How is Interest on Unpaid Taxes Calculated?

Interest on unpaid federal taxes is a daily-compounded charge the IRS applies to any tax not paid by the due date. The IRS sets the rate each quarter using the federal short-term rate plus a statutory add-on (for most underpayments that add-on is 3 percentage points). Because interest compounds daily, even a short delay can add up — and penalties may apply in addition to interest.

This entry explains the rules, shows step-by-step calculations (including the daily compounding formula), gives practical examples, and outlines actions taxpayers can take to limit interest costs. It also links to useful resources about repayment options like installment agreements.

Sources and rules

  • The IRS publishes interest rates and explains how they’re applied on its website each quarter. See the IRS page on interest rates for the current rate and rules (IRS — Interest Rates).
  • Interest starts accruing from the original due date of the return (normally April 15 for calendar-year individual returns) and continues until the tax is paid in full or the liability is otherwise resolved (e.g., credit applied). See IRS guidance on interest and penalties.

How the rate is set

  • The basic formula the IRS uses is: federal short-term rate + statutory add-on. For most individual and small-business underpayments that add-on is 3 percentage points. The IRS updates the federal short-term rate quarterly and posts the composite interest rate for underpayments and overpayments.
  • Because these rates change quarterly, always check the IRS interest-rate page for the period when the underpayment occurred.

Daily compounding: two calculation methods

There are two ways to compute interest on an unpaid tax balance:

1) Exact daily-compounded formula (precise):

Balance after N days = Principal × (1 + r/365)^N

where r is the annual interest rate expressed as a decimal (for example, 0.04 for 4%) and N is the number of days the balance is unpaid.

2) Simple (approximate) daily interest (used for quick estimates):

Interest ≈ Principal × r × (N/365)

This simple method gives nearly the same result for short intervals and small rates and is often adequate for quick planning. The IRS technically compounds daily, so the compounded formula is exact.

Worked examples (useful templates)

Note: the IRS posts a different rate each quarter. The numbers below are examples only and use a hypothetical annual interest rate to illustrate the math.

Example A — 30-day estimate (quick check):

  • Principal: $2,000
  • Assumed annual interest rate: 4.00% (0.04)
  • Days unpaid: 30

Approximate simple interest:
Interest ≈ $2,000 × 0.04 × (30/365) = $6.58 (rounded)

Exact daily compounding:
Balance after 30 days = $2,000 × (1 + 0.04/365)^30
= $2,000 × (1 + 0.000109589)^30
≈ $2,006.58 (so interest ≈ $6.58)

Example B — six-month (183 days) compounding:

  • Principal: $5,000
  • Assumed annual interest rate: 4.00% (0.04)
  • Days unpaid: 183

Simple estimate:
Interest ≈ $5,000 × 0.04 × (183/365) = $100.27

Daily compounding exact:
Balance = $5,000 × (1 + 0.04/365)^183 ≈ $5,101.10 (interest ≈ $101.10)

Because compounding on daily periods increases the effective charge slightly, the compounded result is marginally higher than the simple estimate.

Why interest grows faster than people expect

  • Daily compounding: Interest charged each day adds to the principal used to compute the next day’s interest. Over months or years the gap between simple and compounded interest widens.
  • Interest plus penalties: Interest is charged on the tax balance, and some penalties (like the failure-to-pay penalty) are applied to the same outstanding amount. Penalties and interest can interact and increase the total faster than a casual estimate.

Common special cases and exceptions

  • Different rates for overpayments: The IRS also pays interest to taxpayers when they overpay, but at a different rate (usually the short-term rate plus a smaller add-on). Check the IRS interest-rate page for specifics.
  • Large corporate underpayments or special statutory adjustments: Certain corporate underpayments or specific tax provisions can trigger different statutory add-ons. If you represent a corporation or have an unusual tax situation, review the IRS notice for that quarter or consult a tax professional.
  • Abatements and administrative relief: Interest is generally not abatable for simple inability to pay. Abatement is rare and usually limited to administrative errors by the IRS or specific statutory relief. The Taxpayer Advocate Service and IRS guidance describe narrow circumstances where relief may be granted.

How interest works with installments and collection alternatives

  • Interest continues to accrue on unpaid balances even when you enter an installment agreement with the IRS. The monthly or periodic payments reduce the principal, but interest applies until the full balance is satisfied.
  • For information on installment options and how interest interacts with payment plans, see our guide on how installment agreements work: How Installment Agreements Work: Types and Setup Tips.
  • To apply for an IRS payment plan online, including details about how payments are scheduled and how interest is applied, see our step-by-step post: How to Apply for an Online Installment Agreement with the IRS.

Penalties vs. interest — how they differ

  • Interest is the cost of borrowing from the government: it is charged on unpaid tax balances from the due date forward and compounds daily.
  • Penalties are separate charges that the IRS imposes for specific failures, most commonly:
  • Failure-to-file penalty (generally higher — encourage filing even if you can’t pay).
  • Failure-to-pay penalty (applies to unpaid amounts and is in addition to interest).

Because penalties can be larger than interest, filing on time and requesting extensions when needed can reduce total cost. If you cannot pay the full amount, file the return on time and pay as much as possible to limit failure-to-pay penalties.

Practical steps to limit interest and reduce total cost

  1. File on time even if you can’t pay in full. Filing avoids or reduces the failure-to-file penalty, which can be more costly than interest.
  2. Pay as much as you can electronically (IRS Direct Pay or EFTPS) to reduce principal and future interest.
  3. Consider an installment agreement if you can’t pay now. Interest still accrues, but a managed plan prevents enforced collection actions. Use the IRS online agreement tool or the Form 9465 process.
  4. Adjust withholding or estimated tax payments to avoid underpayment next year.
  5. If the IRS made a clear error or delay caused by IRS mistakes, ask about interest abatement — documentation will be essential.
  6. If you have a low balance and short timeline, a short-term personal loan with lower interest than the IRS rate might be cheaper; compare effective APRs carefully.

Recordkeeping and what the IRS will bill you

  • The IRS will send notices showing the balance, including accrued interest and penalties. Keep a copy of your return, payment confirmations, and any installment-agreement correspondence.
  • If you disagree with the IRS calculation, respond promptly. The IRS provides procedures to request an account review or appeal certain determinations.

When to get professional help

  • If the unpaid balance is large, involves corporate tax, or spans many tax years, consult a CPA, enrolled agent, or tax attorney. In my practice, cases over a few thousand dollars often benefit from professional negotiation (installment terms, offers in compromise, or partial-payment arrangements) because small adjustments in timing or structure can save hundreds in interest and penalties.

Resources and authoritative links

Professional disclaimer

This article is educational and does not replace personalized tax advice. Tax law and IRS procedures change; check the IRS website for current rates and consult a tax professional about your specific situation.

Bottom line

Interest on unpaid taxes is a predictable, daily-compounded cost that can materially increase what you owe. Use the daily-compounding formula to estimate the charge for any period, file returns on time, pay as much as you can, and consider an installment agreement if immediate full payment isn’t possible. Reviewing current IRS interest rates each quarter and working with a tax professional when balances grow are the best ways to limit long-term costs.