In a statement posted to its website on February 3, 2023, the IRS asked certain taxpayers to temporarily hold off on filing their 2022 returns until it could issue guidance on how to treat special tax refunds and payments made by approximately 20 states in 2022. The IRS published additional guidance to resolve this issue a week later—clarifying that most taxpayers needn't report state relief payments as income on their 2022 returns.
The last-minute IRS announcement disrupted the tax filing process, albeit briefly, and caused some taxpayers to question whether they should file for an automatic six-month extension … just in case the IRS finds other issues that require clarification. Although there don't appear to be any other lingering uncertainties in the tax rules for 2022, there may be other valid reasons to extend your 2022 deadline from April 18, 2023, to October 16, 2023, as well as some potential drawbacks to watch for.
Filing an Extension
In addition to giving the IRS extra time to work the "bugs" out of the current tax code, filing for an extension can give you extra breathing room. This can come in handy if, for example, you haven't received all the paperwork (including W-2s, 1099s and K-1s) or finished all the necessary transactions to complete your 2022 federal tax return. It's also helpful for snowbirds who are out of town, as well as people who are ill or too busy working to file by Tax Day. Dealing with a major life event—such as the birth of a child, divorce or moving—could also prompt you to file an extension.
The process of filing for an automatic six-month extension is simple: Ask your tax advisor to file Form 4868 by April 18. Doing so gives you until October 16, 2023, to file your 2022 return—and avoid late filing penalties.
But there's a catch: An extension to file isn't an extension to pay your tax bill. By Tax Day, you must make a good-faith estimate of your tax liability. To avoid penalties, by April 18, you generally must have paid at least:
- 90% of the current year's tax liability, or
- 100% of the prior year's liability.
The latter threshold increases to 110% of the prior year's (2021 in this case) liability if your adjusted gross income (AGI) for 2022 was over $150,000 ($75,000 if your filing status for 2022 is married filing separately).
Reasons to Extend Your Deadline
Examples of situations where an extension may provide opportunities to collect data or complete transactions that could reduce your 2022 tax liability include:
Business auto expenses. If you use a vehicle for your self-employed business, you can deduct either:
- Actual expenses (including depreciation expenses) related to your business use, or
- A simplified flat mileage rate prescribed by the IRS.
For 2022, the IRS issued midyear guidance that increased the flat mileage rate for business travel to better reflect increased fuel prices. As a result, the flat rate is 58.5 cents for each mile of business travel between January 1, 2022, and June 30, 2022, plus the actual cost of any tolls and parking fees. The flat rate increases 4 cents to 62.5 cents per mile of business travel between July 1, 2022, and December 31, 2022.
Even though the midyear adjustment adds an extra step to the calculation, the flat rate is still easier to use. But, if you take the time to examine your records, you might determine that using the actual expense method produces a bigger deduction. An extension gives you extra time to compile the detailed records needed to support the actual expense method.
Important: You can generally switch to the actual expense method if you've used the flat rate to deduct business auto expenses in a prior year. But, if you've previously claimed a deduction for accelerated depreciation on the vehicle, you generally can't switch to using the flat rate on that vehicle in subsequent tax years.
Medical expense deductions. Under current tax law, if you itemize deductions in 2022, you can deduct unreimbursed medical expenses in excess of 7.5% of AGI. For itemized deduction purposes, medical care is defined as "procedures and care for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body." IRS regulations further stipulate that medical care includes medical, laboratory, surgical, dental, and other diagnostic and healing services. Care that's merely beneficial to your general health isn't considered medical care.
A portion of the fees paid to enter and reside in a continuing care retirement community can qualify as medical expenses for medical expense itemized deduction purposes. Such fees often are substantial—so they can push you over the AGI threshold.
Important: The IRS also issued midyear guidance that increased the flat mileage rate for deductible medical expenses for 2022. The flat rate is 18 cents for each mile of medical-related travel between January 1, 2022, and June 30, 2022, plus the actual cost of any tolls and parking fees. The flat rate increases by 4 cents to 22 cents per mile of medical-related travel between July 1, 2022, and December 31, 2022.
Compiling all the documentation to support a medical expense deduction can take time and effort. Remember that health care providers need time to work through invoices with your insurance company (or Medicare) and there may be a delay between when you receive services and when you receive the final bill. A tax professional can help you understand which costs are deductible.
In-progress "like-kind" exchanges. An extension can provide extra time if you need to complete a like-kind exchange that you initiated in late 2022. Under Section 1031 of the tax code, you can defer the capital gains tax hit on transfers of real estate if you exchange it for qualifying "like-kind" property.
To qualify for a tax-favored like-kind exchange, you must receive the replacement property by the earlier of:
- Midnight of the 180th calendar day following the date you relinquished your property, or
- The due date of your federal income tax return for the tax year in which you relinquished your property, including any extensions.
For instance, an investor might swap a warehouse for an apartment building or vacant land in a like-kind exchange. If the transaction qualifies for Sec. 1031 treatment, there's generally no tax due on a timely exchange, except for any "boot" received (such as cash to make up for differences between the properties' fair market values).
Before you file for an extension, be aware of the potential drawbacks. First and foremost, you must pay your estimated tax liability for 2022 by April 18, 2023. If you underpay, you'll owe an interest charge penalty. In addition, if it turns out that you're due a refund for 2022, filing an extension will postpone it. In effect, you're granting Uncle Sam interest-free use of your refund money.
Plus, filing an extension just postpones the inevitable. Rather than allow this dreaded chore to hang over your head all summer, it might be easier to check it off your to-do list this spring—and then move forward with tax planning for the 2023 tax year.
Important: Despite rumors that an extended tax return increases your exposure to an IRS audit, there's no evidence to support that theory. In fact, an extension could reduce the risk of an audit if you're using the extra time to fix errors, assemble your records or clear up inconsistencies.
To Extend or Not to Extend?
The clock is running out on filing your 2022 tax return. An extension stops the clock and gives you extra time to plan out your final tax strategy. Contact your tax advisor to discuss these and other possible solutions specific to your situation.