What Is the IRS Interest Rate for Payment Plans and Unpaid Taxes?

If you owe money to the IRS, you usually have to pay interest on the unpaid balance. This interest accrues until you pay off the entire tax debt, whether you have a payment plan or don’t pay off your tax bill on time. The exact interest rate changes several times a year and depends on macroeconomic factors. 

That being said, the interest rate most taxpayers have to deal with is the federal short-term rate (rounded to the nearest whole number) plus 3%. Let’s take a closer look at how IRS interest rates work for payment plans and other unpaid taxes. 

Interest on IRS Payment Plans and Tax Underpayments

If you owe money to the IRS where interest accrues (like with a payment plan), the interest you pay as of May 1, 2024, is 8%, with interest compounded daily. If the taxpayer is a C-corporation and there’s an underpayment of taxes that exceeds $100,000.00, then the interest rate is 10%. 

We get these numbers by taking 5% (this is the January 2024 federal short-term rate rounded to the nearest whole number) and then adding 3% or 5% (in the case of C-corporations with underpayment balances that exceed $100,000.00).

Current IRS Interest Rate Vs. Earlier Interest Rates

Compared to the past few years, there’s not been much change. But if we look at the IRS interest rate over several decades, we can see big differences. For example, the IRS interest rate has been as low as 3%, but as high as 22%. The reason for this variation is because the Federal Reserve sets certain interest rates that banks, other lenders, and the IRS use as a starting point for setting their own interest rates.

When the economy is growing rapidly, it often results in a rise in prices (inflation). To combat this, the Federal Reserve may raise interest rates. This makes it more expensive to borrow money, which is designed to slow down consumer buying. The hope is that this will reduce inflation.

If the economy is sluggish or contracting, the Federal Reserve might reduce interest rates. This makes it cheaper to borrow money which the Federal Reserve hopes will encourage people to borrow money and spend it. All of this means that when “times are tough,” the interest the IRS charges for unpaid taxes is more likely to be lower than when there’s a booming economy. 

Calculating Interest Based on Amount Due 

The IRS interest rate compounds daily. That means that interest is assessed to your account daily, and then, the next day, more interest compounds on the interest that has accrued. This cycle continues until you pay off the debt in full. 

Here’s an example of the interest you would pay after one year for a hypothetical amount of money owed to the IRS with the 8% interest compounded daily:

• If you owe $10,000.00, the interest for one year will be $832.78
• If you owe $50,000.00, the interest for one year will be $4,163.88
• If you owe $100,000.00, the interest for one year will be $8,327.76
• If you owe $250,000.00, the interest for one year will be $20,819.39

If the rate falls below 8%, the interest you pay for one year will be lower. If the rate goes higher, the interest will be higher. Also, as you make payments, you will reduce the principal (underlying tax debt), and thus, you will pay less in interest.

When Does Interest Start Accruing on Tax Debts? 

The IRS assesses interest on your account the very first day that you are late and haven’t paid off the entire tax debt. Interest will continue to accrue until you have paid off the balance. Even if you set up a payment plan, interest will continue to accrue on your account. 

The IRS doesn’t just charge you interest for unpaid taxes. If you overpay the IRS, you will also earn interest on the overpayment. To give you an example, imagine you file a tax return and you pay the amount due. A year later, you amend your return and you get a $1,000.00 refund. 

The IRS will pay you interest on the refund. The interest starts the day that the return was due or filed, and it continues until the IRS sends you the $1,000.00 refund plus interest.

Interest Rate for Corporate Vs. Individual Taxes 

As mentioned earlier, the IRS uses a different interest rate for different taxpayers. For individual income tax balances, the IRS uses an interest rate that comes from the federal short-term rate plus 3%. That applies both to underpayments and overpayments. 

If a corporation makes an overpayment, the rate is the federal short-term rate plus 2%. For overpayments of more than $10,000.00, this rate drops to the federal short-term rate plus 0.5%.

