Understanding How the IRS Calculates Interest on Delinquent Taxes

How does the IRS calculate interest on delinquent taxes?

The IRS calculates interest on delinquent taxes using the federal short-term rate plus three percentage points (set quarterly under IRC §6621). Interest accrues and compounds daily from the original due date of the tax until the balance is paid in full, and it applies to tax, penalties, and previously assessed interest.

Brief overview

When you miss a federal tax payment, the Internal Revenue Service (IRS) charges interest on the unpaid balance. That interest is not simple interest — it compounds daily — and the rate is tied to the federal short-term rate that the Treasury sets, plus a statutory add-on. The daily compounding and quarterly rate resets mean interest can grow faster than many taxpayers expect.

How the IRS sets the interest rate (authoritative source)

  • The legal foundation for IRS interest rates is section 6621 of the Internal Revenue Code; the IRS publishes the actual rates quarterly on IRS.gov. See the IRS page “Interest Rates” for current and historical rates (IRS.gov). IRS – Interest Rates.
  • For most individual underpayments, the interest rate equals the federal short-term rate plus 3 percentage points. The IRS updates the federal short-term rate every quarter, so the effective interest charged can change during a multi-month delinquency.

(Inline source: IRS, “Interest Rates”, updated quarterly.)

How interest is calculated (step-by-step)

  1. Determine the unpaid principal balance: start with the tax shown on the return or assessed by the IRS, plus any assessed penalties and previously charged interest.
  2. Use the applicable interest rate for each day the balance is unpaid. The IRS rate is expressed as an annual percentage; interest is computed daily using rate/365.
  3. Apply daily compounding: each day’s interest is added to the balance, and the next day’s interest is calculated on the new balance.

Mathematically, a simple approximation for short periods is:

Daily interest = unpaid balance × (annual rate / 365)

Because the IRS compounds daily, a more accurate approach for longer periods uses the compounding formula, applying each day’s rate to the evolving balance.

Example (rounded for clarity):

  • Unpaid tax: $10,000
  • Annual interest rate: 5% (federal short-term 2% + 3)
  • Daily rate = 0.05 / 365 = 0.00013699

After 60 days (approximation using simple daily interest):

  • Interest ≈ $10,000 × 0.00013699 × 60 ≈ $82.20

Because of daily compounding the true amount will be marginally higher. The IRS computes interest for each day and will change the rate if the quarter changes during the period.

What items interest applies to

Interest charged by the IRS attaches to:

  • The unpaid tax balance shown on a return or assessed by the IRS.
  • Civil penalties (failure-to-pay, failure-to-file, accuracy-related) once those penalties are assessed. Interest compounds on these amounts.
  • Previously assessed interest (interest-on-interest).

Note: Filing an extension to file does not extend the due date to pay tax. Interest starts from the original due date (usually April 15 for individuals), not the extension date.

Penalties vs. interest — how they differ (and interact)

  • Interest is a charge for the time value of unpaid tax and compounds daily. It cannot be waived except in very limited circumstances.
  • Penalties are separate, usually calculated monthly as a percentage of unpaid tax. For example, the failure-to-pay penalty is generally 0.5% per month up to 25% of the unpaid tax, with a higher failure-to-file penalty if you do not file a return. (See IRS Topic 653 for details.)

Interest is calculated on the total unpaid amount, including penalties, so penalties can increase the base on which interest compounds. (IRS Topic 653 and the “Interest Rates” page explain these interactions.)

Rate changes and how they affect your balance

  • The IRS sets rates quarterly (January, April, July, October). If the applicable rate changes while you still owe tax, the IRS will compute interest using the rate in effect for each day of the delinquency.
  • Practically, this means a long delinquency that spans multiple quarters will be calculated with a blended effective rate across those quarters.

Who is affected

  • Individuals, estates, trusts, partnerships and corporations can all owe interest on unpaid federal tax balances. The applicable statutory add-on may differ for certain corporate situations, but most individual taxpayers should expect federal short-term rate + 3 percentage points for underpayments. Always check the IRS rate notices for exact applications to corporate or large corporate underpayments.

Real-world examples and one client case

Example A — Individual taxpayer:

  • $5,000 unpaid tax; quarterly rate (hypothetical) = short-term 1% + 3 = 4% annual
  • Daily rate = 0.04/365 ≈ 0.0001096
  • Interest after 6 months (~183 days) ≈ $5,000 × 0.0001096 × 183 ≈ $100 (approx.; compounding increases this slightly)

Client case (anonymized): In my practice I had a self-employed client who underestimated their estimated tax and left $7,500 unpaid. Over two months their interest and penalties pushed the balance to about $7,850. The combination of daily compounding and an assessed failure-to-pay penalty produced most of the increase.

Practical steps to limit interest charges

  1. Pay as much as you can as soon as possible. Interest is charged daily, so each dollar you remit lowers future interest.
  2. File on time even if you can’t pay. Filing avoids larger failure-to-file penalties and keeps options like offers in compromise and payment plans available.
  3. Apply for an installment agreement (payment plan) if you need time to pay. Interest continues to accrue while on an installment agreement, but penalties may be reduced or assessed differently. Contact the IRS or use the online agreement application. (See IRS Direct Debit installment agreements.)
  4. Consider short-term financing with a low interest rate only if the loan interest will be lower than IRS interest and penalty costs. Compare costs and factor in loan origination fees.
  5. If you have a reasonable cause (serious illness, natural disaster), you can request abatement of penalties; interest is rarely abated but interest abatement is possible in very limited, fact-specific cases. Keep documentation and consider professional help.

How to compute interest precisely (tools and resources)

  • The IRS calculates interest on its systems and will show accumulated interest on notices and bills. If you want to simulate a calculation, use the daily-rate approach and recompute for each day or quarter when the rate changes.
  • For faster accuracy, use the IRS’s notice details or consult a tax professional. Several tax software packages and calculators can reproduce the IRS method by applying daily compounding and quarterly rate changes.

Common mistakes taxpayers make

  • Assuming penalties are the only charge — interest often exceeds penalties over time.
  • Believing an extension to file extends the time to pay — it doesn’t.
  • Not checking quarterly interest rates — if rates rise, past unpaid amounts will accrue interest at the new rates for subsequent days.
  • Thinking interest can be negotiated away easily — the IRS rarely cancels interest; it’s statutory.

Related internal resources

For more background and next steps, see these FinHelp articles:

Frequently asked questions (brief)

  • Does an extension to file delay interest? No. Interest on unpaid tax starts on the original due date regardless of filing extensions (IRS guidance).
  • Can I appeal interest charges? You can appeal penalties with reasonable cause; interest generally cannot be appealed away unless there was an IRS error or a very limited statutory basis.
  • Will interest keep accruing during an installment agreement? Yes — interest continues while tax remains unpaid, although some penalty reductions may apply.

Final professional tips and disclaimer

In my experience as a CPA and CFP®, the fastest way to reduce IRS interest costs is to pay as much of the principal as possible as soon as you can, then set up a manageable payment plan for the remainder. Document any circumstances that might support a penalty abatement request and consult a tax professional for complex situations.

This article is educational and not personalized tax advice. For decisions that affect your taxes, consult a licensed tax professional or contact the IRS directly. Authoritative information is available on the IRS website: https://www.irs.gov/newsroom/interest-rates.

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