Why interest on late taxes grows quickly

When you miss a tax due date, interest begins to accrue on the unpaid balance from the original due date until the IRS receives full payment. Interest is calculated using the federal short-term rate plus 3 percentage points and compounds daily; the IRS updates the rate quarterly. Because interest compounds every day, even modest principal balances can grow quickly, which makes early action important (IRS, Payments and Interest: https://www.irs.gov/payments).

In my practice I’ve seen three common taxpayer mistakes: (1) assuming interest will stop if you ignore notices, (2) filing late to avoid filing penalties but not paying anything, and (3) using high-cost credit to bridge the gap without checking cheaper alternatives. The guidance below focuses on legal, practical steps that consistently reduce total cost.

Key strategies to reduce interest and penalties

Below are actionable strategies ranked roughly from fastest impact (reduce interest immediately) to longer-term relief options.

  1. Pay as much as you can immediately
  • Every dollar you pay reduces the principal that interest compounds on. Even a partial payment lowers future daily interest accrual. Use IRS Direct Pay (no fee), EFTPS, or an electronic payment to move money quickly (IRS, Payments: https://www.irs.gov/payments).
  • If you cannot pay the full amount, prioritize paying the balance of the tax liability before optional penalties you might owe from other agencies.
  1. File on time even if you can’t pay in full
  • Filing avoids or reduces the Failure-to-File penalty, which is usually substantially higher than the Failure-to-Pay penalty. The Failure-to-File penalty can be up to 5% per month of the unpaid tax, while the Failure-to-Pay penalty is generally 0.5% per month (IRS, Penalties: https://www.irs.gov/penalties). Filing also preserves eligibility for some penalty relief programs.
  1. Set up an IRS installment agreement quickly
  1. Choose direct-debit installment agreements when possible
  • Direct-debit plans often have lower setup fees and fewer compliance problems. They also reduce the chance of default, which would re-start aggressive collection and additional penalties.
  1. Request penalty abatement where eligible
  • The IRS can abate (remove) penalties for reasonable cause (serious illness, natural disaster, or other documented events) or under the First-Time Penalty Abatement policy if you meet eligibility rules. Interest, however, is set by statute and is rarely abated except in narrow circumstances involving IRS error. See IRS Penalties for specifics: https://www.irs.gov/penalties.
  1. Consider an Offer in Compromise (OIC) if you can’t pay
  • An OIC lets you settle your tax debt for less than the full amount if you can prove inability to pay. The OIC process is document-intensive and has eligibility requirements; it’s best for taxpayers with little disposable income after necessary living expenses. See IRS guidance on the Fresh Start and OIC programs. Use a qualified tax professional when pursuing an OIC—you’ll need accurate financial statements and realistic projections.
  1. Evaluate temporary, lower-cost financing options carefully
  • A low-interest personal loan or a 0% introductory credit card (if you can pay the card before the promotional rate expires) may cost less than IRS interest if you can secure those terms. Compare fees: many tax-payment processors charge a convenience fee for credit card payments; those fees plus card interest can exceed IRS interest. Always compare total cost and risks before borrowing to pay taxes.
  1. Ask for Currently Not Collectible (CNC) status if you have hardship
  • If you can show you lack the ability to pay basic living expenses after taxes, the IRS may place your account in CNC status. This halts active collection but does not stop interest or penalties from accruing; CNC is a temporary relief for extreme hardship.
  1. Stay on top of notices and communicate early
  • Ignoring IRS notices will often make the situation worse. Respond promptly and keep good documentation. Early, proactive communication increases options and improves the odds of penalty relief if you have reasonable cause.

Practical examples and a simple math illustration

  • Example (illustrative): if the IRS interest rate is 7% annual, a $5,000 unpaid balance will accumulate roughly $175 in interest over six months (5000 * 0.07 * 0.5 = $175). If instead you set up a payment plan and pay $900 at the start, the remaining principal is $4,100 and six months of interest at the same rate would be about $143 — a $32 savings in interest plus reduced risk of additional penalties.
  • In practice, I advised a small-business owner to pay 30% of a short-term tax bill immediately and set up a direct-debit installment for the remainder. That reduced their six-month interest costs and prevented a lien from being filed while they stabilized cash flow.

How to pick the right option for your situation

  • If you can pay within 30 days: prioritize paying in full to stop interest and avoid extended penalties. File any missing returns immediately.
  • If you can only make partial payment but can sustain monthly payments: apply for an installment agreement (preferably direct debit) and pay as much as feasible upfront.
  • If you lack ability to pay beyond basic living expenses: gather documentation and pursue CNC or consult about an Offer in Compromise.
  • If penalties are the primary pain point and you have plausible reasonable cause: request penalty abatement and provide clear documentation.

What the IRS won’t usually do: abate interest

  • Interest is prescribed by statute and is generally not abated except where the IRS made a procedural error or a court orders otherwise. You should assume penalties can sometimes be removed but interest usually remains. For authoritative language see IRS interest information: https://www.irs.gov/payments.

Record-keeping and documentation

  • Keep copies of all payment confirmations, bank statements showing cleared payments, correspondence with the IRS, and any forms submitted. If you request penalty abatement or an offer in compromise, documentation demonstrating your circumstances (medical records, disaster declarations, bank records) will be essential.

Additional resources and internal guides

Professional tips from practice

  • Maintain a tax-sinking fund: set aside a fixed percentage of each paycheck or business deposit into a separate account for taxes.
  • Review withholding and estimated taxes mid-year: adjusting withholding can prevent future late payment surprises.
  • When in doubt, consult a CPA or enrolled agent: negotiating installment terms and preparing OIC documentation correctly improves outcomes and reduces unnecessary fees.

Final checklist (quick actions to take now)

  • File any missing returns immediately.
  • Make the largest payment you can now via Direct Pay/EFTPS.
  • Apply for a direct-debit installment agreement if you can’t pay in full.
  • If eligible, request penalty abatement for reasonable cause or first-time abatement.
  • If you face serious hardship, explore CNC or Offer in Compromise with professional help.

Professional disclaimer: This article is educational and not individualized tax advice. Rules, rates, and procedures change; consult the IRS or a qualified tax professional for advice specific to your facts and current 2025 rules. Authoritative sources include IRS.gov and the Consumer Financial Protection Bureau.