Why this matters
Missing a tax payment doesn’t just mean you owe the original tax; it usually triggers two separate charges from the IRS: interest and one or more penalties. Interest is a financial charge that grows every day the balance remains unpaid. Penalties are civil fines calculated as a percentage of the unpaid tax. Together they can turn a manageable bill into a large debt quickly.
How interest works (the basics)
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Calculation method: The IRS sets the interest rate for underpayments and overpayments quarterly. In general, the rate for individuals is the federal short-term rate plus 3 percentage points; for corporations the formula can differ. The IRS compounds interest daily on the unpaid balance (see IRS: Understanding Interest Charges).
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What interest is charged on: Interest applies to the unpaid tax, plus to later-added penalties and certain additional taxes. Because interest compounds, penalties themselves begin to accrue interest once assessed.
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How to estimate interest: Use the IRS interest-rate page for the current quarterly rate (https://www.irs.gov/payments/interest-rates). For a rough manual estimate, convert the annual rate to a daily rate (annual rate ÷ 365), then multiply by the unpaid balance for each day outstanding. For exact amounts, request an IRS account transcript or use the IRS online tools.
How penalties work (main types)
Two penalties matter most for late tax payments:
- Failure-to-file penalty (FTF)
- What it is: A penalty for not filing a required return by the due date (including extensions).
- Typical rate: Generally 5% of the unpaid tax for each month (or part of a month) the return is late, up to a maximum of 25% (see IRS: Penalties). If the return is more than 60 days late, there is a minimum penalty equal to the lesser of $485 (amount adjusts periodically) or 100% of the tax due.
- Interaction with failure-to-pay: If both penalties apply in the same month, the failure-to-file penalty is reduced by the amount of the failure-to-pay penalty for the same period. That means the combined monthly penalty typically won’t exceed 5.5% in a month where both apply.
- Failure-to-pay penalty (FTP)
- What it is: A penalty for not paying your tax by the due date.
- Typical rate: Generally 0.5% of the unpaid tax per month (or part of a month) up to 25% of the unpaid tax. The monthly rate can be reduced to 0.25% if the taxpayer has an installment agreement in place and the agreement involves a direct debit installment agreement (policies and qualifying conditions can change; check the IRS pages and your agreement terms).
Other penalties that can increase cost
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Trust fund recovery, payroll penalties, and estimated tax penalties for underpaying payroll/estimated taxes are separate and can be more severe. Payroll-related failures can also trigger trust fund penalties that are personal liabilities for responsible parties.
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Accuracy-related penalties may apply if the IRS finds underreported income due to negligence, substantial understatement, or fraud.
How interest and penalties interact
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Order of application: The IRS adds penalties first and then charges interest on the new total (unpaid tax + penalties). Because interest compounds daily, assessed penalties immediately start generating interest.
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Example illustration (conservative, simplified): Suppose you owe $2,000 and you pay two months late. You’d normally see a 5% FTF penalty for the first month ($100) if you didn’t file on time, plus a 0.5% FTP penalty per month (roughly $10 per month) and interest compounded daily on the outstanding balance and any penalties. That combination can quickly push the balance well above $2,000. (For precise calculations, use IRS tools or ask the IRS for a balance due computation.)
Practical steps if you can’t pay in full
- File on time even if you can’t pay. Filing reduces or eliminates the larger failure-to-file penalty and keeps your options open for payment plans.
- Pay what you can by the due date. Reducing the unpaid principal lowers both interest and percentage-based penalties.
- Request an installment agreement. An approved installment agreement spreads payments over time and may reduce monthly failure-to-pay penalties (see our guide on when to consider an installment agreement and how to set one up).
- Internal links: For step-by-step guidance, see When to Consider an Installment Agreement: Pros, Cons, and Process (https://finhelp.io/glossary/when-to-consider-an-installment-agreement-pros-cons-and-process/) and Setting Up an IRS Installment Agreement (https://finhelp.io/glossary/setting-up-an-irs-installment-agreement/).
- Consider other relief options. If you truly can’t pay, the IRS offers options such as an Offer in Compromise (OIC) in limited situations. Compare options (installment agreement vs. offer in compromise) to choose the best route (https://finhelp.io/glossary/installment-agreements-vs-offers-in-compromise-which-is-right-for-you/).
Penalty relief and exceptions
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First-Time Penalty Abatement (FTA): Qualifying taxpayers may receive penalty relief for a single tax period if they have a clean compliance history (no prior penalties in the last three years), filed required returns, and paid or arranged payment of taxes due (see IRS: First Time Penalty Abatement).
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Reasonable cause: The IRS may abate penalties if you can show reasonable cause—events beyond your control such as natural disasters, serious illness, or other mitigating circumstances. Documentation is critical.
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Statutory exceptions: Military service, disaster relief, and certain other statutory exceptions can affect both filing deadlines and penalties. Always check IRS guidance for current relief programs.
How to check the exact amount owed
Request an IRS account transcript, log in to the IRS online account portal, or contact the IRS to get a current balance due. The IRS provides updated interest rates and exact computations on its website (https://www.irs.gov/payments/understanding-interest-charges).
Common mistakes to avoid
- Filing and assuming no payment means no penalties. You can file a return on time but still owe failure-to-pay penalties and interest if you didn’t pay.
- Ignoring notices. IRS notices usually include specific amounts, deadlines, and instructions. Respond promptly to reduce enforcement risk.
- Assuming credit-card or third-party payments always minimize penalties. A payment method doesn’t change interest/penalty accrual, and third-party payment fees or processing delays can affect when a payment is considered received.
Real-world examples (illustrative)
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Scenario A: Taxpayer A files late and owes $5,000. Failure-to-file penalty builds at 5% per month for the first several months, plus interest on unpaid tax and penalties. By month four, penalties alone may approach the statutory cap for failure-to-file if the return remains unfiled and unpaid.
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Scenario B: Taxpayer B files timely but can only pay half the balance. FTP penalties and daily interest apply to the unpaid portion. Setting up an installment agreement reduces immediate collection actions and can reduce the monthly FTP penalty rate depending on agreement terms.
Frequently asked questions (brief)
Q: If I file an extension, will I avoid penalties? A: An extension extends the time to file, not to pay. You must pay any expected tax by the original due date to avoid FTP penalties and interest.
Q: Can the IRS forgive interest or penalties? A: Interest is statutory and rarely abated; penalties may be abated for reasonable cause, first-time abatement, or statutory relief. You must request relief and provide supporting documentation.
Q: Will entering an installment agreement stop interest? A: No—interest continues to accrue until the tax is paid in full. Some installment agreements reduce the monthly FTP penalty rate; interest still applies.
Professional tips from practice
- Prioritize filing on time. In my work with clients, filing the return on time when funds are short avoids the much larger failure-to-file penalty.
- Pay what you can by the due date. Even a partial payment lowers penalties and interest on the remaining balance.
- Use direct debit installment agreements when possible. They often qualify for lower IRS fees and, in many cases, reduced FTP penalty rates and lower default risk.
Authoritative sources and further reading
- IRS — Understanding Interest Charges: https://www.irs.gov/payments/understanding-interest-charges
- IRS — Penalties: https://www.irs.gov/payments/penalties
- IRS — First Time Penalty Abatement: https://www.irs.gov/individuals/penalty-relief-and-procedures-first-time-penalty-abatement
Disclaimer
This article is educational and does not replace personalized tax advice. For help tailored to your situation, consult a qualified tax professional or contact the IRS directly. Rules and rates change; verify current interest rates and penalty amounts on the IRS website.