Special Tax Alert
Yesterday, the IRS and Treasury announced in a news release that they will issue guidance that provides a 32-day postponement, to May 17th, for certain individuals to either file or extend their 2020 income tax return and pay their 2020 income tax liability. While the announcement of the grace period is welcome news to taxpayers, there are many reasons why taxpayers should currently still plan to file their tax returns and make their tax payments by the April 15th deadline.
What Is a Grace Period?
Based on the IRS’ recent COVID-19-related guidance regarding tax deadlines (see, for example, Notice 2020-35, discussed here), the forthcoming guidance is expected to provide a grace period, rather than an extension, for individuals to either file or extend the due date of their 2020 income tax returns and pay their 2020 income tax liability. By providing a grace period, the IRS would be treating a tax return or tax payment made by May 17th as timely filed or paid, for interest and penalty purposes. However, it is important to note that the grace period does not change the actual due date or change the date that the tax return is actually filed or the payment is actually made. Therefore, penalties, interest, and additions to tax for late filing and late payment will begin to accrue on any remaining unpaid balances as of May 17th.
What Does and Doesn’t the Grace Period Apply To?
Based on the announcement, the grace period applies only to individual taxpayers whose tax returns are due on April 15, 2021. Those taxpayers can defer the payment of taxes due on their 2020 tax return, including self-employment taxes, until May 17th.
However, it is important to be mindful of what the announcement does not apply to. As explained below, the grace period does not affect:
Taxpayers who reside in Texas, Oklahoma, and Louisiana (they may still take advantage of their earlier relief);
Taxpayers’ 2021 estimated tax payments, which remain due April 15th;
Taxpayers who do not have a federal income tax filing deadline of April 15th;
State income tax deadlines; and
Non-income tax deadlines.
Taxpayers Who Reside in Texas, Oklahoma, and Louisiana
The IRS has already provided a grace period until June 15, 2021 with respect to various individual and business tax returns and associated tax payments for taxpayers that reside In Texas, Oklahoma, and Louisiana. Taxpayers in those jurisdictions should review the IRS guidance to determine what returns and taxes the grace period applies to.
2021 Estimated Tax Payment Questions
In general, to avoid being subject to a penalty for underpayment of estimated taxes, an individual must either have taxes withheld or make estimated tax payments of the lesser of 90% of the tax for the current year or 100% of the tax shown on the return for the prior year. Because the announced grace period does not apply to the 2021 estimated tax payment that is due on April 15th, taxpayers are left with questions, including:
How can taxpayers ensure that they are within the safe harbor so that they do not underpay their 2021 estimated taxes?
It appears that taxpayers will need to have their 2020 federal tax return finalized by April 15th so that they know the amount of tax shown on that tax return.
Will the IRS issue further guidance that allows an overpayment due to a payment that accompanies a 2020 extension request (an extension payment) that is filed during the grace period to count toward a taxpayer’s 2021 first quarter estimated tax obligation?
In general, in applying the penalty for failure to pay estimated tax, the IRS compares the amount of the required installment to the amount that is paid on or before the due date of the installment. Traditionally, the deadline to make an extension payment is the same as the deadline to make the first estimated tax payment for the following taxable year. Therefore, any overpayment of prior year taxes that a taxpayer elects to credit against estimated tax for the following year (rather than requesting a refund) is timely if made with respect to a taxpayer’s first quarter estimated tax payment.
Due to the announcement, the date to make an extension payment is later than the date the 2021 first quarter estimated tax payment is due. Without further guidance, it would appear that an overpayment of 2020 taxes caused by an extension payment made during the grace period may not qualify as a timely payment of 2021 first quarter estimated taxes, and therefore the taxpayer could be subject to a penalty for underpaying estimated taxes. Without further guidance, it appears that the only guaranteed mechanic to avoid this result is to make the 2020 extension payment by April 15th, the deadline to make the 2021 first quarter estimated tax payment.
State Income Tax Deadlines
As is customary with income taxes, states are free to set their own deadlines for filing state income tax returns and paying state income tax. Approximately 70% of states conform to the individual federal filing date of April 15th. However, not all of these states automatically conform to changes in the federal due dates. Therefore, the announcement does not provide any guidance with respect to state tax deadlines and taxpayers are encouraged to determine whether the states where they file income tax returns have provided specific guidance. For example, California and Oregon have already provided guidance extending the due date of 2020 state income tax returns and associated payments. Although Oregon has extended the due date for estimated tax payments to May 17th, California provided that the extension does not apply to estimated tax payments due on April 15, 2021. Other states, however, have not provided such guidance and are either tied to the deadline to file federal income tax returns (for example, Pennsylvania) or have deadlines that are unrelated to the deadline to file a federal income tax return (for example, Delaware).
Non-Income Tax Deadlines
It is important to keep in mind that the announcement does not apply to non-income taxes, including employment taxes, gift taxes, or information returns. Similarly, many states have not provided extensions with respect to non-income taxes (for example, sales and use taxes, employment taxes, or property taxes).
A&M Taxand Says
As noted at the outset, this TAW is in response to an IRS news release, which came after immense pressure from Congress and the taxpayer community. However, the official guidance that implements the announcement has yet to be released. While we are hopeful that the guidance will address some of the outstanding questions, without further guidance it seems that a prudent taxpayer would still have their 2020 tax return finalized by April 15, 2021. This will enable taxpayers to take advantage of the grace period for the payment of their 2020 tax liability, while still timely satisfying their obligation to pay the first installment of their 2021 estimated tax liability by April 15, 2021. Each taxpayer’s circumstances are unique. Alvarez & Marsal is happy to consult with you regarding the deadline to file and pay your federal and state income tax returns.
IRS Provides New Grace Period for Certain Taxpayers’ Filing and Payment Deadlines
The IRS continues to provide guidance as part of its ongoing efforts to implement the CARES Act and respond to the economic challenges arising from the COVID-19 pandemic. As part of our continuing coverage of COVID-19 relief, this Tax Special Alert highlights Notice 2020-35, which was issued on May 28, 2020.