallowance

If any person files a written waiver of the requirement that he be mailed a notice of disallowance, the 2-year period prescribed in paragraph (1) shall begin on the date such waiver is filed.

(4) Reconsideration after mailing of notice

Any consideration, reconsideration, or action by the Secretary with respect to such claim following the mailing of a notice by certified mail or registered mail of disallowance shall not operate to extend the period within which suit may be begun.

We see the following:

The IRS has 6 months to respond to a claim for refund. If no response is forthcoming within that time, the taxpayer can sue for refund, as long as the suit or proceeding occurs within the two-year period beginning with the date the IRS formally disallowed the claim.

What if the IRS never responds to the claim? Your tax advisor (CPA or attorney) will likely recommend you file suit within 2 years from filing the claim. If you file, a tax CPA will hand you off to a tax attorney. A tax CPA can do a lot, but one must be a member of the bar to litigate.

What happens if you miss the Section 6532 deadline?

Let’s look at this next artful arrangement:

26 U.S. Code § 6514 - Credits or refunds after period of limitation

(a) Credits or refunds after period of limitation

A refund of any portion of an internal revenue tax shall be considered erroneous and a credit of any such portion shall be considered void—

(1) Expiration of period for filing claim

If made after the expiration of the period of limitation for filing claim therefor, unless within such period claim was filed; or

(2) Disallowance of claim and expiration of period for filing suit

In the case of a claim filed within the proper time and disallowed by the Secretary, if the credit or refund was made after the expiration of the period of limitation for filing suit, unless within such period suit was begun by the taxpayer.

(3) Recovery of erroneous refunds

For procedure by the United States to recover erroneous refunds, see sections 6532(b) and 7405.

(b) Credit after period of limitation

Any credit against a liability in respect of any taxable year shall be void if any payment in respect of such liability would be considered an overpayment under section 6401(a).

Section 6514(a)(2) can be brutal: the IRS is prohibited from issuing the refund unless within such period suit was begun by the taxpayer.

Oh, this is all big corporate tax stuff, you say. Unless your name is Apple or Nvidia, can this ever reach you?

Yepper.

What if you filed for an ERC (employee retention credit) and (1) have never heard back from the IRS or (2) did hear back but the IRS disallowed the claim? The IRS has been using Letter 105C (if they disallowed the ERC claim in full) or Letter 106C (if they partially disallowed the claim). A 105C letter will include language like this:

         

There is the disallowance language that Sections 6532 and 6514 allude to.

When was the IRS sending out these letters?

After running ERC claims through a risk-scoring algorithm, the IRS sent out approximately 28,000 letters 105C and 106C during the summer of 2024. If the taxpayer responded (to the 105C or 106C), the IRS would then conduct an mini-audit before sending the file to Appeals.

2024 plus 2 years equals 2026 – your two-year statute of limitations is coming up.

Is there a way to avoid filing in Court but still preserve your rights to a refund?

Yes. Let’s go back to Section 6532(a)(2).

There is a form that goes with it.

  

Here is the Internal Revenue Manual on Form 907:

On first impression, I like the Form 907 option. What more do we need to know about it?

(1)  First, you are still within Section 6532, so this must be done within the 2-year window.

(2)  Both parties – you and the IRS – must sign Form 907.

(3)  If the case is being actively worked, the Revenue Agent or Appeals Officer can hopefully help obtain the appropriate IRS signature.

But what if the case is not being actively worked?

There are several ways this can happen:

·      The file is lost (I had one lost in IRS Kansas City a few years ago; it held up a real estate closing).

·      You are waiting for the protest to be transferred to Appeals.

·      The protest has been transferred to Appeals but remains unassigned.

·      The protest was transferred and assigned but your AO is no longer working at the IRS. It again is … unassigned.

·      You never even filed a protest to either Letter 105C or 106C.

The IRS considers Form 907 to be an internal form, to be initiated by IRS employees. If you have settled on Form 907 and your back is to the wall on obtaining an IRS signature, consider the Taxpayer Advocate.

But give yourself breathing room. I suspect that trying to obtain an IRS signature on short notice – whether actively worked or not, assigned or unassigned – will prove futile.

You might have to file suit to preserve the claim.

 

An Ugly Case Over An Ugly Penalty

 

You know that the IRS pays especial attention to foreign transactions of U.S. citizens. We are to report foreign bank accounts, for example, should they exceed a certain balance.

Did you know that you may also have to report gifts made to you by individuals (and entities) overseas and exceeding certain threshold amounts?

That may come as a surprise, as we anticipate gifts to be tax free (and unreported) by the recipient. To the extent we pay attention to this area of tax, it is the donor - not the donee - who reports a gift. It is even possible to have a tax (the gift tax) if one cumulatively gifts “too much” over a lifetime.

Let’s be candid here: this is not a risk you or I have to sweat.

What got me thinking about it is a recent case coming out of California. Ms. Huang litigated over IRS penalties for her failure to timely report gifts from her overseas parents. She used TurboTax to prepare her taxes, and TurboTax advised her incorrectly about the gifts. She believes she has reasonable cause for abatement of those penalties.

I agree with her.

I also think this area of tax law is a mess.

Let’s go over this – briefly.

