If you don't pay all the taxes you owe when they are due, you may owe penalties as well as interest on the outstanding balance. Likewise, if the IRS owes you a refund and doesn't pay it promptly, the agency adds interest to your refund once it's issued.
The amount of interest you'll owe or receive depends on current IRS interest rates.
What are IRS Interest Rates?
The IRS announces interest rates on underpayments and overpayments every quarter. These rates are based on the federal short-term rate, one of the Applicable Federal Rates published monthly by the IRS.
The underpayment and overpayment interest rate is the federal short-term rate plus three percentage points for individuals and businesses other than corporations. For corporations, the underpayment rate is the federal short-term rate plus three percentage points, and the overpayment rate is the federal short-term rate plus five percentage points. For corporate overpayments over $10,000, it's the federal short-term rate plus one-half of a percentage point.
What are the Current IRS Interest Rates?
So, for the fourth quarter of 2021, those rates are:
- 3% for overpayments (2% in the case of a corporation)
- 0.5% for the part of a corporate overpayment that exceeds $10,000
- 3% for underpayments
- 5% for large corporate underpayments (underpayments greater than $100,000)
These rates were announced in the IRS's Revenue Ruling 2021-17.
Receiving Interest for IRS Overpayments
Significantly overpaying your tax liability generally isn't the best move. Instead, most tax professionals recommend trying to estimate your tax liability just right. You don't want to write a big check at tax time and owe penalties. But you also don't want to receive a big refund because it's like giving the IRS an interest-free loan.
However, one group of taxpayers earns interest on their overpayments: people who file their tax returns on time but receive late refunds.
The IRS generally has 45 days from the date you filed your tax return or the date your return was due—whichever is later—to issue your refund. If the agency doesn't process your return and issue a refund within that timeframe, it owes you interest at a 3% rate.
What are IRS Penalties?
In addition to interest, you may owe penalties if you pay your taxes late or pay less than the required amount in estimated payments.
IRS penalties don't change as often as IRS interest rates. While the IRS charges a variety of penalties, the penalties for late payments and underpayments are as follows.
Failure to Pay Penalty
Whether you file your taxes on time or request an extension, the IRS requires you to pay the amount you owe by the tax filing deadline. If you don't pay by that date, the IRS can assess a Failure to Pay penalty.
This penalty is currently 0.5% of the tax you owe per month, capped at 25% of amount of tax due. The IRS will lower your Failure to Pay penalty to 0.25% if you set up an installment agreement.
Failure to Pay Proper Estimated Tax Penalty
The IRS requires taxpayers to pay taxes throughout the year as they earn or receive income—either through withholding or quarterly estimated tax payments. If you don't pay enough throughout the year, the IRS can charge a Failure to Pay Property Estimated Tax penalty.
The IRS determines this penalty by calculating how much you should have paid for each quarter. Then it multiplies the difference between what you should have paid and what you did pay by the effective interest rate applicable to that period. This means you may owe a penalty for one quarter and not the others.
Disputing IRS Penalties and Interest
The IRS uses penalties and interest to encourage taxpayers to follow the rules and pay their taxes on time, but it also provides options to have penalties and interest removed for those who qualify.
There are two main reasons the IRS might consider removing a penalty, also known as penalty abatement.
If you didn't file your return on time or pay the tax you owe due to extenuating circumstances, the IRS might agree to waive your penalties. Examples of reasonable cause include a natural disaster, house fire, serious illness, or the death of an immediate family member.
First-Time Penalty Abatement
If you normally pay your taxes on time, but the due date just slipped your mind, the IRS may be willing to grant you one-time penalty relief. To qualify, you must have filed all your tax returns, paid your outstanding balance or set up an installment agreement, and have no other penalties in the past three years.
To request penalty abatement, call the toll-free number on the IRS notice you received. Keep in mind that the IRS generally doesn't remove interest unless the interest charges stem from “an unreasonable error or delay." To dispute interest, you'll need to complete Form 843, Claim for Refund and Request for Abatement.
If you need help getting penalties or interest removed, work with a qualified tax professional. They can call the IRS or send a letter requesting that penalties and interest be reduced or removed on your behalf.