If I file an extension to complete my tax return after the IRS deadline, are there any mistakes I should avoid that involve stock compensation income?
The deadline for filing federal tax returns with the IRS for the 2022 tax year is April 18, 2023. If you cannot file by the due date, you must obtain an official six-month extension of your filing period, though you must still pay any tax you owe by the deadline. You owe income tax with your tax return if your payroll withholding and any estimated tax payments during the tax year did not cover the total amount of your tax.
The IRS routinely postpones the filing due date for taxpayers in areas affected by natural disasters. You can find out whether you qualify for a postponement in the IRS website section Tax Relief In Disaster Situations. For most of California, the April 18 due date for 2022 tax returns has been extended to May 15, 2023.
Filing An Extension
In any tax year, stock compensation income, such as from an NQSO exercise, an ISO or ESPP disqualifying disposition, or the vesting of restricted stock, can raise your income tax and make your return complex. For help, see a special section of this website called Reporting Company Stock Sales.
To gain an automatic six-month extension for the due date of your tax return (October 15), you can use IRS Form 4868, Application For Automatic Extension Of Time To File. Alternatively, you can file for an extension through the IRS Free File system. If you're a US citizen or resident alien living overseas, or are in the military on duty outside the US, you receive an automatic two-month extension to file your return and pay any amount due without requesting an extension.
The extension applies only to the filing of your tax return. It does not apply to any tax you may owe, which you must pay by the original IRS filing deadline to avoid penalties.
You must accurately estimate how much tax you need to pay. By paying 100% of your tax when you file the extension, you avoid interest and penalties. See the IRS tips on errors to avoid.
The IRS automatically processes a six-month filing extension if you pay all or part of your taxes electronically by the deadline. You don't need to file a paper or electronic Form 4868 when making a payment with IRS Direct Pay, the Electronic Federal Tax Payment System, or with a debit or credit card. Simply select "extension" as the reason for the payment.
Alert: If you can file your tax return by the deadline but cannot pay all of your tax bill, do not file an extension. To avoid a late-filing penalty, file your return on time and pay as much as you can. The IRS will then send you a bill or notice for the remaining amount you owe, including any penalties and interest. If you lack the funds to pay your income tax, you may want to consider asking to pay by installments, or you may want to work out with the IRS an online payment agreement, offer in compromise, or temporary delay in collection until your financial situation improves. See another FAQ for information on arranging an installment plan or an offer in compromise with the IRS.
The IRS has different penalties for the failure to file at all and for underpaying taxes owed. The safe harbor for avoiding a penalty for your extension is paying at least 90% of the total actual income tax. If you owe any taxes with the actual return that you file by the extension deadline, you owe interest on any underpayment going back to the original filing due date. The IRS publishes the rates every quarter (see Internal Revenue Code Section 6621). If you end up paying more than 10% of your total tax with your actual return after the deadline, interest and penalties will apply. To avoid the failure-to-file penalty on what you owe, you must file the extension no later than the original deadline of your return.
Bear in mind that the penalty for failing to file is generally more costly than the penalty for failing to pay. The penalty for missing the initial filing due date or the extended deadline is 5% (4.5% for filing late and 0.5% for paying late) of the balance due for each month, or part of a month, up to a maximum of 25%. You can face a failure-to-pay charge of 0.5% a month on any unpaid taxes if you have not paid at least 90% with the extension. The IRS does not assess both penalties for the same period. The 0.5% penalty will also be assessed if you do not pay all of the tax due with the final tax return.
Alert: In an announcement (June 29, 2020), the IRS states that the penalty rate for failure to pay tax is cut to half while an installment agreement is in effect. The usual rate of 0.5% per month is reduced to 0.25%. For the calendar quarter beginning July 1, 2020, the interest rate for underpayment is 3%.
If you lack the funds to pay your income tax, you may want to consider asking to pay by installments or working out an offer in compromise with the IRS (see a related FAQ), or even paying by credit card through special service providers (they charge a fee for a percentage of the payment).
Alert: Starting in 2020, the minimum penalty for the failure to file a federal tax return within 60 days after the due date is either $435 or 100% of unpaid tax, whichever is lower. The dollar penalty is adjusted annually for inflation.
Different Extension Form For US Taxpayers Outside The United States
Income received by US citizens living anywhere in the world is subject to US federal income tax laws, though you are actually taxed only if your yearly income exceeds a certain amount ($112,000 in 2022). US citizens and resident aliens abroad can request an extension of the filing deadline on IRS Form 2350. When you file, be sure to claim the foreign earned income exclusion on IRS Form 2555 or IRS Form-2555-EZ, which you attach to your IRS Form 1040 tax return.
Remember To File An Extension For Your State Return
Don't forget about your state tax return. For example, if you pay tax to the state of California and cannot file by the due date, you get a six-month filing extension. As with your federal return, you will still need to pay at least 90% of any tax you owe by the original filing deadline.
Note: You can test your knowledge of tax-return extensions with a quiz from the AICPA.
Looking Ahead: Estimated Tax Payments
If you expect additional income from stock grants, and if your salary withholding and the withholding at the statutory rate for supplemental income will be inadequate to cover the taxes you will owe for the full year, consider making estimated tax payments (or see if you can adjust your salary withholding). To avoid any penalties on your tax return next year, be sure that over the upcoming year you pay the IRS either 90% of your expected tax bill or 100% of last year's taxes (for adjusted gross incomes over $150,000, it is 110%). The penalties are calculated on a quarterly basis, so you need to make estimated tax payments in the quarter that you have earned the income (see IRS Form 2210). If you are basing your estimated tax payments on your prior year's tax, then the estimated payments should be spread equally over the four quarters to avoid penalties.