How does the IRS calculate interest on late payments?
When you owe federal tax and don’t pay by the due date, the IRS starts charging interest on the unpaid balance the day after the tax is due and continues until the balance is paid in full (IRS: Interest Rates). The annual interest rate equals the federal short‑term rate plus 3 percentage points and is set quarterly by the IRS; interest compounds daily.
Key rules to remember
- Rate formula: federal short‑term rate + 3% (published quarterly by the IRS) (IRS: Interest Rates).
- Compounding: interest compounds daily; the IRS calculates interest on the daily balance.
- Start date: interest begins accruing the day after the tax due date, even if you filed for an extension to file (an extension to file is not an extension to pay).
- Applies to: unpaid income tax, certain penalties, and other balances owed to the IRS.
How the math works (practical formula)
- Daily rate = annualinterestrate / 365.
- Daily compounding factor over N days = (1 + daily_rate)^N.
- Accrued interest = startingbalance * ((1 + dailyrate)^N – 1).
Example: $5,000 unpaid at 7% annual interest for 30 days
- Daily rate = 0.07 / 365 ≈ 0.00019178.
- Factor = (1 + 0.00019178)^30 ≈ 1.005803.
- Interest ≈ $5,000 × (1.005803 − 1) ≈ $29.01.
This matches the IRS method of daily compounding and explains why small delays can still produce noticeable cost increases.
Penalties vs. interest
Interest is separate from penalties. Common penalties include the failure‑to‑file penalty and the failure‑to‑pay penalty. The failure‑to‑pay penalty is generally 0.5% per month (up to a maximum) but can be reduced to 0.25% per month once a taxpayer is in an approved installment agreement. Interest continues to accrue on both the unpaid tax and any assessed penalties (IRS: Penalties).
Who is affected
All taxpayers with unpaid federal tax balances—individuals and businesses—are subject to IRS interest. It applies regardless of whether you filed a timely return but underpaid or filed late and still owe tax.
Real‑world considerations from practice
In my work advising clients, the most common surprises are:
- Filing for an extension to file, then assuming payment is also extended. It isn’t—interest begins the day after the original due date.
- Underestimating daily compounding. Even modest annual rates create monthly growth when compounded daily.
Practical strategies to reduce interest costs
- Pay as much as possible by the due date. Any reduction in principal immediately reduces interest accrual.
- Use IRS online payment options for faster processing (electronic payments post quickly and reduce days interest accrues).
- If you can’t pay in full, apply for a payment plan right away. The IRS offers streamlined installment agreements and other options; setting up a plan can reduce failure‑to‑pay penalty rates to 0.25% per month for active agreements (IRS: Online Payment Agreement).
- Request short‑term relief or an extension to pay only in limited cases; the IRS may temporarily delay collection if you qualify as currently not collectible, but interest still accrues.
- Ask about penalty abatement for reasonable cause. While interest is rarely abated, penalties may be reduced or removed in qualifying situations—this indirectly lowers the total amount owed (see IRS guidance on penalty relief).
- Consider low‑cost financing only if the interest and fees on the loan are lower than the IRS rate and collection risks.
When to consult a professional
Consult a tax pro if your balance is large, if you receive IRS notices you don’t understand, or if you’re considering an Offer in Compromise or partial‑payment plan. These options have strict requirements and tradeoffs; professional help can preserve options and limit unnecessary cost.
Internal resources
- How to Build a Successful IRS Payment Plan: Budgeting for Taxes (finhelp.io) — practical guidance on creating a plan and budgeting for tax payments: https://finhelp.io/glossary/how-to-build-a-successful-irs-payment-plan-budgeting-for-taxes/
- When to Use Form 9465 vs. Form 433‑F for Payment Plans (finhelp.io) — explains which IRS forms and documentation the IRS uses for different payment agreement types: https://finhelp.io/glossary/when-to-use-form-9465-vs-form-433-f-for-payment-plans/
Authoritative sources
- IRS: Interest Rates — quarterly interest rates and explanation of the rate formula: https://www.irs.gov/interest-rates
- IRS: Online Payment Agreement — how to request an installment agreement and effects on penalties: https://www.irs.gov/payments/online-payment-agreement-application
- IRS: Penalties — overview of common penalties and possible relief: https://www.irs.gov/payments/penalties
Common mistakes to avoid
- Assuming an extension to file delays interest accrual. It does not.
- Paying only the minimum on an informal arrangement without a formal IRS agreement; interest continues to accrue on remaining balances.
- Ignoring IRS notices—interest and penalties can grow, and collection actions may follow.
FAQ (short answers)
- If I can’t pay, will interest stop? No — interest continues to accrue until you pay in full, although an approved installment agreement reduces certain penalties.
- Can I get interest abated? Interest is generally not abated; penalty abatement may be available for reasonable cause (IRS guidance).
Professional disclaimer
This content is educational only and does not replace personalized tax advice. Consult a qualified tax professional for guidance specific to your situation.
(Information current as of 2025; readers should confirm the current quarterly rates and rules at the IRS links above.)
