What Is the IRS Interest Rate for Taxes Owed?

When taxpayers do not pay their tax obligations in full or on time, the Internal Revenue Service (IRS) may charge interest. This interest acts as a charge for the use of money, similar to loans or credit card balances. Understanding how IRS interest works is important for taxpayers, as it applies to various forms of tax debt, including underpayments and unpaid balances. The application of interest ensures that taxpayers compensate the government for the period they have had the use of funds that were rightfully due.

How Interest Rates are Set

The Internal Revenue Service establishes interest rates on tax underpayments and overpayments quarterly. These rates are determined by taking the federal short-term rate and adding three percentage points for most individual and corporate underpayments. For instance, if the federal short-term rate is 4%, the IRS underpayment rate for that quarter would be 7%. Large corporate underpayments may be subject to a higher rate, specifically the federal short-term rate plus five percentage points.

The IRS publishes these rates through official channels, such as its website and revenue rulings. Since the federal short-term rate can fluctuate, the applicable interest rate on an outstanding tax debt may change each quarter. This means a single tax liability could accrue interest at different rates over its lifespan, depending on the quarter in which the interest accrues.

When Interest Accrues

Interest begins to accrue on unpaid tax liabilities from the original due date of the tax return until the date the balance is fully paid. This applies even if a taxpayer was granted an extension to file their return, as an extension to file is not an extension to pay.

Underpayment of estimated tax can also lead to interest charges if insufficient payments were made throughout the year. Additionally, if an accuracy-related penalty or a fraud penalty is assessed, interest is charged on the portion of the underpayment related to that penalty from the original due date of the return until the balance is satisfied.

How Interest is Calculated

IRS interest is calculated on a daily compounding basis. This means that interest is not only charged on the original unpaid tax amount but also on the accumulated interest from previous days. Each day, the outstanding balance, which includes any previously accrued interest and penalties, is used to calculate the new day’s interest.

For example, if a taxpayer owes $10,000 and the annual interest rate is 7%, interest is added to the balance daily. The next day’s interest is calculated on this new, higher amount, and this process continues until the entire tax debt is paid in full.

Paying and Stopping Interest

The most direct way to stop the accrual of interest on tax debt is to pay the outstanding tax liability in its entirety. The IRS offers several convenient payment methods, including IRS Direct Pay, electronic funds withdrawal, or payments via debit card, credit card, or digital wallet. Third-party processing fees may apply for card payments. Taxpayers can also pay by check or money order through the mail.

Interest abatement by the IRS is a limited occurrence. It is granted only under specific circumstances, such as when interest accrues due to an unreasonable error or delay by an IRS officer or employee in performing a ministerial or managerial act. These acts involve procedural or mechanical actions that do not require judgment or discretion. Abatement may also be considered in cases involving certain disasters or if the interest resulted from erroneous written advice provided by the IRS. Factors like a taxpayer’s lack of funds or unawareness of their tax obligations are not sufficient grounds for interest abatement. If an underlying penalty is removed, interest on the unpaid tax amount still applies.