Is There Interest on Taxes Owed to the IRS?

Owing money to the IRS can be more expensive than many realize. In addition to penalties, interest accrues on unpaid tax balances, increasing the total amount owed. This added cost often catches taxpayers off guard when they assume only late fees apply.

Understanding how interest works and its effect on tax debt is essential for managing payments effectively.

When Interest Is Assessed

Interest on unpaid taxes begins accruing from the original due date of the return, not when the IRS issues a notice. Even if a taxpayer files an extension, interest still accrues from the standard filing deadline—typically April 15—on any unpaid amount. Paying at least an estimated amount by the due date can help minimize costs.

The IRS determines the interest rate quarterly based on the federal short-term rate plus 3%. For individual taxpayers, this rate is compounded daily, meaning the balance grows continuously. If the federal short-term rate is 5%, the total annual interest rate on unpaid taxes would be 8%. Since this rate is adjusted every three months, long-standing balances may see fluctuations in total interest charged.

Interest applies to various tax liabilities, including income taxes, payroll taxes, and certain penalties that remain unpaid. If a taxpayer amends a return and owes additional tax, interest is assessed from the original due date of the return, not when the amendment was filed. Similarly, if an audit results in additional tax owed, interest accrues from the original due date of the return under review, not from the date the IRS issues the audit determination.

How Daily Interest Rates Are Calculated

The IRS uses a daily compounding method, meaning the amount owed increases slightly each day. This results in a higher total cost over time compared to simple interest, which only applies to the original balance.

Accrual Method

Interest accrues daily, meaning each day’s interest is added to the principal, and the next day’s interest is calculated on the new, slightly higher balance. The formula used by the IRS follows this structure:

Daily Interest = (Annual Interest Rate ÷ 365) × Outstanding Balance

For example, if a taxpayer owes $10,000 and the annual interest rate is 8%, the daily interest rate would be approximately 0.0219% (8% ÷ 365). On the first day, the interest charge would be about $2.19. On the second day, interest would be calculated on $10,002.19, slightly increasing the amount owed. Over time, this compounding effect results in a growing balance.

Compounding Impact

Daily compounding means interest applies not just to the original tax debt but also to previously accrued interest. This creates an exponential growth effect, where the longer a balance remains unpaid, the faster it increases.

For instance, if a taxpayer owes $50,000 and does not make any payments for a year at an 8% annual interest rate, the total interest accrued would be higher than $4,000 due to compounding. Instead of simply multiplying $50,000 by 8%, the daily compounding formula results in a slightly larger amount. Using the formula for daily compounding interest:

A = P × e^(rt)

where:
– A is the final amount,
– P is the principal ($50,000),
– r is the annual interest rate (0.08),
– t is the time in years (1),
– e is the mathematical constant (approximately 2.718).

Applying this formula, the total balance after one year would be around $54,162, meaning the interest added is over $4,162 instead of a flat $4,000.

Partial Payments

Making partial payments slows the accumulation of interest but does not stop it entirely. When a taxpayer submits a payment, the IRS first applies it to any outstanding penalties and interest before reducing the principal balance.

For example, if a taxpayer owes $20,000 and makes a $5,000 payment, the IRS may apply $500 to interest and penalties, leaving only $4,500 to reduce the principal. The new balance of $15,500 will then continue accruing interest daily. Paying down tax debt as quickly as possible minimizes the compounding effect over time.

Taxpayers who cannot pay in full should consider structured payment plans, as these can help manage interest costs while avoiding additional collection actions. Even small, consistent payments can make a difference in limiting the long-term financial burden.

Penalties vs. Interest

While both penalties and interest increase the amount owed to the IRS, they serve different purposes and are calculated separately. Interest compensates the government for delayed tax payments, while penalties enforce compliance and discourage late filing, underpayment, or failure to report income accurately.

The most common penalty is the failure-to-pay penalty, which applies when taxes are not paid by the due date. This penalty is 0.5% of the unpaid tax per month, up to a maximum of 25%. If the IRS issues a final notice of intent to levy and the balance remains unpaid for 10 days, the rate increases to 1% per month.

Late filing penalties are more severe. If a taxpayer does not submit a return by the deadline and still owes taxes, the failure-to-file penalty is 5% of the unpaid amount per month, up to a maximum of 25%. If both the failure-to-file and failure-to-pay penalties apply in the same month, the total penalty is capped at 5%, with the failure-to-file penalty reduced to 4.5%.

Accuracy-related penalties can also add to the total owed. If the IRS determines that a taxpayer understated their income or improperly claimed deductions, a 20% penalty may be assessed on the underpaid amount. In cases of fraud, this penalty jumps to 75%. Unlike interest, which is applied automatically, accuracy-related penalties often result from audits or IRS reviews, meaning taxpayers may not be aware of them until years later.

Payment Arrangements and Their Influence

Establishing a payment arrangement with the IRS can affect both the total amount owed and the risk of enforced collection actions. The IRS offers several structured repayment options, each with its own implications for interest accrual and financial flexibility.

For individuals who cannot pay their full liability immediately but can resolve it within a short period, a short-term payment plan allows up to 180 days to pay in full without requiring a formal agreement. However, interest continues to accrue, and failure to pay within the allotted time can lead to penalties or a transition to a formal installment agreement.

Long-term installment agreements provide an extended repayment structure for those unable to resolve their balance within six months. These agreements require taxpayers to make monthly payments based on their financial capacity, preventing immediate collection actions such as liens or levies. The IRS uses Form 9465 to process these requests, and approval is generally granted for balances under $50,000 without requiring financial disclosures. Higher amounts necessitate a more detailed review, including submission of Form 433-F or 433-A to assess income, expenses, and available assets.

A key advantage of entering into an installment agreement is the potential reduction of failure-to-pay penalties. While interest continues to accrue, the penalty rate is lowered to 0.25% per month instead of the standard 0.5%. Taxpayers who establish direct debit agreements may find it easier to maintain compliance, as missed payments can result in default and reinstatement of full penalty rates.

For those facing financial hardship, the IRS offers alternative arrangements such as Partial Payment Installment Agreements (PPIAs) or Currently Not Collectible (CNC) status. PPIAs allow taxpayers to make reduced monthly payments based on their ability to pay, with the remaining balance potentially being forgiven after the collection statute expiration date (CSED), typically 10 years from the tax assessment. CNC status temporarily halts collection efforts for taxpayers who can demonstrate that paying any amount would cause significant financial distress.

Additional Fees Beyond Interest

Beyond interest and standard penalties, the IRS may impose additional fees that further increase the total amount owed.

One of the most significant fees is the federal tax lien filing fee. When a taxpayer has a substantial unpaid balance, the IRS may file a Notice of Federal Tax Lien to secure its claim against the taxpayer’s assets. While the IRS does not charge the taxpayer directly for filing the lien, it can severely impact creditworthiness, making it more difficult to obtain loans or financing.

Another potential cost is the fee associated with setting up certain payment agreements. While basic installment agreements have minimal costs, structured plans such as direct debit or payroll deduction agreements may have setup fees ranging from $31 to $225. If an agreement is defaulted and must be reinstated, an additional fee applies. If the IRS refers a delinquent account to a private collection agency, taxpayers may also face collection fees, further escalating the total amount owed.