If a corporation has a large underpayment, the interest rate is the federal short-term rate plus 5%. Generally, the IRS will only accept payment plans from over a certain monetary threshold with businesses if the entity is out of business. This means that if you set up installment payments on a large corporate debt, your interest rate is likely to be 2 points higher than it would be for a payment plan on individual income tax.

Other Costs for an Installment Agreement or Payment Plan 

The interest rate is not the only cost you can incur when you set up a payment plan on your back taxes. The failure-to-pay penalty will also likely continue to accrue on your account while there’s a balance. This fee starts at 0.5% of the balance per month for each month (or part of the month) the balance goes unpaid. However, this penalty won’t exceed 25% of the unpaid tax amount.

This penalty will rise to 1% per month if you don’t pay your taxes within 10 days of receiving a notice from the IRS about its intent to place a levy on your property. However, if you have a payment plan with the IRS, the failure-to-pay penalty drops to 0.25% per month while you make payments.

In addition to interest and penalties, you may also need to pay fees to set up or make payments on your payment plan. For short-term payment plans (those lasting 180 days or less), there’s no fee to set it up, whether you do it by telephone, online, in-person, or by mail. For long-term payment plans (sometimes known as installment agreements), the setup fees are as follows:

• Direct debit payment plan set up online: $31.00
• Direct debit payment plan set up by mail, telephone, or in-person: $107.00
• Direct debit payment plan for qualified low-income taxpayers: $0.00
• Payment plan without direct debit set up online: $130.00
• Payment plan without direct debit set up by mail, telephone, or in-person: $225.00
•  Payment plan for qualified low-income taxpayers: $43.00 (this can be reimbursed under certain conditions).

You may also have to pay the following fees if you want to make changes to an existing payment plan:

•  Making changes to an installment agreement online: $10.00
• Making changes to your installment agreement by mail, telephone, or in person: $89.00
• Making changes online if you’re a qualified low-income taxpayer: $10.00 (this can be reimbursed under certain conditions)
• Making changes by mail, telephone, or in-person if you’re a qualified low-income taxpayer: $43.00 (this can be reimbursed under certain conditions)
• Making changes to an existing direct debit installment agreement if you’re a qualified low-income taxpayer: $0.00

When making a payment with a credit or debit card, you’ll need to pay a processing fee, which varies based on the processor used. The exact payment fees can be found on the IRS’ website, but generally, you can expect to pay a few dollars or up to about 2% of the payment amount. 

How to Calculate Your Monthly Payment With Interest 

When you apply for a payment plan, the application prompts you to calculate your minimum monthly payment by dividing your total balance by 72. That shows you how much you need to pay so that you pay off your debt in six years. If the collection statute expires sooner, you will need to adjust this number accordingly. For instance, if your debt expires in three years, you will divide the total balance by 36. 

If you want to account for interest, you should calculate the interest on your account for one year. Then, divide this number by 12. Let’s take a look at a hypothetical to help illustrate.

Imagine you’re an individual taxpayer who owes $20,000.00 to the IRS and you’ll pay this off over six years. The base monthly payment will be $277.78 ($20,000/72 months). Your annual interest (compounded daily) will be $1,665.55 (based on the current 8% interest rate), so your monthly interest will be approximately $138.80 (1,665.55/12 months). Add these two numbers together and you can expect a total monthly payment of roughly $416.58.

Keep in mind this is just an estimate because your total interest costs will be lower over time. This is because every time you make a payment, you’re reducing the principal (underlying unpaid tax balance) which reduces the interest. Despite being just an approximation, this is an easy calculation you can do to ensure that you have enough money to make your monthly payments, even when accounting for the interest. 

If you have a penalty, you can use the same process described above, but add the appropriate penalty percentage (0.25% for the failure-to-pay penalty when there’s a payment plan in place) to the IRS interest rate (8% as of May 2024). So instead of taking 8% of 20,000.00, you’d take 8.25% of $20,000.00 (which is $1,719.77). 

