I'm often asked if filing an extension will eliminate penalties charged by the IRS... and how much are the penalties.

* Failure to File Penalty - a "Valid" extension will relieve this during the extension period
* Failure to Pay Penalty
* Interest

Each is calculated differently. Here is a quick overview.

Failure to File Penalty

The failure-to-file penalty is calculated based on the time from the deadline of your tax return (including extensions) to the date you actually filed your tax return. The penalty is 5% for each month the tax return is late, up to a total maximum penalty of 25%. The percentage is of the tax due as shown on the tax return. If your tax return is more than five months late, simply multiply your balance due by 25% to calculate your failure to file penalty.

So... should I file an extension if I owe taxes?
This actually varies depending on if the filing of the extension is deemed "valid" by the IRS.  In order for the extension to be valid, you must approximate the amount of taxes that you may owe when you file the tax return.  If you estimate tax is going to be owed, you need to pay that amount with your extension for it to be considered valid.

What if you can't estimate the appropriate amount of taxes due?  Well, if there is a reasonable explanation as to why you can not estimate the amount due, or if your estimate was reasonable (the final balance due is less than $1,000), then you will have met the test for a valid extension.

Failure to Pay Penalty

The failure-to-pay penalty is calculated based on the amount of tax you owe. The penalty is 0.5% for each month the tax is not paid in full. There is no maximum limit to the failure-to-pay penalty. The penalty is calculated from the original payment deadline (the original April 15th filing deadline) until the balance due is paid in full.

Interest

Interest is calculated based on how much tax you owe. Interest rates change every three months. Currently, the IRS interest rate for underpayment of tax is 5% per year. The interest is calculated for each day your balance due is not paid in full.

IRS interest rates are variable and are set quarterly. For more information see www.IRS.GOV