Quick answer

Penalty interest = daily, compounded interest on unpaid tax (rate tied to the federal short‑term rate + statutory add‑on). Penalty fees = specific charges for violations (for example, failure to file and failure to pay) calculated as set percentages or statutory minimums.

How penalty interest works

  • Basis: The IRS posts interest rates quarterly. For underpayments the rate is the federal short‑term rate plus a statutory add‑on; interest compounds daily and continues until the balance is paid in full. (See the IRS interest page for current quarterly rates.)
  • Calculation: The IRS applies a daily rate (annual rate ÷ 365) to the unpaid balance and compounds each day. Because the rate is adjusted quarterly, interest for long delays may use multiple rate periods.
  • Practical example: As a rule of thumb, a $1,000 unpaid balance at a 7% annual rate will incur roughly $35 of interest over six months (0.07 × 0.5). Because the IRS compounds daily and changes rates periodically, treat this as an approximation.

Sources: IRS — Penalties overview and Interest on underpayments: https://www.irs.gov/penalties and https://www.irs.gov/newsroom/what-is-interest-on-unpaid-taxes

How penalty fees work (common types)

  • Failure‑to‑file penalty: Generally 5% of the unpaid tax for each month or part of a month the return is late, up to a statutory maximum. There is also a minimum penalty for returns filed more than 60 days late (the exact dollar minimum is adjusted periodically by the IRS).
  • Failure‑to‑pay penalty: Typically 0.5% of the unpaid tax for each month or part of a month the tax is unpaid, also subject to a cap.
  • Other penalties: Trust fund recovery penalties, accuracy‑related penalties (e.g., 20% for substantial understatements), information return penalties, and payroll tax penalties have different rules and calculations.

Note: Exact dollar minimums and certain reduced rates can change annually. Always check the IRS penalty pages for the latest figures: https://www.irs.gov/penalties

Who is affected

  • Individual taxpayers who file late or pay late.
  • Businesses that miss payroll deposits, file late information returns, or underpay payroll taxes — they often face larger penalties or different statutory rules.

In my practice I’ve seen small misfilings become expensive because interest keeps compounding while a taxpayer waits to resolve the balance.

Common misconceptions

  • Myth: Fees stop once you enter a payment plan. Reality: Penalty fees may stop or be reduced in some agreements, but interest generally continues to accrue until the full balance is paid.
  • Myth: Penalty fees are always larger than interest. Reality: Depending on the delay and balance, interest can quickly add up and sometimes exceed fixed penalties.

How to reduce or remove charges

  • File on time even if you can’t pay the full amount — filing reduces the failure‑to‑file penalty.
  • Pay as much as you can immediately to reduce interest and penalty base.
  • Request an IRS payment plan — a streamlined installment agreement can limit penalties and make repayment manageable. See our guide on building a payment plan: How to Build a Successful IRS Payment Plan: Budgeting for Taxes.
  • Ask for penalty abatement if you have reasonable cause (medical emergency, natural disaster, etc.) or qualify for first‑time penalty relief. Learn how to request relief: How to Request Penalty Abatement from the IRS.
  • Consider professional help for large balances — a CPA or tax attorney can negotiate installment agreements, offers in compromise, or prepare a reasonable‑cause abatement request.

Practical checklist

  1. File any missing returns immediately.
  2. Pay what you can now; interest accrues daily.
  3. Set up a payment plan promptly to limit penalties and collections actions. (See our payment‑plan guide linked above.)
  4. If you believe you have reasonable cause, prepare documentation and submit an abatement request.

Final notes and disclaimer

This entry summarizes how the IRS commonly applies penalty interest and penalty fees. Laws, rates, and dollar minimums change; confirm current rates and rules at the IRS pages linked above before acting. This content is educational and not individualized tax advice — consult a qualified tax professional for guidance on your situation.