Ways to Reduce Penalties and Interest With the IRS 

Setting up a payment plan helps to minimize the penalties on your account. As indicated above, your failure-to-pay penalty will drop to 0.25% per month once you set up a payment plan. 

Additionally, you can ask to have the penalties abated. The IRS will typically agree to remove your penalties if this is the first time you have incurred penalties or if reasons out of your control caused you to pay or file late. This includes things like death, illness, and natural disaster. If the IRS removes penalties, it should also remove the interest that accrued on the penalties. 

Unfortunately, other than that, the IRS won’t remove interest from your account. Generally, the only way to get interest removed is to prove that you paid or filed late due to receiving incorrect written advice from the IRS. Keep your correspondence to make sure you have proof to back up these types of claims.

Alternatives to IRS Payment Plans 

If you have good credit, you may be able to get a loan to pay off your tax debt. If the loan has a lower interest rate than an IRS installment agreement or payment plan, you can save money in the long run. Alternatively, you can use a credit card to pay off your tax debt, but if the interest rate is higher, you will end up spending more in the long run. 

However, a higher interest rate is worth it for some people. If you pay off your tax debt, you don’t have to worry about the IRS issuing a federal tax lien or continuing to send letters and notices. Often, the IRS will issue a tax lien even if you set up a payment plan. Also, should you have to eventually declare bankruptcy, it’s usually easier to discharge a loan or credit card balance than a tax debt. 

IRS Interest Rate and Payment Plan FAQs

How does the IRS calculate interest on unpaid taxes?

The IRS adjusts the rate each quarter based on the federal short-term rate in the first month of the previous quarter. For instance, the IRS interest rate in the first quarter of the year is based on the fed rate from October of the previous year. The interest for the second quarter of the year is based on the federal funds rate from January.

Can I save money if I borrow money to pay off my tax bill?

It depends. If you can borrow money with an interest rate that’s lower than the applicable IRS interest rate, it might be worth looking into. For example, if you get a credit card offer with 0% interest for 18 months on any purchases made during a given time period, it’ll probably be cheaper to go with this option.

If you decide to go this route, you need to fully understand the terms of this offer and what happens when the offer ends. For instance, when this promotional period ends, the interest rate that applies to any remaining balance will almost assuredly be higher than whatever interest rate the IRS would charge you. You should expect this credit card’s interest rate to at least be double the IRS rate, if not triple.

Also, most offers like this will only last for six or 12 months. Even if you get more time with 0% interest, 18 months is far shorter than an IRS long-term payment plan or installment agreement. Finally, remember that you’ll need to pay a fee to a card processor to pay your taxes with a credit card. This will be smaller than the IRS interest, but it’s something to include in your calculations. 

Do I always have to pay the IRS interest for unpaid tax balances?

Usually, yes. In rare instances, you can ask the IRS to reduce or remove interest. This will typically occur if you can show that the tax balance or interest was the direct result of the IRS making a mistake, giving incorrect advice, or creating an unnecessary delay.

To ask for the IRS to reduce or remove interest, you can send them a signed letter explaining why you feel you’re entitled to the interest reduction or removal. Alternatively, you can complete IRS Form 843, Claim for Refund and Request for Abatement. If you submit this request and disagree with the IRS’ decision, you may appeal it. 

Get Help Dealing With the IRS and Minimize Interest Payments

If you’re like most taxpayers, interest will accrue anytime that you owe the IRS money. And the interest will accrue even after you set up a payment plan. However, by making payments, you can reduce the amount you pay in interest as you’ll be lowering the underlying balance and possibly lowering any applicable penalty interest charged.

If you feel like a payment plan or installment agreement isn’t enough to help you settle your tax debt with the IRS, you can consider other options, like an offer in compromise. The tax pros at the W Tax Group provide free consultations to help you explore this and other possibilities for resolving your tax issues with the IRS.