When Does the IRS Have to Pay Interest?

A common question that the IRS is often tasked with answering is - How is it that the IRS gets to charge interest on overdue taxes, but does not pay interest to taxpayers when they hold your refund?

Here is the easy response: They do it because they can. And because they have to, in order to encourage compliance with the tax law. That said, we know that does not satisfy the question in any judicious or sensible way.

However, it's not true that the IRS never pays interest. They do, under special circumstances.

Here is the legal response. Under § 6611 of Title 26 of the Internal Revenue Code, if a taxpayer files a claim for a credit or refund for any overpayment of tax imposed under this section, and if such overpayment is refunded within 45 days after such claim is filed, no interest shall be allowed.

By setting out this parameter, it also means that the IRS will pay interest on claims for refunds delayed by forty-five days or more. A claim for refund is made via a tax return filing; delays of more than forty-five days are subject to payable interest.

The source and timing of the delay has to be considered before you assume that the IRS will pay out interest.

By definition, the IRS has six to eight weeks to process a paper tax return that is mailed. Electronically filed tax returns are done within three weeks. A refund claimed by an amended tax return takes eight to twelve weeks. If forty-five days has passed beyond these given timeframes, then interest may be considered.

If the delay was caused by an incomplete or unprocessable tax return, no interest will be paid.

For example, if certain line items were left off of the return, if you failed to sign your tax return, or if you neglected to attach all required schedules and earning statements - All of these errors will delay your tax return but no interest will be paid, since the error was your own.

If there was another circumstance that resulted in a delay of an overpayment or refund, you also may be entitled to interest.

Again, the source of the error would need to be IRS error. For example, if the IRS incorrectly directly deposited your refund to a third-party's account, even though the correct account and routing number were on your tax return, then you may be owed interest.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. Under the same IRC section above, the overpayment rate is the sum of the federal short-term rate plus 3 percentage points. The IRS generally pays out interest around the four or five percent margin.

The IRS never pays interest on refunds that are from previous tax years if a taxpayer delays the filing of their tax return. By law, an individual has three years to make a claim for a refund; once that time passes, the refund is lost to the statute.

This does not mean however that an individual who knows they have a refund can wait until year two or three in order to file and expect that the IRS will grant interest. The IRS is not a bank, and taxpayers should not treat the government as such.

More from this Contributor:

5 facts about interest on unpaid taxes

An overview of the penalties and interest charged by the IRS

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