IRS Interest Rates: What Taxpayers Need to Know

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Staff Writer - Angela
October 24, 2018

IRS interest rates increased as of April 1, 2018. If you are making installment payments on a past-due tax balance, these new rates were assessed on a quarterly basis beginning the second quarter of this year.

What Are the New Interest Rates?

IRS interest rates are tied to the Federal Reserve interest rates, which have also increased over the past several years. The IRS uses the Reserve’s short-term interest rates rounded to the nearest percentage point, plus 3 percentage points. The updated interest rates are as follows:

  • 4% for corporate overpayments (2.5% of any balance portion exceeding $10,000)
  • 5% for individual overpayments
  • 5% for individual underpayments
  • 7% for corporate underpayments.

These rates compound daily and are assessed quarterly. According to the Motley Fool, an individual tax debt of $10,000 will accrue a daily interest of $1.37 until it is paid. If it takes you a year to pay the debt, you will ultimately pay the IRS $10,500.05.

Underpayment rates, which are updated each quarter, are published by the IRS.

What Other Fees and Penalties Are Charged?

The IRS interest rates on past-due taxes are assessed in addition to penalties for late payments. These include:

  • 0.5% per month for every month the tax is past due, up to a maximum 25% penalty
  • 5% per month for every month you fail to file your tax return, up to a maximum 25% penalty.

If you owe taxes and have not filed your return, you will only be charged the 5% monthly penalty, not 5.5%. If you have not filed your taxes but do not owe any money to the IRS for the return in question, you will not be penalized.

Although filing an extension gives you an additional six months to file your tax return, interest will continue to accrue during this time. However, you will not be charged penalties during this grace period.

If you can prove your failure to file or pay your return has a reasonable explanation, the IRS may agree to waive penalties. You’ll still be responsible for the interest, however.

You may not be penalized for a tax underpayment if:

  • The underpaid amount is less than $1,000
  • You did not owe taxes or received a refund last year
  • The underpaid amount is less than 10 percent of what you owe
  • You are retired
  • You are disabled
  • You are subject to other special circumstances, such as a natural disaster or a hurricane.

How Can I Avoid IRS Interest and Penalties?

When you get hired for a new job, your employer will require you to fill out IRS Form W-4. This information is used to determine the correct amount of withholdings. When you file your annual tax return, if the amount withheld exceeds your calculated tax liability, you’ll receive a refund from the IRS.

On the other hand, if the taxes withheld from your checks are insufficient to cover your tax liability, you’ll have to pay the balance. If you are unable to do so by the deadline, you will be required to pay penalties and interest as a percentage of the past-due balance amount.

If you are a freelancer, you must make estimated quarterly tax payments, which are typically based on the taxes assessed for the previous year. Failing to make these payments can also result in underpayment.

Assessing your tax liability before it is due is the best way to avoid underpaying the IRS. and getting hit with penalties and IRS interest rates. You can also submit a new W-4 to your employer to increase the amount of your withholdings, which may result in a refund when you file your tax return. Use the IRS withholdings calculator to determine the correct percentage of your salary to withhold.

What Happens When I Have a Tax Underpayment?

If you have underpaid your taxes, the IRS will send you Form 2210, which compares the total amount you owe to the amount withheld from your paychecks.

What Happens If I Overpay My Taxes?

When your withheld taxes exceed your tax liability, the IRS will send you a refund. If this is not received within 45 days of the tax deadline for that year, you may be eligible for 5% interest. This means if your refund is $500, the IRS will send you $525 if the refund is late.

The IRS may also pay interest if they assess and amend your return for a higher tax amount in error.

What If I Can’t Afford to Pay What I Owe the IRS?

If your tax bill is higher than you can afford to pay, you do have options. Paying as much as possible as soon as possible can help you minimize interest and penalties. Other steps you can take include:

  • If you think you’ll be able to pay the past-due amount within 120 days, you can file for an extension at no additional cost.
  • You can also apply for an installment agreement if you owe less than $50,000. File Form 9465 to request a monthly payment plan.
  • If you have a financial hardship and cannot pay your tax bill, you may qualify for an Offer in Compromise. With this route, the IRS agrees to settle your tax debt for only a small percentage of what you owe. You must meet certain eligibility requirements, however.

Because failure to file penalties are much more expensive than failure to pay penalties, it’s important to file your taxes even if you don’t think you’ll be able to pay what you owe. The IRS will attempt to collect your unpaid tax debt even if you don’t file a return. In extreme cases, a federal tax lien can be placed on your house, car, or other property. This means the IRS has a legal claim to your property until the taxes are paid in full. Liens can also be levied against bank accounts and future wages.

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