Quick answer

When you miss a filing or payment deadline the IRS typically assesses two separate types of charges: penalties (flat percentage rates applied monthly) and interest (a daily compounded rate based on the federal short‑term rate plus 3 percentage points). Penalties stack and can hit different maximums depending on whether you failed to file, failed to pay, or both. Interest is compounded daily and changes quarterly — the IRS posts current rates on its website (see: https://www.irs.gov/payments/penalties-and-interest and https://www.irs.gov/payments/interest-rates).

How the two charges differ and interact

  • Failure-to-file penalty: Generally 5% of the unpaid tax per month (or partial month) up to a maximum of 25%.
  • Failure-to-pay penalty: Generally 0.5% of the unpaid tax per month (or partial month) up to a maximum of 25%.
  • If both penalties apply in the same month, the failure-to-file penalty is reduced by the amount of the failure-to-pay penalty for that month (so the combined charge for that month is generally 5% – 0.5% = 4.5%).
  • Interest: Calculated on the unpaid tax amount plus any penalties, compounded daily. The rate equals the federal short‑term rate plus 3 percentage points and is adjusted quarterly.

(Official IRS guidance: see IRS Penalties and Interest: https://www.irs.gov/payments/penalties-and-interest and IRS Interest Rates: https://www.irs.gov/payments/interest-rates.)

Step-by-step: how the IRS calculates charges on an unpaid tax balance

  1. Determine the unpaid tax (principal). This is the tax shown on the return minus payments and credits received by the due date.
  2. Apply failure-to-file penalty (if applicable): 5% per month (or partial month) of the unpaid tax, up to 25%.
  3. Apply failure-to-pay penalty (if applicable): 0.5% per month (or partial month) of the unpaid tax, up to 25%.
  4. Compute interest daily on the unpaid tax plus accumulated penalties. The IRS compounds interest daily using the rate announced for the quarter.
  5. Add penalties and interest to the principal balance to get the total balance due; penalties and interest themselves accrue further interest until paid.

Formula examples (simplified):

  • Monthly failure-to-pay penalty = unpaid tax × 0.005 × number of months late (capped at 25% of tax)
  • Daily interest (approximate) = unpaid balance × [(1 + r/365)^(days late) − 1], where r = current annual IRS interest rate (federal short‑term rate + 3%).

Two short numeric examples (illustrative only — interest rates change)

Example A — small, short delay

  • Unpaid tax: $2,000
  • Months late (penalty): 3 months
  • Assume IRS interest rate (annual) for illustration = 6% (this is an example — see IRS for current quarterly rates)
    Penalties: $2,000 × 0.005 × 3 = $30
    Interest (approximate daily compounding for 90 days): $2,000 × [(1 + 0.06/365)^{90} − 1] ≈ $30
    Total roughly = $2,060

Example B — longer unpaid balance and an installment agreement

  • Unpaid tax: $10,000
  • 12 months late
  • Penalty without an agreement: $10,000 × 0.005 × 12 = $600 (note: capped at 25% over time)
  • Interest varies by quarter; over a year at 6% annually, interest ≈ $600 (compounded daily)
  • If placed on an IRS direct-debit installment agreement, the monthly failure-to-pay penalty is generally reduced (for the period covered by the agreement) to 0.25% per month — cutting the penalty cost roughly in half for that period (IRS: see payment-plan guidance).

Why my examples differ from other sources: interest fluctuates quarterly; the IRS posts current rates each quarter (https://www.irs.gov/payments/interest-rates). Use the IRS quarterly table to get precise numbers for your period.

Special rules and common exceptions

  • Minimum penalties for late filing: If you file very late (more than 60 days after the due date), the IRS imposes a minimum failure-to-file penalty that is a fixed dollar amount or 100% of the unpaid tax in extreme cases; the dollar minimum is adjusted periodically. Check the IRS penalties page for the current minimum.
  • Reduced failure-to-pay penalty under installment agreements: For taxpayers on approved installment agreements, the failure-to-pay penalty is typically reduced to 0.25% per month for the term of the agreement (confirm with the IRS for your plan details).
  • First-time penalty abatement (FTA): The IRS may waive penalties for taxpayers with a clean compliance history who meet the FTA criteria; this is discretionary and not automatic. It generally applies to certain penalties but not the accrued interest (interest is not abated).
  • Reasonable cause abatement: Penalties (but generally not interest) can be abated if you demonstrate reasonable cause — for example, serious illness, natural disaster, or other circumstances beyond your control. Documentation is essential.
  • Special penalties: There are additional, separate penalties (trust fund recovery, accuracy-related penalties, fraud penalties) that have different rates and rules and can far exceed the failure-to-pay/failure-to-file penalties.

(For details on abatements and reasonable cause see IRS penalty relief guidance: https://www.irs.gov/payments/penalties-and-interest.)

Practical strategies to limit penalty and interest costs (my field experience)

  1. File on time even if you cannot pay in full. Filing removes the much larger failure-to-file penalty and preserves refund eligibility if one exists.
  2. Pay as much as you can by the due date. Penalties and interest are calculated on the unpaid balance; reducing principal cuts both charges.
  3. Apply for an installment agreement promptly. In my practice I’ve found that many taxpayers lower monthly costs and reduce the monthly failure-to-pay penalty (IRS payment plans) by enrolling early. See FinHelp’s guidance on choosing plans: Choosing Between a Streamlined Installment Agreement and a Partial Payment Plan.
  4. Request penalty abatement when you have reasonable cause or qualify for first‑time abatement. Document events (hospital stays, business shutdowns, etc.) and follow IRS instructions for requesting relief.
  5. Consider an Offer in Compromise only if you can’t pay through reasonable means; it’s strictly for people who cannot pay their full tax liability within the statutory collection period.

For a focused look at how penalties and interest behave under different payment arrangements, see FinHelp’s primer: How Penalty and Interest Are Treated Under Different Payment Plans.

Common misconceptions (and reality)

  • Misconception: “If I ignore it, penalties stop.” Reality: Penalties and interest continue to grow until the debt is paid or the IRS agrees to an alternative resolution.
  • Misconception: “Penalties apply only to large balances.” Reality: Percentage penalties apply to any unpaid tax; small balances still accrue penalties and interest that can be meaningful for low-income taxpayers.
  • Misconception: “The IRS can’t collect after a long time.” Reality: The IRS generally has a 10-year collection statute from assessment, and during that period it can use liens, levies, and other collection tools. Some actions (bankruptcy, offers in compromise) can affect or suspend collection, but these are complex and fact-specific.

What to do right now if you have a late or unpaid tax bill

  • Confirm the balance and due date in any IRS notices or by using your IRS online account.
  • File any missing returns immediately to stop additional failure-to-file penalties.
  • Pay as much as you can; even partial payments lower interest and penalties.
  • Request a payment plan online or by phone if you cannot pay in full (see IRS Online Payment Agreement tools).
  • Keep written records of your communications with the IRS and note any payment plan terms.

When to contact a tax professional or advocate

Contact a CPA, enrolled agent, or tax attorney if your balance is large relative to your income, if the IRS has filed a lien or levy, or if you want to explore an Offer in Compromise or collection due-process hearing. In my practice I prioritize quick filing, negotiation of realistic installment agreements, and documentation that supports penalty relief requests.

Sources and further reading

Professional disclaimer: This article is educational and does not substitute for personalized tax advice. Tax rules change and the IRS updates rates and dollar thresholds periodically; consult a qualified tax professional or the IRS directly for guidance on your situation.