Overview

When you owe taxes for more than one year or have multiple IRS accounts (for example, individual income tax and employment taxes for a small business), the IRS calculates a balance due by totaling the assessed tax for each year, then adding penalties and interest for each liability. The agency’s posting and payment-allocation rules determine which assessed balances are reduced first and how quickly penalties and interest grow (IRS guidance: https://www.irs.gov/businesses/small-businesses-self-employed/understanding-your-balance-due).

Step-by-step: how the IRS builds the total balance

  1. Determine assessed tax per year or account
  • The starting point is the tax assessed for each tax year (original return, audit, or Notice of Deficiency). Each assessed amount is tracked separately on your IRS account.
  1. Add penalties that apply to each assessed liability
  • Common penalties: failure-to-pay (typically 0.5% of unpaid tax per month, up to 25% total if not resolved) and failure-to-file penalties. Penalty rules differ by type and can reduce or increase based on whether returns or payments are timely (IRS penalties overview and specifics: https://www.irs.gov/).
  1. Add interest to each assessed balance
  • Interest accrues from the due date until the tax is paid in full. Interest rates are adjusted quarterly, compound daily, and are generally the federal short-term rate plus 3 percentage points (current rates published quarterly by the IRS: https://www.irs.gov/payments/interest-rates).
  1. Apply payments and credits per IRS posting rules
  • When you send a payment, the IRS posts it to a specific account or tax year per its posting rules. In practice, payments reduce assessed amounts according to the agency’s allocation process (which can mean the oldest assessed balances are reduced first). Check your account transcript or online account to confirm postings.

How payments are applied (why sequencing matters)

  • Designating a payment: If you include a written designation (for example, payment for 2021 Form 1040 balance) the IRS will generally try to honor it, but the agency’s internal posting rules control final allocation.
  • Payment priority: The IRS posts and applies payments and credits based on account types and dates. That affects whether you stop interest and which penalties stop accruing immediately.

Quick example

  • 2020 assessed tax: $1,000; penalties accrued to $300; interest $50 — total $1,350.
  • 2021 assessed tax: $1,500; penalties $200; interest $30 — total $1,730.
  • Unpaid total shown: $3,080.
  • A single payment of $1,000 will be posted and applied according to IRS rules; it may reduce the oldest assessed balance first, which changes future interest and penalty accrual.

Common consequences when multiple years are unpaid

  • Interest compounds daily and can materially increase the amount you owe the longer balances remain unpaid.
  • Multiple years of unpaid tax raise the chance of enforced collection actions (IRS lien, levy, or offset of refunds).
  • Penalties stack by assessed liability; addressing older liabilities first often reduces total future penalties.

Practical steps to reduce the balance due and protect your rights

  1. Pull your IRS account transcript and review assessments
  • Order transcripts at IRS.gov or view your account online to see assessed balances, penalties, and interest. This lets you confirm what the IRS says you owe.
  1. Confirm posting and allocate payments strategically
  • If you want a payment to target a specific year, include a clear written designation and follow up in writing with the IRS. Keep proof of delivery.
  1. Consider relief options
  • Short-term: set up an Installment Agreement (the IRS offers multiple payment-plan options) — see IRS payment plans: https://www.irs.gov/individuals/payment-plans-installment-agreements.
  • Penalty relief: request First-Time Penalty Abatement or administrative relief where eligible.
  • Longer-term: Offer in Compromise (only for taxpayers who demonstrably cannot pay the full amount) or request Currently Not Collectible status.
  1. Work with a professional
  • A CPA, enrolled agent, or tax attorney can request transcripts, negotiate an agreement, and prepare penalty-abatement requests. In my practice, early review of the notice stack and transcripts lets me prioritize which balances to address first to minimize compounded interest.

Where to learn more (authoritative sources + internal guides)

Relevant FinHelp articles

Common mistakes to avoid

  • Ignoring notices: penalties and interest keep growing; some collection actions require no additional notice.
  • Assuming payments go where you want: always confirm posting and keep records.
  • Not checking for errors: the IRS occasionally misapplies payments or posts assessments incorrectly — an account transcript exposes mistakes.

Professional disclaimer

This entry explains how the IRS aggregates taxes, penalties, and interest across multiple years and accounts for general education only. It is not personalized tax advice. For specific questions about your liabilities, consult a qualified tax professional or the IRS directly.

Sources

IRS publications and pages cited above (2025).