How the IRS calculates interest on late tax payments
When you owe tax and don’t pay by the due date, the IRS charges interest on the unpaid balance. The interest rate for underpayments is the federal short-term rate plus 3 percentage points; the IRS sets the rate quarterly and compounds interest daily (so small balances grow faster than simple interest would predict) IRS, Topic No. 653 and IRS Payments.
In my practice advising individual and small-business clients, I’ve seen how even short delays raise costs: a missed payment can generate interest that continues to accumulate until the IRS receives full payment or you enter an agreement to resolve the balance.
How to read the rate and where to find the current value
- The IRS announces interest rates each quarter (Jan, Apr, Jul, Oct). Watch the IRS Newsroom or Topic No. 653 for the official quarterly announcement.
- Example: the formula is “federal short-term rate + 3 percentage points” for individual underpayments. The actual percentage depends on that short-term rate for the preceding month(s) and therefore changes each quarter.
Source: IRS quarterly interest announcements and Topic No. 653 (IRS).
The math: daily compounding and a step-by-step calculation
The IRS compounds interest daily. That means the agency applies the daily rate to the outstanding balance every day and adds that interest to the balance for the next day’s calculation.
Step-by-step (illustrative example using a hypothetical annual rate):
- Determine the annual interest rate for the quarter (for example purposes only, say 5.00% annually). The IRS announces the actual rate each quarter; don’t assume 5% is current.
- Convert to a daily rate: divide the annual rate by 365 (or 366 in a leap year). For 5.00%: daily rate = 0.05 / 365 = 0.0001369863 (≈0.01369863%).
- Compute daily interest: multiply the unpaid balance by the daily rate. If you owe $10,000, daily interest ≈ $10,000 × 0.0001369863 ≈ $1.37.
- Compound: add the daily interest to the balance; tomorrow’s interest will be calculated on that slightly larger amount. Over many days this makes interest slightly higher than simply multiplying by (annual rate × fraction of year).
Important: the IRS’s daily compounding means rounding and leap-year rules can affect the exact cents of interest. For official balances, use the IRS interest rate announcement and tools or contact the IRS for an exact amount.
When interest starts and when it stops
- Interest begins accruing from the original due date of the tax (usually the filing deadline for the return or the due date for estimated tax) and continues until the full amount is paid or otherwise resolved.
- Filing an extension to file a return does NOT extend the time to pay. You must pay the tax by the original due date to avoid interest.
- Interest continues to accumulate while a case is in collections and typically continues during installment agreements unless the agreement specifies otherwise. Interest also accrues on penalties.
Reference: IRS Topic No. 653 and IRS Payments.
Interaction with penalties and other charges
Interest is separate from—and in addition to—penalties such as the failure-to-file penalty and the failure-to-pay penalty. The failure-to-pay penalty is a percentage of the unpaid tax charged per month until the balance is paid or reaches a statutory limit. Interest is charged on the unpaid tax and generally on the accrued penalties as well (so unpaid penalties may themselves attract interest).
For a deeper look at how the IRS applies interest versus penalties, see our glossary piece: “How the IRS Applies Interest vs Penalties on Late Tax Payments”.
Internal link: How the IRS Applies Interest vs Penalties on Late Tax Payments – https://finhelp.io/glossary/how-the-irs-applies-interest-vs-penalties-on-late-tax-payments/
Practical examples (illustrative)
Example 1 — short delay
- Tax owed: $5,000
- Hypothetical annual rate: 6.00% (example only)
- Daily rate: 0.06 / 365 = 0.000164384
- Daily interest: $5,000 × 0.000164384 ≈ $0.82 per day
- 30 days interest ≈ $24.60 (compounded daily yields a hair more)
Example 2 — longer delay and compounding
- Tax owed: $20,000
- Hypothetical annual rate: 5.00%
- Daily interest ≈ $20,000 × (0.05/365) ≈ $2.74 per day
- Over a year, daily compounding increases the effective interest slightly above 5.00% because each day’s interest earns interest thereafter.
Note: These examples use round numbers to demonstrate the method. Use the IRS’s current quarterly rate and the exact number of days to compute an official amount.
Why this matters: compounding and cash flow
Daily compounding means even short delays cost real money. For small-business owners or tight monthly budgets, the interest on unpaid tax can reduce working capital and increase borrowing needs. Paying sooner or arranging a formal payment plan can reduce how much interest you pay over time.
Options to limit interest and manage unpaid tax
- Pay as much as you can by the due date. Any payment reduces the principal and therefore the base on which interest accrues.
- If you cannot pay in full, consider an IRS installment agreement. An installment agreement does not stop interest, but it may reduce immediate financial strain while you pay the balance. (See our step-by-step guide: “How to set up an IRS payment plan”.)
Internal link: How to set up an IRS payment plan – https://finhelp.io/glossary/how-to-set-up-an-irs-payment-plan/
- Request penalty abatement if you have a reasonable cause (penalties may be waived in eligible circumstances), but note that abating a penalty does not usually erase the interest that has already accrued—interest typically remains unless the IRS made a calculation error.
- Consider short-term financing only as a last resort; sometimes a low-interest personal loan costs less in total than prolonged IRS interest and penalties.
Common mistakes and misconceptions
- “Filing stops interest”: Filing your tax return on time does not stop interest on unpaid tax. Interest starts at the payment due date until full payment.
- “Interest rates are fixed”: The IRS rate changes quarterly. Always check current rates before relying on past values.
- “Installment plans stop interest”: Most installment agreements do not stop the accrual of interest; you’ll keep accruing interest on the unpaid balance while you pay under the plan.
What to do if you disagree with interest charges
If you believe the IRS computed interest incorrectly or the IRS made a processing error, you can:
- Review the IRS notice carefully to understand the dates and amounts used in the interest calculation.
- Contact the IRS or your tax professional for a recalculation. The IRS will correct obvious computational errors. Keep records of your payments and dates to support your case.
For complex situations (collections, liens, or offers in compromise), consult a tax professional.
Tools and resources
- IRS — Topic No. 653 (Interest): https://www.irs.gov/taxtopics/tc653
- IRS Payments information: https://www.irs.gov/payments
- IRS quarterly interest rate announcements (search “IRS announces interest rates” on the IRS Newsroom)
Additional reading on our site:
- How the IRS Applies Interest vs Penalties on Late Tax Payments: https://finhelp.io/glossary/how-the-irs-applies-interest-vs-penalties-on-late-tax-payments/
- How to set up an IRS payment plan: https://finhelp.io/glossary/how-to-set-up-an-irs-payment-plan/
Professional disclaimer
This article is educational and does not replace personalized tax or legal advice. Rules and rates change; verify current IRS rates and discuss your situation with a licensed tax professional before making decisions. In my practice, I recommend running a precise interest calculation using the IRS’s announced quarterly rate and exact day counts before agreeing to a payment strategy.
(Author: Senior Financial Content Editor & CPA experience noted.)
