As a tax planner and an advocate of automated accounting systems, I’ve said many times that preparation of the tax return is the least important and certainly least valuable service that I provide. I’ve used the phrasing, even over the objections of tax preparers, that the business tax return should almost effortlessly “fall out” of a properly functioning business accounting system. Yet that is less likely to happen when a business automatically files for a tax return filing extension and not take on their accounting tasks as soon as possible.
I am convinced that there are compelling reasons to tackle the business tax return as early as possible and not automatically file for an extension. Here are five of those reasons:
- Most small business owners address their annual accounting and financial statement preparation at the same time or immediately before they address tax return preparation. Also, in my observation, most small businesses have some types of accounting, compliance and internal control deficiencies. These problems are an unfortunate but inherent part of operating a business in today’s complex environment. Some of these are serious problems (fraud, sales that were not invoiced, lagging collections, unpaid fees that are accruing penalties, etc.). The sooner these are found and addressed, the better. An earlier annual accounting timetable addresses the internal accounting deficiencies of last year sooner and not allow them to continue to taint this year’s books into August and September. When preparing a businesses extended tax return in early September, for example, I often discover a problem from the prior year that has continued though the first eight months of the current year. Filing a tax extension often has the psychological effect of a ‘out of sight, out of mind’ mentality that allows the business owner to postpone addressing business accounting. In my experience this is the most important reason to avoid the almost automatic response of filing a business tax return extension.
- For tax planning purposes, the most effective tax-saving strategies need to look forward and work best when implemented as early as possible based on current tax data. That tough to do when it’s already September of the current when we first look at last year’s financial results. For example, the Tax Cuts and Jobs Act triggered a loss of tax deductions for some employees and partners that I’ve covered in other blog posts like here and the series of industry specific tax planning articles that began here. The changes occurred January 1, 2018 so the loss of tax benefits is already affecting these taxpayers even if they don’t know it. These adverse tax effects can be mitigated, however, only when the business addresses their changed tax planning situation. In my experience, the psychological effect of filing a tax return extension is to postpone tax planning as well. In this case, the potential tax saving doe the period of delay (typically six months) are lost and not recoverable.
- For small business clients that rely on defined benefit pension plans for many higher income clients we must also pay attention to the plan deadlines. The pension plan contribution calculation typically considers the net taxable income of the owner/employee. The pension plan actuarial work and administration is stalled until the tax accounting is addressed. (My clients typically use defined benefit pension plans more often than the clients of other tax planners simply because this has evolved as a niche practice).
- The deadline for making a contribution for a calendar year pension plan is September 15. This pension plan contribution deadline is earlier than the extended corporate calendar return due date for a C corporation of sole proprietorship is October 15. The pension plan contribution does not extend. The plan has its own plan year that is nor extended because the business tax filing is extended1.
- A delayed business tax return delays the tax planning of the individual partners or members. This has the same effect as #2 above. Additionally, an extended business tax return often creates extra work (and fees) for communication between the business and individuals’ accountants. It would simply be more efficient to have the Schedule Ks from the business tax return ready when the individual’s tax preparer looks for them.2
1 IRC Section 404 generally allows for the employer’s retirement plan contribution to the preceding taxable year as long as it is made by the employer’s tax return due date including extensions. For businesses using a cash basis accounting, the pension contribution must actually be made to be on tax return of that prior year. IRC Section 404(a)(6) and IRC Section 430 may require small business pension plans to make the contribution earlier than the tax return due date.
2 Tension may be raised when the individual taxpayers needs to present a copy of the filed tax return to a third-party by a specific date, for example for college tuition scholarships, government-required disclosures, or refinancing a home mortgage.