April 15 always seems to arrive before people feel they are ready for it, but there's a simple way to extend this daunting deadline for tax returns. If you're unable to complete your returns by that deadline, you can file Form 4868, an application for automatic extension, with the Internal Revenue Service (IRS).

When you file for an extension, you're simply asking for more time to complete your tax forms. The IRS is not granting you more time to pay any taxes that are due. If you owe taxes as of April 15, expect to pay interest - and possibly a penalty - on the amount due if you choose to take the extension. Read on to learn how to give yourself the gift of time, without paying an arm and a leg for the privilege.

Penalties
Whether you're subject to a penalty depends on the amount of taxes owed after April 15. (To learn more, see Tax Tips For The Individual Investor.)

Let's look at the basics:

• Failure to File Penalty: If you don't file an extension request by April 16, the "failure to file" penalty runs at a rate of 5% of the balance due per month, up to a maximum of 25% of the taxes owed.
• Failure to Pay Penalty: If you file for an extension, and you owe more than 10% of your final tax liability or $1,000 (whichever is more), expect to get hit with a "failure to pay" penalty that runs at 0.5% per month - that's in addition to any interest you'll owe on the balance due.
• Interest: If you have a balance due to the IRS after April 15, expect to be charged interest. The interest rate is generally around 8%, which is a lot less than the rate charged by most credit card companies.

For example, let's say you earn $100,000 this year and have a total federal tax liability of $20,000. To avoid the 0.5% per month failure to pay penalty, you can't owe more than $2,000 when you file a tax return later this year. By having 90% of your total tax liability paid by April 15, filing an extension provides for an extra six months to come up with the remaining tax dollars owed at a relatively low interest rate.

What if you weren't able to complete your tax returns by April 15, and didn't bother to file for an extension? Unless you can show the IRS "reasonable cause", expect to be assessed the failure to file penalty of $100 per month (on a $2,000 balance due). To find out what the IRS considers reasonable cause, see Exhibit 7 - Determining Reasonable Cause and Good Faith.

Can't Pay All Your Taxes By April 15?
What if you need more time to pay your taxes? If the amount you owe is low enough that you won't be subject to the failure to pay penalty, then file an extension by April 15 and pay the remaining balance due when you submit your tax forms prior to October 15.

If you owe so much in taxes that you won't be able to pay them off by October 15, one option is to file the paperwork to enter into an installment arrangement with the IRS. This is done by completing Form 9465, and attaching that form to the front of your federal income tax return. On this installment request form, you tell the IRS how much you can afford to pay each month and the day of the month that the payment will be made. 

The IRS generally charges a fee of between $52 and $105 to any taxpayer who enters into an installment arrangement. In addition, the IRS will charge interest at the prevailing federal rate (approximately 8% per year), and a reduced 'failure to pay' penalty of 0.25% per month on the outstanding balance. Plus, failure to make a scheduled payment will cause the remaining outstanding balance to become immediately due. In addition, you generally aren't allowed to enter into an installment agreement if you have an open installment agreement for a previous year that hasn't been paid off yet.

Additional Incentive for Self-Employed Individuals
Self-employed individuals might benefit from filing for an extension as well. That's because they have until the due date of their tax return, including extensions, to fund their retirement accounts for the year. If an individual doesn't have a retirement plan set up yet, an SEP IRA can be established as late as the extended due date of his or her tax return, or October 15. (To read more about filing retirement tax forms, see The Saver's Tax Credit: An Added Incentive To Fund Your Plan, Retirement Plan Tax Forms You May Need To File - Part 1 and Part 2.)

By filing Form 4868 with the IRS, you get an additional six months to fund your retirement plan and deduct the contribution made on your prior year's return. One strategy common to self-employed individuals is to pay the full amount of taxes due with an extension, and then to fund their retirement plans prior to October 15.

Keep in mind that an extension does not give you any extra time to fund your Roth IRAs, Traditional IRAs and Coverdell Education Savings Accounts (ESAs). The due date for these tax-advantaged retirement plans and college savings accounts is April 15.

Always Submit Your Paperwork On Time
The moral of this story is simple. Because the 'failure to pay' penalty is so much smaller than the 'failure to file' penalty, always try to file all of your tax returns and extension requests on a timely basis, even if you're unable to pay the full amount of the taxes due at that time. Simply filing on time will save you a lot of money and frustration, so take a moment to check your filing now and see whether an extension would benefit you.

To read some commonly asked questions about taxes, see How do I avoid paying excess taxes on securities I have sold?, How can I make sure I'm ready to file my taxes? and Which is better for tax deductions, itemization or a standard deduction?

by Andrew Schwartz (Contact Author | Biography)

Andrew D. Schwartz, CPA, has developed the knack for writing easy-to-understand articles about tax and financial planning issues. Since graduating cum laude from the Wharton School of the University of Pennsylvania in 1987, Andrew has been working in public accounting. In 1990, he formed the CPA firm Schwartz & Schwartz, P.C., which specializes in the tax and financial planning issues applicable to young professionals. In addition to meeting with hundreds of clients each year, Andrew's responsibilities include writing all of his firm's tax and financial planning newsletters and maintaining his firm's nationally recognized website, www.mdtaxes.com. Andrew is also one of the writers for Mostad & Christensen, a marketing company that publishes newsletters and articles for CPA firms.