What Is the Interest Rate on Unpaid Taxes?
Understand the IRS's interest charges on unpaid taxes. Get clear insights into how it works and its implications for taxpayers.
When taxes go unpaid, the Internal Revenue Service (IRS) charges interest on the outstanding balance. This interest serves as compensation for the time the government did not have access to the funds owed. It is a statutory charge, meaning it is required by law, and it applies to any underpayment of tax, including those resulting from calculation errors or insufficient withholding. The purpose of this interest is to ensure fairness and encourage timely compliance with tax obligations.
How Tax Interest Rates Are Determined
The IRS sets interest rates on underpayments and overpayments on a quarterly basis. These rates are determined by taking the federal short-term rate and adding three percentage points for taxpayers other than corporations. This rate can vary for corporations, especially for large underpayments exceeding $100,000, where the rate is the federal short-term rate plus five percentage points.
Interest on unpaid taxes is compounded daily, which means it is calculated on the previous day’s balance including any already accrued interest. This daily compounding can cause the total amount due to increase quickly. Taxpayers can find the most current and historical quarterly interest rates directly on the IRS website.
When Interest Begins to Accrue
Interest on unpaid taxes generally begins to accrue on the original due date of the tax return. This applies even if a taxpayer has been granted an an extension to file their return, as an extension to file does not extend the time to pay any taxes owed. Interest continues to accumulate daily until the tax liability is paid in full.
Interest also applies to underpayments of estimated tax throughout the year, which can occur if taxpayers do not pay enough tax through withholding or quarterly estimated payments. Additionally, interest can be charged on any unpaid penalties, accruing if a penalty is assessed and not paid by its due date.
Distinguishing Interest from Penalties
It is important to understand the distinction between interest and penalties, as they serve different purposes within the tax system. Interest is a charge for the use of money, compensating the government for the delay in receiving funds. Penalties, on the other hand, are punitive measures imposed for failing to meet specific tax obligations, such as failing to file a return on time or failing to pay taxes when due.
While interest is a statutory charge that generally cannot be waived, penalties may sometimes be abated under certain circumstances. Interest can also accrue on unpaid penalty amounts, further increasing the total debt if not addressed promptly.
Requesting Interest Abatement
Under limited circumstances, the IRS may abate, or remove, accrued interest. This relief is typically granted when interest is due to unreasonable errors or delays by the IRS in performing ministerial or managerial acts.
Interest abatement is generally not granted due to taxpayer error, ignorance of the law, or financial hardship. To request an abatement, taxpayers typically file Form 843, “Claim for Refund and Request for Abatement.” This form requires a detailed explanation of how the IRS’s actions caused the unreasonable error or delay that led to the interest accrual.