First, there are two considerations with foreign gifts:

·       Disclosure

·       Taxation

It is unlikely that there will be a tax, but it is likely that you must report the gift. There is even a specialized form for this – Form 3520: 

Trust me, one can have a long career in public accounting and never see this form.

The filing threshold varies depending on the donor:

Gifts From Foreign Individuals

·       The threshold is $100,000. Not surprisingly, multiple gifts from the same person (say mom) must be added together.

o   BTW, if mom gets creative and arranges to transfer more than $100 grand via various family members, there is a related party rule that will combine all those donors into one person – and put you over the $100,000 threshold.

o   Once required to file, each gift of $5 thousand or more is to be separately identified and described.

o   There may be excellent reasons for the multiple gifts. There are numerous countries which impose restrictions on outbound currency transfers. South Korea, for example, places a limit of $50,000 (USD).

Gifts From Foreign Corporations or Partnerships

·       The reporting threshold is greatly reduced if a business entity is involved – to $19,570.

·       In addition to the usual gift information, one is also to provide the name, address, and tax identification number (if such exists) for the entity.

Inheritances

The IRS takes the position that an inheritance is comparable to a gift. If one inherits from a nonresident, the inheritance might be reportable on Form 3520.

EXAMPLE: Carlos is a lawful permanent resident of the U.S. His uncle – a nonresident alien - passes away, leaving Carlos a house in a foreign country. While the residence is outside the U.S., Carlos is a U.S. permanent resident and should file a Form 3520.

Let’s change the example a little bit:

EXAMPLE: Carlos’ uncle was also a lawful permanent resident of the United States, even though he lived for substantial periods outside the U.S. The inheritance now is from one “US person for tax purposes” to another, and there is no need to file Form 3520.

  The penalties for not filing a 3520 can be onerous.

·       5% of the gift amount for each month a failure to file exists. In the spirit of not bayoneting the dead, the IRS will (fortunately) stop counting once you get to 25%.

·       If the IRS contacts you before you contact them, the penalty changes. It then becomes $10,000 for each month you fail to file Form 3520 after request.

·       Penalties will apply even if you filed a 3520, if the IRS believes that the return is incomplete or incorrect.

·       BTW this penalty can chase you unto death – and beyond. There are cases where the IRS has demanded penalties from the estates of deceased individuals.

So, what happened to Ms. Huang?

Her name is Jiaxing Huang, and in 2015 and 2016 her parents gifted substantial sums to help her relocate to the U.S. and purchase a home. Ms. Huang, like millions of others, used TurboTax to prepare her taxes for those years. She asked - and TurboTax informed her - that donors, not donees, are required to report gifts. Based on that feedback, she did not file Form 3520 for those years.

COMMENT: TurboTax was correct, IF one was talking about gifts from a U.S citizen or lawful permanent resident to another. It was not correct in specialized circumstances – such as that of Ms. Huang’s.

A couple of years later she learned of her filing obligations. Trying to play by the rules, she immediately filed Form 3520 for 2015 and 2016. She was late, of course, but she filed before the IRS ever contacted her – or had any reason to suspect that she was even required to file.

The IRS responded – here is a (too) common reason people hate the IRS – with penalties exceeding $91 grand.

COMMENT: The IRS churns these letters automatically. They do not go by human eyes. I propose – as a small improvement – that the someone at the IRS review these letters and related files before sending out such onerous penalties. I understand workforce limitations, but let’s be blunt: HOW MANY NOTICES CAN THERE BE?

Ms. Huang submitted an abatement request based on reasonable cause.

The IRS denied the request. They then withheld her 2019 ($280) and 2022 ($7,859) tax refunds.

Of course.

She appealed the denial of abatement within the IRS itself.

COMMENT: She was trying.

She instead learned that her penalty had jumped to over $153 grand. With interest she was topping $190 grand.

This was so egregious that even the IRS backed down. Appeals reduced the penalty to slightly over $36 grand.

Ms. Huang paid it.

COMMENT: No!!!!!

Two weeks later she filed a Claim for Refund.

COMMENT: Yes!!!!!

Her grounds? Abatement of the penalties – as well as the 2019 and 2022 tax refunds the IRS intercepted.

Let’s take a moment to explain why Ms. Huang paid the penalty.

In many if not most areas of tax law, one can bring suit without paying the tax (or penalty or whatever). That is one of the attractions of the Tax Court: you can get a hearing before sending the IRS a nickel. Not all areas of tax law are like this, however. An area that is not? You guessed it: Form 3520 penalties.

COMMENT: If you think about it, this is one way to keep people from bringing suit. How many can afford to pay the tax (or penalty or whatever) AND pay a tax attorney to litigate? It’s a nice scam you have there, Agent Smith.

The government did its usual: an immediate motion to dismiss the complaint. They even offered four reasons why the Court should dismiss.

The Court agreed with the government on three of the reasons.

It did not agree with the fourth: whether Ms. Huang’s reliance on tax software such as TurboTax under these circumstances could constitute reasonable cause.

Ms. Huang will have her day in Court.

But at what cost to her.

And why – when the IRS is hemorrhaging employees and losing budget allocations it likely should not have received in the first place – are they wasting their time here? The facts are unattractive. Ms. Huang is not a protestor or scofflaw. She tried. She got it wrong, but she tried. There is no win condition here for the government.

Our case this time was Jiaxing Huang v United States, Case No 24-cv-06298-RS, No District California.