Internal Revenue Code Section 6601: Interest on Tax Underpayments

Owing taxes to the IRS doesn’t just mean paying the original amount due—interest accrues on unpaid balances, increasing the total owed over time. Internal Revenue Code (IRC) Section 6601 governs how this interest is applied when taxpayers fail to pay on time.

Scope of IRC 6601

IRC Section 6601 applies to any unpaid federal tax liability, ensuring the government is compensated for delayed payments. This includes income, estate and gift, employment, and excise taxes. Interest begins accruing from the original due date, regardless of extensions, whether the underpayment results from a miscalculation, audit adjustment, or late filing.

Unlike penalties, which require a triggering event, interest accrues automatically without IRS notification. Even if a taxpayer is unaware of an outstanding balance, interest continues to grow until the full amount is paid. This can lead to significant additional costs, particularly when disputes prolong resolution.

There are limited exceptions where interest may be suspended or reduced. Under IRC Section 6404(g), if the IRS fails to notify an individual of additional tax due within 36 months of the filing date, interest on that portion may be suspended. Additionally, for tax assessments arising from mathematical or clerical errors, interest may not begin accruing until the taxpayer is formally notified.

Determining the Interest Rate

The interest rate on unpaid federal taxes under IRC Section 6601 is variable and adjusts quarterly. It is based on the federal short-term rate, calculated using market yields of U.S. Treasury securities. For individuals, the rate is the federal short-term rate plus three percentage points. Corporations generally face the same rate, but for large corporate underpayments—balances exceeding $100,000—the rate increases to the federal short-term rate plus five percentage points.

This structure ensures the interest rate reflects economic conditions. If Treasury yields rise due to Federal Reserve policy changes, the interest rate on tax underpayments increases. Conversely, when interest rates decline, the cost of carrying a tax liability decreases. Since these rates update every three months, taxpayers with outstanding balances should monitor IRS announcements to anticipate changes.

Beyond compensating the government, the interest rate discourages delayed payments. Since the rate is often higher than what taxpayers might earn in a savings account, postponing payment can lead to greater financial strain. Businesses, in particular, must weigh the cost of accruing interest against alternative financing options, such as short-term loans or credit lines, which may offer lower rates.

Period of Accrual

Interest on unpaid taxes begins accumulating from the original due date and continues until the balance is fully paid. Even if a taxpayer makes payments over time, interest continues to be charged on any remaining unpaid amount.

For taxpayers disputing an assessment, interest accrues while the issue is being resolved. If a tax liability is reduced through an appeal or court ruling, the IRS adjusts the interest accordingly. However, if the dispute results in a higher balance due, additional interest is applied retroactively to the original due date.

In some cases, interest accrual may be temporarily suspended. If the IRS fails to notify a taxpayer of additional tax due within a specified timeframe, interest may be halted for that period. Relief measures, such as disaster declarations or pandemic-related extensions, may also temporarily pause accrual under certain conditions.

Adjustments for Partial Payments

When a taxpayer makes a partial payment, the IRS applies payments first to the tax principal before reducing any accumulated interest. Unless the full principal is paid off, interest continues accruing on the remaining balance. For example, if a taxpayer owes $10,000 in tax and $2,000 in interest, a $5,000 payment reduces the tax liability to $5,000, but interest will still be charged on that amount.

The timing of partial payments affects the total interest paid. Making payments earlier reduces the principal sooner, decreasing the base on which interest is calculated. Taxpayers who can make multiple smaller payments throughout the year rather than waiting until they have the full amount may lower their overall costs. Additionally, taxpayers entering into installment agreements should be aware that interest continues to accrue on the unpaid balance, even if they are making regular monthly payments.

Coordination with Penalties

Interest on tax underpayments under IRC Section 6601 operates separately from penalties, but both can significantly increase the total amount owed. While interest accrues automatically, penalties are triggered by specific taxpayer actions, such as failing to file a return or underreporting income.

The failure-to-pay penalty, outlined in IRC Section 6651(a)(2), is one of the most common penalties accompanying interest charges. This penalty is calculated at 0.5% of the unpaid tax per month, up to a maximum of 25%. Since interest accrues on both the tax owed and any assessed penalties, delaying payment can cause a rapidly growing balance. The failure-to-file penalty, generally 5% per month (capped at 25%), is more severe but does not directly impact interest calculations unless it increases the total tax due. Accuracy-related penalties under IRC Section 6662, which apply to understatements due to negligence or substantial misstatements, can also lead to additional interest charges if they result in a higher assessed liability.

Taxpayers who qualify for penalty abatement, such as first-time penalty relief or reasonable cause waivers, may see reductions in their total amount due. However, even if a penalty is removed, interest on the underlying tax liability remains unless the principal is fully paid. This distinction is important for those negotiating with the IRS or seeking relief, as eliminating penalties does not stop the accrual of interest.

Payment Obligations

Paying tax liabilities on time is the most effective way to avoid accumulating interest and penalties. If full payment by the original due date is not possible, taxpayers have several options to manage their liabilities.

The IRS offers installment agreements that allow taxpayers to make monthly payments. While these agreements prevent more severe collection actions, such as liens or levies, they do not stop interest from accruing. Short-term payment plans, available for balances under $100,000, provide up to 180 days to pay without requiring a formal installment agreement. For larger or longer-term debts, a structured installment plan may be necessary, with interest continuing to apply until the balance is fully resolved.

In some cases, taxpayers facing financial hardship may qualify for an Offer in Compromise (OIC), which allows them to settle their tax debt for less than the full amount owed. While an OIC can reduce the principal balance, interest continues to accrue until the IRS accepts the offer. Additionally, those who cannot pay due to extreme financial difficulties may request a temporary delay in collection, though this does not eliminate interest charges.