Background

Interest on unpaid federal tax exists to compensate the government for the time value of money and to encourage timely payment. The IRS sets interest rates quarterly; for underpayments the rate is generally the federal short‑term rate plus 3 percentage points and is compounded daily. Always check the IRS interest page for the current quarterly rate (IRS, Interest).

How the IRS Calculates Interest (Plain Language + Formula)

  • Daily compounding: interest starts the day after the tax due date and compounds daily on the unpaid balance (including any previously accrued interest).
  • Daily rate: annual_rate ÷ 365 (IRS uses a 365‑day basis).
  • Compound formula (precise): interest = unpaidbalance × [(1 + dailyrate)^(days) − 1].

Example (step-by-step)

  • Scenario: $5,000 unpaid tax; use a 7.00% annual rate as an illustrative example only (check IRS for the current rate).
  • Daily rate = 0.07 ÷ 365 ≈ 0.00019178.
  • If unpaid for 100 days: interest ≈ 5,000 × [(1.00019178)^100 − 1] ≈ $96.50.

Notes on Practical Calculation

  • The IRS rounds daily calculations at specific steps; your independent calculation may differ by a few cents to a few dollars. Use IRS-provided worksheets or your notice’s figures to reconcile amounts.
  • Interest continues to accrue even if you are appealing an assessment or have a penalty abatement unless the IRS specifically suspends interest.

When You Can Challenge Interest

You can seek review of interest charges in these common situations:

  1. Clear computational or date errors — e.g., IRS used the wrong due date, misapplied payments, or double‑counted amounts.
  2. IRS delay or administrative error — if the IRS caused an unreasonable delay that materially increased interest, ask the IRS to review or involve the Taxpayer Advocate Service (TAS) if you suffer economic harm (Taxpayer Advocate Service).
  3. Corrected tax liability — if the underlying tax is reduced after audit, appeal, or an Offer in Compromise, interest will be recalculated to reflect the corrected liability (so a challenge to interest follows a successful substantive challenge).

When challenges are unlikely to succeed:

  • Simple inability to pay is not a reason to abate interest; interest is statutory and routinely continues while balances remain unpaid.
  • Routine penalties do not automatically remove interest; interest is charged on tax and penalties unless specifically abated.

How to Challenge: Step‑by‑Step (Practical Checklist)

  1. Review the IRS notice: note the assessed tax, penalties, interest rate, and the dates used.
  2. Recalculate interest: use the daily compounding formula and the IRS’s published quarterly rates to confirm the amount.
  3. Gather documentation: proof of payment dates, correspondence, bank statements, and any items that show IRS error or delay.
  4. Contact the IRS: use the phone number on the notice or write to the address shown. Explain the error, attach your recalculation and evidence, and request a corrected computation.
  5. Escalate if needed: if the IRS denies relief and you believe the decision is incorrect, consider requesting Appeals review or contacting the Taxpayer Advocate Service.

Tools and Alternatives to Reduce Interest Costs

  • Pay as soon as possible: every day you postpone increases interest expenses.
  • Installment agreement: spreading payments reduces immediate cash strain; interest still accrues on the unpaid balance while you’re in the plan. For help, see our guide on setting up an affordable installment agreement with the IRS (Setting Up an Affordable Installment Agreement with the IRS).
  • Streamlined options: low‑balance taxpayers may qualify for streamlined installment plans with simpler rules (Streamlined Installment Agreements: Requirements and Limits).

Common Mistakes to Avoid

  • Assuming interest only starts after you receive a bill — it starts the day after the tax due date.
  • Not reconciling IRS math with your own records before calling — start with a clear, documented recalculation.
  • Waiting to ask for help — if IRS processing delays or errors caused extra interest, early engagement and, when warranted, TAS involvement can reduce harm.

Practical Tip From Practice

In my practice, the most recoverable issues are payment‑application mistakes (payments credited to the wrong year or taxpayer) and calculation errors on amended returns. Document payment timing carefully and keep copies of IRS notices; a clear paper trail speeds resolution.

Authoritative sources

Disclaimer

This article is educational and does not replace personalized tax advice. For case‑specific guidance, consult a qualified tax professional or enrolled agent who can review your notices and records.