Federal tax law authorizes the Internal Revenue Service to charge and collect interest on the income taxes you fail to pay by the filing deadline for your return -- which for most individuals is April 15. The rate of interest the IRS charges on unpaid taxes is the same for all individual taxpayers. Since interest rates are established by the federal government, and available to the public, you can always calculate how much IRS interest will accrue in any given period.
When the IRS Charges Interest
In any year you fail to pay your entire income tax bill by the filing deadline, the IRS immediately starts charging your account interest on the amount you underpay. Interest continues to accrue until the tax is fully paid, regardless of how long it take you to pay it off. This can occur for a number of reasons, but commonly it’s the result of having an insufficient amount of tax withheld from your paycheck or, if self-employed, failing to make estimated tax payments. Obtaining an automatic extension of time to file doesn't stop IRS interest from accruing during the extension period as it only extends the time you have to file a return -- not for paying the tax.
Read More: IRS Imputed Interest Rules
Interest Rates Used by the IRS
The amount of interest the IRS can charge is governed by federal law. Under the Internal Revenue Code, the IRS calculates your interest rate by adding 3 percent to the federal short-term rate. This short-term rate is established by the Department of the Treasury on a quarterly basis -- meaning the interest rate can potentially increase or decrease every three months. The IRS continuously updates and publishes the interest rates it’s mandated to use, which you can apply to your unpaid tax balances to get an idea of how much interest the IRS will charge you.
Penalties on Tax Underpayments
Separate IRS penalties exist for underpaying your taxes and for failing to file a return, or filing late. These penalties are calculated on the amount of tax you owe but fail to pay by April 15. Penalty charges are in addition to, not in lieu of, the interest the IRS charges you on the unpaid tax balance. If you prepare a return that reports an amount due to the IRS but you don’t pay it off when filing the return, for example, you’ll start incurring a monthly late-payment penalty that’s equal to one-half of 1 percent of the unpaid tax . This occurs until you reach a zero balance or the maximum allowable penalty of 25 percent has been charged -- whichever comes first.
IRS Interest on Penalty Charges
When the IRS imposes a penalty, it’s treated as an addition to your outstanding tax balance. As a result, the IRS will calculate interest on the penalties as well as the original amount of past-due income taxes. In other words, as your outstanding balance with the IRS increases each month for penalties, the monthly interest will increase too.
- IRS.gov: Topic 653 – IRS Notices, Bills, Penalties and Interest Charges
- Cornell University Law School: Internal Revenue Code Sec. 6601
- IRS.gov: Interest Rates Remain the Same for the First Quarter of 2015
- Cornell University Law School: Internal Revenue Code Sec. 6621
- Cornell University Law School: Internal Revenue Code Sec. 6651
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.