5 Facts About IRS Interest on Unpaid Taxes

Although the IRS is not a lender in the traditional sense of the word, they do charge penalty and interest on most unpaid tax balances.

For a detailed explanation of IRS penalties, see the article An Overview of Penalties Charged by the IRS.

Here are five facts about IRS interest charges:

1. Interest is compounded daily.

IRS interest is compounded, and the new amounts are assessed daily to the balance. By definition, compounded interest means that the amount is calculated based on both the principal (the tax and the assessed penalties) and the previously accrued interest. In other words, interest is assessed on interest.

The interest rate for the second quarter of 2011 is 4 percent. This does not mean however that the tax, penalty and interest get reassessed at 4 percent every day and added to the balance. If you have a $200 balance to the IRS, and assuming you filed the return timely, the amount of interest would increase each day by less than one dollar.

If you have a large individual balance, and if you did not file the return on time, then total penalty and interest charges could top 20 percent.

2. The interest rates are subject to quarterly changes.

According to Federal law, IRS interest rates are determined on a quarterly basis. Other than for corporations, interest is computed based on the federal short-term rate plus 3 percentage points.

Over the past few years, IRS interest rates have hovered around 4 to 6 percent. The highest interest rate charged over the last decade was 8 percent, from July of 2006 through the end of calendar year 2007. Interest rates dropped to 3 percent for the first quarter of 2011; this was the lowest rate since the 80s.

Beginning January 1, 1999, the interest rate the IRS pays on any overpayment of taxes, except for corporate taxes, is the same as the rate of interest they charge on the underpayment of taxes.

3. Interest is charged from the due date of the return, regardless of when the balance was assessed.

In most cases, interest is charged from the original due date of a tax return, not when a tax balance is assessed.
If a 1040 tax return is filed prior to the April 15 due date, and if that return is showing a balance due to the IRS, interest will start accruing on that balance shortly after the due date and will continue to charge the interest until full payment has been received.

If a return is filed late with a balance, interest will still be computed back to April 15, since that is the date the return should have been filed by.

If a Form 4868 is submitted, which, for the individual filer grants an automatic 6-month extension, interest will begin to accrue from the original April due date, not the October extension date. That's why the IRS makes clear that an extension to file is not an extension to pay; any potential tax due must be estimated and paid in by April 15th.

4. The IRS rarely pays out interest.

Some taxpayers mistakenly believe or feel that the IRS should pay them money for the time that the government supposedly held a refund, until the time a taxpayer makes a claim for their money. Not so.

Although a taxpayer has three years to file a tax return that demonstrates a refund before the refund is lost to the statute, this does not mean that an individual can wait until that three year period is close to expiring and then file a return to claim interest. The IRS is not a bank.

The IRS has standard handling times to process a tax return and administer a refund. For a paper return, this is approximately eight weeks. Electronically filed returns are closer to four weeks.

If the IRS made an error in the processing of your return, then they generally will pay you interest on the refund. If you owe on the tax return and a processing error occurs, there will be no interest reduced in your favor because the IRS will assess the interest based on the original received date.

If you discover that you made an error on your tax return, and if you amend your return to claim an additional refund, the IRS will pay you interest on the additional amount.

5. The IRS will not waive interest charges.

By law, the IRS cannot reduce or eliminate interest charges like they can with penalties. Certain penalties can be waived under what is called reasonable cause. An example of reasonable cause is the waiving of the Failure to File penalty due to loss of records in a fire or flood.

If a change has been made in the tax that you owe, then interest will be reduced and reassessed on the lower amount of tax.

More from this Contributor:

Make a mistake on your tax return? Here's what you need to know

What to do if the IRS intends on auditing you

7 things you didn't know about your federal tax refund